An Ill Timed Call for Fed Tightening
Letter to the Editor

Sir, Raghuram Rajan's call for Federal Reserve tightening could hardly be more ill-timed ("Bernanke must end the era of ultra-low rates", July 29), since it comes at the very time of the increased risk of a double-dip US economic recession and of no more room for fiscal policy easing.

Sadly, the US economic recovery currently faces a number of strong headwinds that make a relapse into recession all too likely as the strong support that US economic growth has been receiving to date from the fiscal stimulus and the inventory cycle now fades. The most serious of these headwinds is the appalling state of the US labour market, which is now weighing heavily on income growth. Further weighing on the US economy are the ongoing foreclosure crisis, prospective cuts in state spending, and the ongoing commercial real estate market bust.

A marked economic slowdown at this juncture must raise deflationary fears, since it would exacerbate the extraordinarily large labour and product market gaps that currently characterise the US economy. Already over the past six months, US core consumer price inflation has decelerated to an annualised rate of barely 0.6 per cent, or the slowest rate in the past 50 years.

If Japan's experience with deflation offers any guide, one must expect that allowing deflation to take hold in the US would highly complicate the prospects for a renewed meaningful US economic recovery. It would do so by increasing the real cost of borrowing, by inducing consumers to defer spending, and by increasing the real debt burden of households and corporations. A Fed tightening at this juncture would only exacerbate these tendencies.

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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