US economy rests upon shaky ground
Opinion Column: Elsewhere in the World
Central banks throughout the world use different processes to control the flow of currency at domestic and international levels. The tools employed by central banks are defined broadly as instruments of monetary policy, and the term has become increasingly relevant in international news throughout the past several years.
Following the housing crisis and subsequent economic recession witnessed in the United States after 2008, the Federal Reserve Bank took many steps with the intention of maintaining its statutory objectives provided by the U.S. Congress. These objectives, known internally as the “dual mandate,” demand by law that the objectives of monetary policy conducted in the U.S. will ensure maximum employment and moderate long-term interest rates, ideally providing the economic foundations necessary to foster a strong economy with sustainable growth and inflation levels.
Historically, the Federal Reserve has succeeded in maintaining its goals, albeit with several instances of human error that represent significant deviations from the norm. For example, during the inflation spike of the late 1970s, then-Chairman of the Federal Reserve Paul Volcker raised baseline interest rates two-fold, resulting in immediately higher unemployment due to increased costs of business. While this was initially recognized as a detriment to the economic climate, Volcker made this move knowing that higher interest rates would curb dangerously high inflation levels, eventually bringing about a healthier market for employment and stable prices. Rest assured, the policy changes implemented by the Federal Reserve have profound effects on the economic climate of the United States, arguably more so than the policies implemented by even the president and Congress.
Since the end of the last major recession, business and economic media maintained a focus on the actions of central banks around the world, specifically in regard to the baseline interest rates maintained by these institutions. For the most part, the major reserve banks cut rates to the lowest levels ever recorded. Some, namely the Federal Reserve, even took the trend further by conducting large-scale asset purchases, a process known as quantitative easing to further catalyze investment in domestic and international equity markets. The idea behind this course of action is relatively simple: Lowering baseline rates decreases the cost of investing across the board, while large-scale asset purchases decreases the potential return on investment of government bonds significantly.
Combined, the end result is an artificially liquid market where investors are enticed, and in some ways forced to place their money in businesses as opposed to safer government bonds. While central banks around the world have certainly taken a pragmatic approach to addressing the slow recovery, their actions in the past several years are evidence of systemic issues in the global economy. Historical baseline rate levels show that even in times of recession and recovery, central banks will lower rates insofar that an effect is felt while maintaining a significant buffer from the zero mark in case of a further downturn. However, recently these same institutions lowered rates to what is essentially zero. Generally, the worry associated with the low interest rate levels implemented to combat the relevant economic headwinds is that growth would take off too quickly, pushing inflation up to uncomfortable levels. The current situation, however, is unprecedented in that even through the implementation of what is essentially the most accommodating monetary policy possible, major central banks throughout the world cannot even meet their inflation targets. All factors considered, the data suggests that the world economy is indeed sluggish, and the institutions tasked with catalyzing growth are hard-pressed to implement methods that will turn the tide of this trend.
Recent news certainly shows that the world economy is standing on uneven footing at best. Reports coming out of China indicating economic deceleration shocked international equity markets in the end of August, inflation projections are decreasing significantly across the board and the complexion of the Eurozone economy provided an ominous undertone to business news since the end of the mortgage crisis several years prior. While the casual observer in the United States may be able to ignore the gritty details due to a relatively strong dollar and labor market, it is of practical importance to be aware of what exactly is going on regarding international monetary policy. Ultimately, the biggest worry today is the risk of deflation, or falling prices that are essentially a theoretical guarantee of an economic recession, or worse. Given that the Federal Reserve is practically operating at its lowest rung and would be hard-pressed to provide further economic stimulation, then the casual observer would certainly be negatively affected by a further downturn.
Connor Siversky is a Rutgers Business School senior majoring in finance with a minor in math. His column, "Elsewhere in the World," runs on alternate Wednesdays.