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Don’t be Fooled by Taper Talk

May 22, 2014 in Economics

By Steve H. Hanke

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Steve H. Hanke

Since last June, most thought the U.S. Federal Reserve’s so-called taper was just around the corner. Well, the Fed’s large-scale asset purchasers did finally begin to take action, but they did so later than most anticipated. It now appears that the door will close on the Fed’s massive asset purchase program late this year. With this in mind, talk has turned to another aspect of the taper — just when will the Fed start to increase the federal funds interest rate? It probably won’t be anytime soon. Yes, the massive distortions created by the Fed’s interest rate manipulations (read: carry trade, among others) will be with us for longer than most anticipate.

Why?

The U.S. is still in the midst of the Great Recession. Yes, there have been recent encouraging economic reports. But, the U.S. economy remains weak and vulnerable. Aggregate demand (measured by final sales to domestic purchasers) tells the tale (see the accompanying chart). The annual trend rate of growth in nominal aggregate demand has been 4.95% since 1987. At the depth of the Great Recession, that metric plunged to a negative annual rate of more than -4.0%. However, aggregate demand bounced back. Indeed, it almost reached the trend rate of growth in late 2011. But, since then, it has slumped to its current 2.86% annual rate. Remarkably, this is very close to the rate of growth in aggregate demand that prevailed during the recession of 1990-91 — the recession that probably cost President George H.W. Bush his bid for a second term.

The Fed will probably be forced to keep federal funds at the zero bound much longer than most think — perhaps well into 2016.”

Just why is the U.S. nominal aggregate demand so weak? It’s all about money. Money dominates. Before we jump to the current status of the money supply, we must ask, what’s the correct measure for the money supply?

To answer that question, we flash back to 1979, when Paul Volcker took the reins of the Federal Reserve System. The state of the economy was dreadful, with double-digit annual inflation running at 13.3%.

Chairman Volcker realized that money matters, and it didn’t take him long to make his move. On Saturday, 6 October 1979, he stunned the world with an unanticipated announcement. He proclaimed that he was going to put measures of the money supply on the Fed’s dashboard. For …read more

Source: OP-EDS

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