The White House sends a wake-up call to the Fed

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Article Highlights

  • The White House is lowering its 2013 growth forecast, from 2.6% to 2.4% while assuming the sequester is ended

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  • Mortgage rates have jumped to above 4.5% for a 30-year loan, while market volatility has jumped

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  • The Fed appears to have given in to taper-scolds who claim that something awful will follow from QE

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  • These risky endeavors will give us a recession like the ones already underway in Europe and many emerging markets.

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  • By September, the most likely outcome for Fed policy will be an acknowledgement that the economy is slowing

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While the Fed appears to be busy preparing markets to "taper" QE as early as September, the White House is lowering its 2013 growth forecast , from 2.6% to 2.4% while assuming the dreaded sequester is ended. Perhaps Jason Furman, the new no-nonsense Council of Economic Advisers chairman wants to send a message by moving closer to the CBO's more tepid 2013 growth forecast of just 1.4%. The CBO number is looking closer to the truth with actual first half 2013 growth running close to its full year figure.

So what is the Fed thinking? Growth is slowing from last year's tepid 1.9% pace, inflation is falling - some measures are below 1% - and the unemployment rate is stuck at 7.6% while the U6 broader measure of unemployment jumped to a disconcerting 14.3% from 13.8% in May, notwithstanding the decent June employment rise of 195,000. Meanwhile, market fear of tapering has spiked interest rates. Mortgage rates have jumped more than a full percentage point, to above 4.5% for a 30-year loan, while market volatility has jumped. Both jeopardize the economic boost from the recovering housing sector.

The Fed appears to have given in to taper-scolds who claim that something awful - bubbles, inflation, higher interest rates - will follow from QE. Never mind that the opposite has happened as inflation falls while interest rates have jumped on talk of ending QE. Inflation-adjusted (real) interest rates have risen even more than surging market rates. Higher real rates jeopardize the housing and stock market recoveries - the pillars of the still-modest growth the US economy is managing. The Fed has burst the bond bubble, if there ever was one, and now they are going to work on alleged housing and stock bubbles. "Success" with these risky endeavors will give us a recession like the ones already underway in Europe and many emerging markets.

The White House is right to lower its growth forecast, if a little timid in the modest reduction. The sequester isn't going away, as the White House number assumes. With the sequester in place, the White House number would be very close to the CBO's near-stall-speed 1.4% growth figure. The Fed needs to lower its overly optimistic 2013 growth forecast of about 2.6% which assumes, given a first half growth rate of 1.4%, an unlikely surge to a 3.8% pace in the second half.

By September, the most likely outcome for Fed policy will be an acknowledgement that the economy is slowing while inflation keeps falling accompanied by an end to its disruptive and ill-timed Taper Talk. No surprise, as this reversal would mark the third time since the financial crisis of 2008 that the Fed has had to back away from hints of tightening tied to overly rosy forecasts.

Maybe Jason Furman would make a good Fed Chairman.

 

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About the Author

 

John H.
Makin
  • John H. Makin is a resident scholar at the American Enterprise Institute (AEI) where he studies the US economy, monetary policy, financial markets, corporate taxation and banking. He also studies and writes frequently about Japanese, Chinese and European economic issues.

    Makin has served as a consultant to the US Treasury Department, the Congressional Budget Office, and the International Monetary Fund. He spent twenty years on Wall Street as the chief economist, and later as a principal of Caxton Associates a trading and investment firm. Earlier, Makin taught economics at various universities including the University of Virginia. He has also been a scholar at the Bank of Japan, the Federal Reserve Bank of San Francisco, the Federal Bank of Chicago, and the National Bureau of Economic Research. A prolific writer, Makin is the author of numerous books and articles on financial, monetary, and fiscal policy. Makin also writes AEI's monthly Economic Outlook which pairs insightful research with current economic topics.

    Makin received his doctorate and master’s degree in economics from University of Chicago, and bachelor’s degree in economics from Trinity College.


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