Weighing the Risks to the Economic Outlook
September 3, 2019
Federal Reserve and Monetary Policy Today
Stonehill College Meehan School of Business
- Takeaway: It was an eventful August in the financial markets amid talk of additional tariffs and tax cuts, the falling 10-year Treasury rate, and volatility in stock prices. But the economic data and forecasts indicate a relatively good domestic economy.
Excerpt: “Despite these headline-grabbing swings in financial conditions, domestic economic conditions have remained relatively benign.
- The economy grew by 2 percent in the second quarter.
- The unemployment rate reached nearly a 50-year low of 3.6 percent in April and currently stands at 3.7 percent.
- Inflation, as measured by the PCE price index, is running below the Federal Reserve’s 2 percent target.”
- Takeaway: The financial market gyrations – during a time of relatively strong U.S. economic conditions – seem to be explained by increased concerns about risks for the U.S. economy from international trade disruptions and other geopolitical situations.
Excerpt: “Potential trade disruptions are emerging at a time when many U.S. trading partners are facing mounting economic challenges. … China is heavily reliant on trade, so trade restrictions will take a bite out of the country’s economic activity. … Japan, South Korea, and many European economies are even more dependent on trade than the U.S., and face a number of unusual challenges of their own.”
- Takeaway: An inverted yield curve – when long-term yields fall below short-term yields – is often seen to portend an economic downturn. But this view is not being echoed in equity markets, bond spreads, or economic forecasts. And this time, the inversion is being driven by the decline in longer-term rates, rather than policy actions to raise short-term rates.
Excerpt: “An alternative explanation is that the inverted yield curve reflects challenging economic conditions in other countries … This provides an incentive for foreign investors to buy U.S. government securities. … But such an increase in demand pushes the price of U.S. securities up, and yields down.”
- Takeaway: Policymakers shouldn’t be overconfident the economy will be just fine or that an economic downturn is inevitable. The data bear watching closely for signs of risks materializing, to determine if any policy adjustments are necessary to achieve the Fed’s mandate.
Excerpt: Should those risks materialize, and threaten the U.S. outlook, then “the appropriate monetary policy would be to ease aggressively. However, to date, these elevated risks have not become reality, at least for the U.S. economy.”
- Takeaway: Economic forecasts and the underlying data are consistent with a U.S. economy growing slightly above its potential rate. Continued strong consumption is key to that outlook – and has been offsetting weaknesses in other components of GDP.
Excerpt: “If the consumer continues to spend, and global conditions do not deteriorate further, the economy is likely to grow around 2 percent, in part because the underpinnings of consumption growth – household income growth and household wealth – remain strong, and consumption accounts for about 70 percent of GDP in the U.S.”