Federal Reserve Term Paper

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Federal Reserve

The key information in the January 14, 2004 Federal Reserve summary ranged from mildly encouraging to 'no change' as far as the economy was concerned. Virtually all areas were experiencing small amounts of employment growth, although there were pockets of decline as well. ("Beige Book," January 14, 2004)

In fact, retail sales were up a small amount, mainly because upscale retail stores were having a good season, although the lower end of the market was faring less well. ("Beige Book," January 14, 2004)

Layoffs and flat wages were a big part of the employment picture. The "Beige Book" reported:

Louis reported layoffs in the biotechnology, food, and tobacco industries. Petrochemical producers suffered from overcapacity in the Dallas district and continued to lay off workers in the Atlanta district. In addition, producers of paper goods in the Boston and Philadelphia districts reported some weakness. (January 14, 2004)

Housing starts were one of the few relatively strong points in the economy in many areas; however, it is likely that wasn't helped so much because people had lots of money to buy houses, but because loans were cheap although not as freewheeling, perhaps, as a year earlier. Commercial real estate was weak nationwide. ("Beige Book," January 14, 2004)

Airline travel was also partially weak, with diminished business travel being partly responsible. But travel for pleasure had picked up considerably, and several districts were reporting expectations of a good year. ("Beige Book," January 14, 2004)

With all the negatives contained in the report balanced by just a few positives, it is difficult to extract any key points that would lead to a decision by the Fed to raise, lower or maintain interest rates. If inflation is classically caused by too many dollars chasing too few goods, that's certainly not the case. Many districts continued to report excess industrial capacity. ("Beige Book," January 14, 2004) During such times, there is usually insufficient industrial capacity, so lowering interest rates to cause capital improvements at manufacturing facilities would be the normal action. However, there is already too much industrial capacity for the goods required; the lack of job expansion is probably partly to blame for that condition. It is difficult to see how the Fed can do anything except maintain the status quo. Lowering rates would not encourage anyone to build more factories if those already on the ground are idle. Raising them would have little effect since no one is investing or spending in large amounts to begin with.

Step Two: Looking at articles discussing just the U.S. economic situation, without relating it to global conditions, makes it possible to believe that the Fed will keep interest rates low forever, or the next best thing to forever. The Fed itself apparently said that it would leave rates low "for a considerable period."

There was some expectation of a rise in federal funds rates, and that made Wall Street nervous. Even though the expected rise -- and it wouldn't be soon -- would be from one percent to two percent, that would still raise the cost of corporate debt slightly which would decrease the value of the underlying stock. (Richards, 2004) The same thing would cause bond yields to be higher, and that would dampen the mortgage market, (Richards, 2004) one of the few markets with any pizzazz in the last Beige Book report. Since that is so -- one of the few positive spots in the domestic economy was housing -- it is less likely that the Fed will raise rates even as early as spring or summer, which is what Wall Street feared. (Richards, 2004) (Richards, 2004)

And then there's the possibility that some of the commentators have lost touch with reality. Knight Kiplinger, of the Kiplinger letter, spoke as if there really was an economic recovery that would actually create jobs in 2004, and then the Fed would have to raise rates to put the brakes on the inflation that would cause. He did say it would be to "dampen the inflationary effect of the U.S. dollar's slide relative to other global currencies," however. (Dinsmore, 2004) But that, too, is a point worth debating. It is not debatable that it matters, considering that few Americans seem to be traveling for business or pleasure (see comments on air travel, above). And corporations are exporting jobs to India and elsewhere and 'living on the economy,' so to speak, so who cares what the dollar is doing? In fact, using the value of Euros or rupees when the dollar is weak would fill corporate coffers nicely.

The tactics the Fed will use to control inflation probably won't change much from what the Fed has ever done. At the moment, the Fed would seem to be between a rock and a hard place. There is a problem with a weak dollar, and according to Richards, there is a problem with Wall Street worrying about something that hasn't happened yet and probably won't for a long time. Dinsmore's report suggests that any increase in the rates, in response to inflation or anything else, probably wouldn't happen later than August because of the upcoming presidential election. (2004) But they all seem to think it won't happen before. And besides, there is no inflation and unless the economy heats up with jobs and wage increases pretty quick, there's unlikely to be. It seems that the Fed ought to be doing something to curb deflation, instead. Kiplinger, living in Virginia Beach, is surrounded by currency being tossed at the military like confetti, and admits as much. (Dinsmore, 2004) But he still proposes that the economic problems are not due to the Bush tax cuts (bringing in less federal cash) and huge increases in military spending for a couple of wars, but to problems with corporate earnings. And yet, Richards says corporate earnings depend on keeping the rates low. Someone is out of step, and it looks like Kiplinger. If there is inflation, it will be due to trying to fill enormous hole created by digging into federal funds for war (among other things) and bringing in even less than ever by cutting taxes.

Step Three: It's hard to find anything Alan Greenspan said about interest rates following the January 14, 2004 Beige Book release. He seemed to be very busy refuting a quote attributed to him by former Secretary of the Treasury O'Neill in his new book. In short, Greenspan seemed to be too busy denying that he ever said anything about Bush's tax cuts being a bad idea to comment on inflation, although one writer did suggest that he was staying hidden because he didn't want to answer as to what he meant by the words used to predict that there wouldn't be much change in the interest rates for quite a while. (Richards, 2004) But the heads of the Federal Reserve districts did have lots to say about interest rates, and one can assume that their thinking reflects that of their boss.

For example, "The central bank's policy committee has said it will be able to stay on hold (with interest rates) for a 'considerable period' without sparking inflation despite strong growth." And that assumes strong growth; the Fed apparently isn't assuming that, since it bases growth on a good labor market. Kansas City Fed President Thomas Hoenig said that "December payrolls, with a gain of just 1,000 new jobs vs. expectations of 130,000, were disappointing." (Thieberger, 2004) This statement, and other like it from the other Fed presidents, does agree with my analysis. There is no inflation and until some movement happens in the economy caused by something, maintaining a low interest rate seems only prudent. Raising it could put the dampers on an economy that is already soggy, if not waterlogged.

Step Four: The most important…

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