Popular Economics Weekly

Right now, the Federal Reserve seems to be the only government agency focused on growing the economy. Washington has otherwise been focused on the sequester agreement, or how to further cut government spending. But such austerity measures don’t grow economies, as the current European experience shows. Europe is in its second year of a repeat recession. Great Britain is in its third recession since its Conservative Party began its own austerity cuts.

That is why Fed Chairman Ben Bernanke’s testimony this week is so important. The Federal Reserve has to continue holding down interest rates for the foreseeable future. He has specifically said that the unemployment rate has to fall to 6.5 percent from its present 7.8 percent before the Fed will begin to raise interest rates.

It won’t be easy, as the so-called deficit hawks on the Fed’s Board of Governors have been sounding off on the dangers of inflation if the Fed keeps buying some $85 Billion per month in bonds and mortgage backed securities that are holding interest rates at historical lows. But there isn’t any inflation. There hasn’t been inflation since the busting of the housing bubble.

“We do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation,” he said in his prepared testimony.

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Graph: Econoday

Year-on-year, overall CPI inflation fell to 1.6 percent in January from 1.8 percent in December (seasonally adjusted). The core rate posted at 1.9 percent in January, matching December’s rate.  This isn’t incipient inflation. It’s incipient deflation, which depresses wages as well as prices. Incipient deflation—or disinflation in this case where pricing aren’t rising as fast—companies can’t raise their prices. So they can’t increase profits and hire more employees. It’s the simplest of equations lost on deficit hawks and those advocating an additional $85 Billion cut in sequester spending.

Housing seems to be the one sector outside of manufacturing that the Fed is having the most effect. Especially with new-home construction. New home sales surged in January, rising 16 percent to a 4-1/2-year high of 437,000, with all regions reporting increases. On a year over year basis, January sales are reported to have risen 29 percent, the same as the increase in single-family building permits over that period.

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Graph: Calculated Risk

And the Case-Shiller Home Price Index showed prices will continue to rise this year. Data through December 2012 reported that all three headline composites ended the year with strong gains. The national composite posted an increase of 7.3 percent for 2012. The 10- and 20-City Composites reported annual returns of 5.9 percent and 6.8 percent in 2012. In addition to the three composites, nineteen of the 20 MSAs posted positive year-over-year growth – only New York fell.

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Graph: Calculated Risk

“Home prices ended 2012 with solid gains, said David M. Blitzer, Chairman of the Index Committee at S&P Dow Jones Indices.

“Housing and residential construction led the economy in the 2012 fourth quarter. In December’s report all three headline composites and 19 of the 20 cities gained over their levels of a year ago. Month-over-month, 9 cities and both Composites posted positive monthly gains. Seasonally adjusted, there were no monthly declines across all 20 cities.”

So we have to thank Ben Bernanke for keeping his word. We also know from both the Japanese and European experience that austerity kills growth rather than boosting it. Europe is back in recession, while Japan just elected a pro-growth administration that wants to spend more to promote growth.

Harlan Green © 2013

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