What can the Federal Reserve do to spur growth when in a liquidity trap?

Kamite

Banned
Aug 8, 2010
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With the economy heading into what looks like a double dip recession, it looks like the Federal Reserve is taking deflation more seriously. It is even a hot topic on Wall Street (http://www.nytimes.com/2010/08/06/b...tml?_r=1&scp=2&sq=Goldman Sachs Morgan&st=cse) with the pessimist kicking the optimist's ass. Anyway, what can the Fed really do here considering that it may be following Japan's lead of wasting money (we don't have) on a problem as intractable as deflation?

http://www.nytimes.com/2010/08/10/business/economy/10fed.html?hp

Fed Will Meet With Concerns on Deflation Rising
By SEWELL CHAN

WASHINGTON — The Federal Reserve will meet on Tuesday faced with a pivotal decision about whether to abandon its presumption that the economy is gradually picking up steam and begin to consider new steps to keep the recovery from sputtering out.
A string of developments, including the weak jobs report last Friday, has altered the sentiment within the central bank, leading Fed policy makers to stop worrying for the moment about the increasingly remote prospect of inflation. Instead, they are increasingly focused on the potential for the economy to slip into a deflationary spiral of declining demand, prices and wages.
Economists, including former Fed officials, say the central bank’s interest rate policy committee is likely, at the least, to acknowledge the slowdown in the recovery, and to discuss steps like reinvesting the proceeds from its huge mortgage-bond portfolio, which could help the economy by keeping more money in circulation.
Not since 2003 has the prospect of deflation been taken so seriously at the Fed, and not since the 2008 financial crisis have the markets been looking so closely to it for guidance. With Congress unwilling to embark on substantial new stimulus spending, the Fed has the only tools likely to be employed anytime soon in response to the economic warning signs.
The Fed’s chairman, Ben S. Bernanke, and other officials believe that the Fed, having lowered interest rates all the way to zero in 2008, still has the ability to avoid deflation. But they are also concerned that any new dose of monetary medicine could carry unintended side effects, making it harder to normalize policy in the future.
Complicating matters, a vocal minority of Fed officials is skeptical that deflation — a spiral of falling wages and prices, which Japan’s economy has experienced since the 1990s — is even a worry.
“The outcome of this meeting is more uncertain than in any in at least the last year,” said Laurence H. Meyer, a former Fed governor.
At the Fed’s last meeting, in June, the prospect of deflation was discussed for the first time this year.
Alan Greenspan, the Fed chairman for 18 years until he retired in 2006, said Friday that the economic outlook had darkened. “It strikes me as a pause in the recovery, but a pause in this type of recovery feels like a quasi-recession,” he said.
He added: “At this particular moment, disinflationary pressures are paramount. They will not last indefinitely.”
Mr. Greenspan said there had been “some evidence of a pickup in inflation” until the Greek debt crisis took hold in the spring. But the resulting uncertainty drove down long-term interest rates — the yield on the benchmark 10-year Treasury note fell to 2.82 percent on Friday, the lowest level since April 2009, and barely budged Monday — in a reflection of what Mr. Greenspan called continuing problems in the financial markets.
Mr. Greenspan declined to make recommendations or predictions for Fed policy, but on Wall Street, there is already talk that the Fed could begin a new round of quantitative easing — buying financial assets to hold down long-term interest rates and increase the supply of money.
Jan Hatzius, chief United States economist for Goldman Sachs, predicted on Friday that the Fed would begin a new round of asset purchases — which could include at least $1 trillion worth of Treasury securities — late this year or early next year. He revised down his forecast for the growth of gross domestic product in 2011 to 1.9 percent from 2.4 percent. He also predicted that unemployment would hit 10 percent in the second quarter of next year.
Among the voting members of the central bank’s policy-setting Federal Open Market Committee this year, the presidents of the Fed’s Boston and St. Louis district banks have warned recently about the threat of deflation, while the Kansas City bank president is known for his view that inflation, the Fed’s traditional enemy, remains the greatest threat. But it is Mr. Bernanke who holds the most say over the outcome.
Randall S. Kroszner, a former Fed governor, said the committee was certain to alter its outlook in its statement on Tuesday.
“I think the language will broadly change to acknowledge the moderation in the pace of the recovery,” he said.
Mr. Kroszner said it seemed increasingly likely that the Fed could announce that it would reinvest the cash it receives as the mortgage bonds it holds mature, rather than letting its balance sheet gradually shrink over time.
In March, the Fed completed its purchase of $1.25 trillion in mortgage-backed securities. A decision to reinvest the bond proceeds in other mortgage-related securities, or in Treasuries, would be largely symbolic but carry great weight, as it would signal concern about the economy, and also make clear that an “exit strategy” from easy monetary policy was not imminent.
The Fed might also be poised to discuss two other options: lowering the interest rate it pays on the roughly $1 trillion in reserves that banks are keeping at the Fed in excess of what they are required to, and altering the “extended period” language it has been using to describe how long short-term interest rates will remain at “exceptionally low” levels.
Frederic S. Mishkin, another former Fed governor, said that most recoveries hit speed bumps, and that economic indicators contained considerable statistical “noise.” He said the Fed would be prudent not to overreact.
“It’s not clear the Fed needs to ease at this point,” Mr. Mishkin said. “If the recovery gets back on track they are still going to have to worry about an exit strategy. Quantitative easing is not a trivial matter. The expansion of the balance sheet leads to many complications for the Federal Reserve.”
But Mr. Meyer, the former Fed govenor, said the committee should take into account not just the probability of various outcomes, but the potential damage associated with each of them.
“Because the cost of a slowdown in growth is so dramatic relative to that of higher inflation, they should follow the risk-management strategy that Greenspan espoused during the last deflation scare,” he said.
During that period, in 2002-3, the Fed kept interest rates low, as the economy recovered from the 2001 recession, to guard against deflation. Those fears did not come to pass. But some now say the Fed kept rates too low for too long, feeding the housing bubble.
“It is by no means a slam dunk,” Mr. Meyer said of the Fed’s decision.
 

child of wonder

Diamond Member
Aug 31, 2006
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We're entering a period where American consumers are starting to realize that they can't just spend themselves silly anymore. An increasing number of people are cutting back and trying to live simpler lives.

This is completely antithetical to our consumer driven economy.
 

Kamite

Banned
Aug 8, 2010
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We're entering a period where American consumers are starting to realize that they can't just spend themselves silly anymore. An increasing number of people are cutting back and trying to live simpler lives.

This is completely antithetical to our consumer driven economy.

I agree. I wonder how long until Washington realizes it? I mean, Obama said exactly that last year but continues policies as if 2008 never happened.
 

Moonbeam

Elite Member
Nov 24, 1999
73,794
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We're entering a period where American consumers are starting to realize that they can't just spend themselves silly anymore. An increasing number of people are cutting back and trying to live simpler lives.

This is completely antithetical to our consumer driven economy.

For years I have gone to the store to buy a few basic things and marveled at the thousands of products there I have never eaten or used and never will.
 

StageLeft

No Lifer
Sep 29, 2000
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For years I have gone to the store to buy a few basic things and marveled at the thousands of products there I have never eaten or used and never will.
And among those products you do use a veritable sh*tload of choices. Look at TVs. Or cars. Do we really need like 50 variations of sedans that people can choose from?
 

chucky2

Lifer
Dec 9, 1999
10,018
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I think the toothpaste and shampoo aisle at the average supermarket is a pretty good example of that. I mean, seriously, just how many different toothpastes are needed? Or shampoo's?

Chuck
 

StageLeft

No Lifer
Sep 29, 2000
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I think the toothpaste and shampoo aisle at the average supermarket is a pretty good example of that. I mean, seriously, just how many different toothpastes are needed? Or shampoo's?

Chuck
I respectfully disagree. I mean, some days I need honey extract in my hair but other days it needs melon. Others I have to go with almonds or papaya. All of these scientifically proven additives to shampoo have their place and time. And for my deodorant do I want cool breeze or ocean mist? What about surf dew?
 

Moonbeam

Elite Member
Nov 24, 1999
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And among those products you do use a veritable sh*tload of choices. Look at TVs. Or cars. Do we really need like 50 variations of sedans that people can choose from?

I think the people's car would be fine, a two cylinder that gets maybe 80mpg and runs for at least a half million miles in single commuter four seater family and cargo variations, pick up open and van enclosed.
 

First

Lifer
Jun 3, 2002
10,518
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Liquidity traps are most famously Japanese and their spending habits were/are extremely different from ours as was/are their labor mobility combined with xenophobic immigration policies. Spending habits alone are enough to assuage such fears of eternal 0 percent rates, but it has indeed been a long-time. If I had to bet I'd bet big on pent-up demand coming to fruition later this year.
 

Kamite

Banned
Aug 8, 2010
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Liquidity traps are most famously Japanese and their spending habits were/are extremely different from ours as was/are their labor mobility combined with xenophobic immigration policies. Spending habits alone are enough to assuage such fears of eternal 0 percent rates, but it has indeed been a long-time. If I had to bet I'd bet big on pent-up demand coming to fruition later this year.

What is your basis for this? Isn't December when we see massive layoffs?
 
Dec 30, 2004
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What is your basis for this? Isn't December when we see massive layoffs?

I don't see any basis for it either. People still too afraid of economy. Healthcare bill seriously affecting business owners next year-->businesses not hiring-->people afraid about economy.
 

totalnoob

Golden Member
Jul 17, 2009
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bernanke-hela379.jpg
 

BoberFett

Lifer
Oct 9, 1999
37,562
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Liquidity traps are most famously Japanese and their spending habits were/are extremely different from ours as was/are their labor mobility combined with xenophobic immigration policies. Spending habits alone are enough to assuage such fears of eternal 0 percent rates, but it has indeed been a long-time. If I had to bet I'd bet big on pent-up demand coming to fruition later this year.

Quoted.
 

StageLeft

No Lifer
Sep 29, 2000
70,150
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Liquidity traps are most famously Japanese and their spending habits were/are extremely different from ours as was/are their labor mobility combined with xenophobic immigration policies. Spending habits alone are enough to assuage such fears of eternal 0 percent rates, but it has indeed been a long-time. If I had to bet I'd bet big on pent-up demand coming to fruition later this year.
Pent up demand of what and from whom? American consumers remain as a whole extremely gun-shy and have little savings as a whole from which to pull from to spend on rubbish. And of those with savings chances are they have at least the first clue about life and thus also see 10%; unemployment and think twice about buying that new bedroom set.
 

StageLeft

No Lifer
Sep 29, 2000
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So today the fed says "The pace of recovery in output and employment has slowed in recent months". And let's remember the pace of recovery was a piece of sh*t anyway. GDP for first quarter revised down to fairly modest levels, Q2 even lower--when all is said and done it isn't likely to even be 2%.
 

sandorski

No Lifer
Oct 10, 1999
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The Fed doesn't have much room to do anything. It might become necessary for another Stimulus Bill.
 

Darwin333

Lifer
Dec 11, 2006
19,946
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We're entering a period where American consumers are starting to realize that they can't just spend themselves silly anymore. An increasing number of people are cutting back and trying to live simpler lives.

This is completely antithetical to our consumer driven economy.

I think you are half right.

A ton of consumers have also been cut off from their never ending credit. They can't use their houses as piggy banks anymore and with their CCs either already maxed or the interest rates sky high they simply don't have the ability to spend anymore borrowed money.

Those that CAN borrow don't want to and those that want to can't.