It appears that key sections of the US Fed are uncertain about the monetary stance it should take for further stimulation of the US economy. Reading between the lines, these sections of the US Fed seem to be of the opinion that a Fiscal stimulus may be more appropriate to boost the US economy rather than further monetary easing as there is ample liquidity in the economy. Earlier, expectations that the US Fed would indulge in purchase of government paper suggested further monetary easing, which has led to the US dollar losing some of its value quite rapidly.
According to the Fed, the key mandate of a monetary authority is to manage the money supply of an economy while avoiding either a steep rise or a fall in prices. While a steep rise in prices can set in an inflationary spiral, a steep fall in prices can result in a contraction in the economy. Beyond a certain point, the monetary lever loses its efficacy to stimulate the economy by itself and fiscal interventions are required to lead the battle against recession.
According to the largest global bond fund, Pacific Investment Management Co, the US economy is likely to expand at the anemic rate of 1.75% in the next year, which might get further constrained, given the shape of things to come. As per the Dallas president of the US Fed, Richard Fisher, the US economy is operating at close to stall speed. Fisher is also of the view that further injections of money supply into the economy may not be of any benefit as the present liquidity in the economy is ample, but is not being appropriately utilized for the purpose of increasing investment and employment. Fisher believes that the industry needs to be given fiscal incentives to hire people. Only such incentives can help the industry take proactive steps and alongside also increase the off take of liquidity. The prevailing easy interest rates will assist the process. However, without a fiscal stimulus, the industry seems to be reluctant to increase hiring and production. Effectively, the vicious cycle of unemployment leading to lower incomes, resulting in subdued demand impacting industry adversely seems to be feeding itself and the way out of it has been eluding policy makers. Quite in tune with this, the nonfarm payroll in September dropped by a more than expected 95000. The unemployment rate also stayed at a flat 9.6%.
Fisher has also evinced his concern that cheap money may be going overseas into speculative investments and fiscal incentives to enhance employment could help contain this outflow of capital and put it to a more productive use. Such flight of capital from the US can also lead to asset bubbles in other parts of the world and can lead to more damage to the global economy, which is still struggling to move forward. The latest move by China to raise interest rates is indicative of the lurking fear of creation of asset bubbles. The other high growth economy of India has already raised interest rates recently.
It is time for the US Fed to take a calculated decision on its monetary policy stance such that the situation remains under control, within the US and in the rest of the world as well.
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