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Is the US Heading for an Economic Bust

December 24, 2015

Is the US Heading for an Economic Bust

On Wednesday December 16 2015 Federal Reserve Bank policy makers raised the federal funds rate target by 0.25% to 0.5% for the first time since December 2008. There is the possibility that the target could be lifted gradually to 1.25% by December next year.

Shostak-1

Fed policy makers have justified this increase on the view that the economy is strong enough and can stand on its own feet. “The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident the inflation will rise over the medium term to its 2 percent objective”, the Fed said in its policy statement.

Various key economic indicators such as industrial production don’t support this optimism. The yearly growth rate of production fell to minus 1.2% in November versus 4.5% in November last year.According to our model the yearly growth rate could fall to minus 3.4% by August.

Although the yearly growth rate of the CPI rose to 0.5% in November from 0.2% in October according to our model the CPI growth rate is likely to visibly weaken.

The yearly growth rate is forecast to fall to minus 0.1% by April before stabilizing at 0.1% by December next year.

So from this perspective Fed policy makers did not have much of a case to tighten their stance.

Shostak-2

Fed policy makers seem to be of the view that the almost zero federal funds rate and their massive monetary pumping has cured the economy, which now seems to be approaching a path of stable economic growth and price stability, so it is held.

On this way of thinking the role of monetary policy is to make sure that the economy is kept at the “correct path” over time.

Deviations from the “correct path”, it is held, occur on account of various shocks, which are often seen as of a mysterious nature. We suggest that the present Fed is following the footpath of Greenspan’s Fed, which was instrumental in setting in motion the 2008 economic crisis.

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