Do US rates need to fall again?

What do we have here, the Fed has lowered growth and inflation forecasts, Freddie Mac (a US based mortgage finance company – think subprime mortgages) suffered record losses, Citibank and Bank of America struggle with credit concerns, and the MIT real estate center recorded a fall in commercial property prices (and the first fall in commercial property values since 2003). On the back of this, the Fed feels the decision to cut rates again is on a knife-edge, with market sentiment pointing to a fall.

In the face of this we have economics idol Paul Samuelson saying that the US economy is in for a hammering, while the price of oil has gone through the roof. So what do we think is going to happen?

Markets are scared, there is no doubt. However, consumption activity has been strong, the low exchange rate will be a boon to the (minority) section of the economy that is involved in exports, and even with the Dow down towards 13000 household wealth is elevated. Furthermore, and most importantly, the labour market remains strong – people are still in jobs. Fed forecasts of 1.8% growth is not bad, given its during a downturn over 2008. It is also important to remember that these new forecasts are not as sudden and new as they seem – they were used as part of the previous cash rate review, before the September quarters strong GDP result. The only reason they have appeared now is because they were part of the minutes for the October cash rate review meeting.

All in all, the US economy might suffer a slowdown, but the situation is far from dire.

Update: The professor at Econbrowser gives a good summary of the Fed revisions. He manages to link the revisions to possible rate hikes, which I find interesting.

  • Kimble

    The falling dollar makes domestic labour appear cheaper, yet we have seen a period of massive growth in out-sourcing. Once the dollar starts to rise, wouldnt outsourcing increase even more?

  • Matt Nolan

    I see outsourcing more as a long-term activity by firms than a short-term activity. In order to receive the same labour input from a different place in the world requires significant capital investment, its not something firms can suddenly do because of the value of the dollar. As a result, the decision on outsourcing will depend on what firms see the long-term value of the dollar as. If this is just a temporary devaluation in the US dollar then firms will look past it for these sorts of long-term decisions.

  • Kimble

    Mmmm, I reckon the long term estimates of the level of the dollar can be heavily influenced by the current level.

    Still, ex-US labour is still cheap even at the dollars record lows, but as the dollar increases the number of firms now viewing it as a sellable strategy to The Board would increase.

    Also, most of the costs usually born by the first movers in outsourcing would have been covered already. (As more companies do it, the easier it is for companies following them.) Systems have been set up in China and India to specifically train people to be out-sourced workers.

  • Matt Nolan

    “long term estimates of the level of the dollar can be heavily influenced by the current level”

    🙂 Bloody economists. They go on about the short-run then their estimates fly around everywhere. I agree that fluctuations can have a disproportionate impact on what people see as the medium term level of the exchange rate, but the long-term level should be based on fundamentals.

    For example, the $NZ/$US should be about 0.65 in my mind if the long term interest rate differential and the higher food prices hold up (structural issues). However, in the medium term (next 3 years say) I can see us staying in the 70s.

    I agree that ex-US labour is cheaper. But ex-US labour will still be cheaper for a while, the trend of increasing outsourcing will continue irrespective of the exchange rate methinks. I agree that there are systems in place, but like you were saying ex-US labour is cheaper, so firms would be using that if there wasn’t capacity bottlenecks in the way, that is where continued infrastructural investment will be required.

    As a result, the change in the exchange rate should not matter, as overseas labour is currently significantly cheaper, even at this low rate of the dollar. Outsourcing will only increase if US companies can manage to increase there facilities overseas – this will depend on credit markets.

    I expect outsourcing to happen, it part of globalisation. If we had freer international labour markets, more of the labour might move to the US, rather than the current state of heavy offshore investment. There is nothing wrong with outsourcing. Workers in developed nations have had a monopoly position on specific jobs for a long time, and no-one likes monopolies.

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