No Need to Fear Inflation, Or Higher Interest Rates

Popular Economic Weekly

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Calculated Risk

The benchmark 10-year Treasury Bond Yield fell back to 3.11 percent today with the stock market selloff, down from as high as 3.22 percent last week. And Gross Domestic Product rose 3.5 percent in Q3’s first estimate last week, following 4.2 percent growth in Q2.

This has to be confounding Federal Reserve Governors, to say the least, that want to raise short term rates another 2 to 4 times (i.e., 0.5 to 1 percent) over the next year. But inflation is not rising, and the Fed’s primary job is to balance economic growth—i.e., maintain growth that is not too hot or too cold—to prevent our economy from overheating. So there’s no need to fear higher inflation, or interest rates.

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Graph: Econoday

In other words, the U.S. economy isn’t overheating. The US Bureau of Economic Analysis just reported that the Personal Consumption Expenditure Index of inflation has been basically flat for months; at 2.0 percent, right on the Fed’s inflation target.

So robust growth with little inflation is the Goldilocks economy we all yearn for, and the stock market should be applauding, not fearing. The Trump tariff and trade wars will do little to damage the growth of either US or China because it’s a small fraction of US trade—16 percent, or $636 billion—which is just 3.2 percent of US GDP. It is possible that Trump’s economic ignorance could cause China to withdraw more of their $1 trillion in Treasury holdings. But such an action would unsettle financial markets, as well as boosting interest rates and damaging the value of China’s own foreign reserves that bolster their over-extended banks.

There is also another reason for the Fed to keep its powder dry and not raise interest rates further at the moment. It turns out Q3 GDP growth doesn’t look so good under further examination, according to the Wall Street Journal and MarketWatch.

Real investment in Q3, said MarketWatch — “in housing, business structures, equipment, software and intellectual property —laid a giant egg, shrinking at a 0.3% rate in the worst performance in years. And a drop in exports led to a big deduction from growth, with fears of worse to come seeming entirely reasonable if Trump follows through on vows of 25 percent tariffs on $200 billion of Chinese exports to the U.S.”

But “If businesses plow money into new software and machines,” said WSJ, “it increases the chances worker productivity will rise, allowing the economy to grow faster without causing inflation. Stronger productivity would take pressure off the central bank to keep raising interest rates. Without follow-through on business investment, the U.S. could face a different outcome: less growth and more inflation that requires the Fed to keep pushing rates higher.”

The real problem is our national debt. A ballooning national debt takes money away from productive investments. Alas, there seems to be no will by either government or the private sector to invest substantially in worker productivity, which hastens the likelihood of another recession, rather than higher inflation.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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