December 14, 2000

On Tuesday, the Federal Reserve will complete its last open market committee meeting of this year. The general consensus is that they will issue a statement suggesting that they are equally concerned about inflation and a weakening economy. Therefore, the Federal Reserve will make no change in interest rate targets at this time.

I think the Federal Reserve needs to be more aggressive in fighting a slowing economy than that.

First, the risk of inflation remains modest. In the first eleven months of 1999, the inflation rate excluding food and energy grew 0.8 percent. The comparable period of this year shows a gain of 1.0 percent. These differences are too small to indicate any rise in inflation.

To be sure, energy prices have soared. However, these price gains created from supply problems have not flowed into other parts of the economy.

Second, money growth remains modest. The combination of currency, checkable deposits, and money market funds has expanded at a 6.4 percent rate in the past 13 weeks. While there might be a slight inflationary tilt to these numbers, growth in October and November has been less than 4 percent at annual rates.

At the same time, bank loan officers are reporting increasing credit restraint. While few corporations have been denied bank credit, expansion of bank lines is not readily available. As a result, some corporate expansion plans have been shaved.

Of greater concern is the access of new equity capital for new ventures. In 1999, the new economy created 750,000 new jobs. This year, the gains may have been less than 400,000 new jobs in that sector. In the last few months, the job growth has slowed further to a rate of only 15,000 per month, as layoffs in internet companies are now approaching 7000 per month.

In short, there is little inflation but increasing strain in obtaining credit.

At the same time, the consumer has stopped spending. Auto sales in November showed a dramatic 2.2 percent drop from the prior month. Department store sales were up only 0.2 percent, despite more days between Thanksgiving and the end of the month than in previous years.

Furthermore, there is little evidence that spending is rebounding in December. Following the post Thanksgiving weekend, when promotions attracted customers, sales have been surprisingly soft. Consumer electronics are behind previous year levels, computer sales are falling, and auto sales remain weak. If these trends are not reversed as Christmas approaches, consumer expenditures may be growing less than 2 percent at annual rates for the quarter.

Fixed investment also appears to be growing much more slowly than the 20 percent gains early this year. Investment in inventory is beginning to slow, but sales are slowing faster. As a result, production probably will be slashed further in consumer durables early in the new year.

At the same time, a strong dollar has stopped the growth in American exports. Imports, however, continue to grow.

Even with a rebound in government spending, which might be slowed by bad weather in the Midwest, it appears that economic activity will expand only about 2.5 percent for the fourth quarter. Furthermore, inventory adjustments suggest that growth of 2 percent or less is very possible for the first quarter.

While employment continues to grow, the gains have been less than 100,000 per month in the past three months. High initial unemployment claims suggest that another month of less than 100,000 job gains in likely in December. Because the labor force tends to expand by about 150,000 per month, this means that unemployment will gradually drift upward in the next several months.

With no inflation outside energy (and some medical bills) in sight and with surprisingly rapidly deterioration in consumer support for this economy, the Federal Reserve needs to turn its attention to the magnitude of this slowing.

Indeed, if the Federal Reserve does not shift policy toward lower interest rate targets soon, consumer confidence could deteriorate further. While I still do not believe a recession will start next year, I can see how one might start. Consumers could be so concerned about job security, that they build their purchasing power.

This would leave even more goods on the shelf. Production cutbacks would then intensify, leading to even more consumer concerns. When a recession no longer is unthinkable, it is time for the Federal Reserve to begin to think about stimulating this economy.


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