While many investors are sitting back and hoping that the Fed may do more to stimulate us out of our current economic slowdown, the Fed may not see the need for any of this.
If we’re invested in stocks, as many people are, or even if we are just concerned generally with the state of the economy, we may be hoping that the Federal Reserve may go from not raising rates this year to putting them back down a little at least.
There’s little doubt that such a thing would breathe a little fire at least into the economy, by expanding the amount of credit out there and in turn increasing the money supply, which is expansionary.
If there is more borrowing, this money that is borrowed gets spent on things. This adds to the economy overall and produces bigger numbers. When this number grows, the stock market gets more optimistic and this tends to raise the trading price of stocks. The companies that we own stock with also get a break on their borrowing costs and this is also expansionary.
If the Fed’s main mission was to promote the growth of the stock market, there is no question that a rate cut would be a great idea right now. We could set up a pretty nice bull market in 2019 if we wanted to, and could just cut rates until we get the desired effect in fact.
That’s not what the Fed does though, and what it really is concerned with is keeping inflation under control. This mission isn’t even about growth rates primarily, although if inflation drops too low, that’s not a good thing either.
Ideally, we would have inflation in a low and tight range, like staying around 2%. That’s actually the goal of the Fed right now, and this is actually a pretty optimal level from an economics standpoint. The story of Goldilocks and the Three Bears comes to mind here, where we want inflation not too high, not too low, but just right, and 2% is just right at the present time anyway.
We often look to GDP though to try to decide this for them, as armchair members of the Fed Open Market Committee, but if we do that, we need to at least understand what this committee actually seeks to accomplish, to even be able to measure what needs to be done if anything and how well we are achieving these goals.
The Concerns About a Coming Recession Aren’t Supported by the Forecasts
Many are fearing a recession these days, even though we’re really not anywhere near the point where we can even say that this is forecast. These concerns are making their way into the stock market, where we see these fears manifest as sell-offs, albeit fairly modest ones thus far.
It is important to separate the impetuous concerns about this from the valid ones though, and when we do, everything that is out there right now does seem to be on the more impetuous side. The Fed tries not to be too impetuous themselves, and even though they are known to act out of haste sometimes, they at least are focused on the actual forecasts and not some nebulous feeling of an impending crisis coming on, seeing growth rates on the decline and not really looking at what we know about where this all may be headed over the next while.
Any intelligent discussion about what the Fed should do here needs to take inflation projections into account, simply because that’s what they do. Inflation came in at 1.9% in 2018, which is very close to the Fed’s goal of 2%, and certainly not something in need of any real adjustment.
On the other hand, GDP grew by 2.9% last year, and it is now projected to drop to around the 2% level and stay right around there for the next 3 years or so. Dropping from 2.9% to, say, 1.9% might not make investors all that happy, but from an economic standpoint, there is no real reason for concern if inflation remains stable over this time.
Things Look Very Good Right Now Already on this Front
The current forecast for inflation is as stable as we will ever see it, and stability is a real plus here, especially stability right around the ideal. Inflation in 2019 is predicted to be 1.8%, with 2020 and 2021 both coming in right at 2%.
Inflation has already been in a tight range over the last 4 years, with a low of 1.8% and a high of 2.1%, and while some are quick to criticize the Fed for acting to slow growth too much, they do know what they are doing, although we do need to judge them on the measuring stick that they actually use.
Growth rates are also projected to come in right around 2% for 2019, 2020, and 2021. This could even be described as simply fabulous, as long as we see this all come to pass. We shouldn’t be too surprised therefore to see the overall attitude of the Fed right now as wanting to stand pat as long as these projections hold up. If they do not, and inflation declines below this enough, then it may be time to step in and help.
This is a lot like having funds in reserve which you deploy when needed, but only when needed. The need here is not just to stimulate the stock market when it might need a little push, as the issues here are bigger than that, as we’re talking about managing the economy as a whole here. Proper inflation management is key to that.
This doesn’t mean that a rate cut isn’t part of the discussion at the Fed these days, but the focus isn’t that we need one now as much as the possibility that we may need one down the road if inflation declines more than we expect it too. Once again, this is not really about growth going down, it’s about inflation dropping, and they are related but not identical.
Kansas City Fed President Esther George weighed in on this issue on Wednesday, and is perfectly happy with how things are progressing, and is not at all concerned that inflation is too low right now. That’s because it really isn’t too low, it’s at a very nice level actually, one that the Fed would want to maintain indefinitely if possible.
The skies are actually pretty blue right now, although we still need to keep our eyes on the horizon and look for any and all approaching storms, although we do need to know what a storm looks like, and what’s going on now isn’t really one.