Federal Reserve Chairman Ben Bernanke and his ragtag team of economists on the Federal Open Market Committee (FOMC) decided to keep short-term interest rates steady at 2 percent once again, saying that "the substantial easing of monetary policy (over the past 10 months), combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth."
Unfortunately for the average U.S. consumer, Mr. Bernanke and the rest of the FOMC (except for dissenting member Richard Fisher) are apparently living in la-la land, as the significant cuts in the federal funds rate — from 5.25 percent last September to 2 percent today — have thus far failed to stimulate the economy in any meaningful way.
For example, the total output of goods and services in the United States (measured as gross domestic product) rose at a year-over-year rate of just 1.8 percent in inflation-adjusted terms during the second quarter of this year. That's compared to 2.5 percent during the first quarter. The decline is largely the result of a significant slowdown in consumer spending.
Worse yet, there's growing evidence that suggests the Fed's rate cuts will continue to fail to stimulate economic activity during the months ahead.
For example, long-term borrowing rates have risen sharply over the past few months (in spite of the Fed's cuts in short-term rates); household net worth has fallen during each of the past three quarters; and the unemployment rate rose during July to the highest level since March 2004.
Meanwhile, consumers remain highly in debt. Total household debt now accounts for approximately 23 percent of the average consumer's after-tax income.
Yet, Bernanke supposedly still believes that the substantial easing of monetary policy should help to promote moderate economic growth.
Amazing, truly amazing! Any 10th-grader could easily reason that his or her parents would cut back on their spending if they saw their net worth decline significantly; their debt grow high in relation to their income; and if they were in jeopardy of losing their jobs.
Unfortunately, the learned economists at the Federal Reserve don't seem to understand that paradigm.
Although the U.S. government's so-called economic stimulus plan (sending $110 billion in tax rebate checks to consumers) led to a modest increase in consumer spending during May, the significant increase in inflation over the past 10 months adversely affected consumers during June.
For example, consumers increased their spending during June at the slowest inflation-adjusted pace since October 2002, when the U.S. economy was coming out of a recession. It's easy to understand why: Their inflation-adjusted incomes fell 2.6 percent from the prior month.
Spending on durable goods, such as home appliances, automobiles, and consumer-electronic equipment fell 1.6 percent compared to both the prior month and the same period a year ago. On a year-over-year basis, consumers have reduced their spending on durable goods during each of the past four months.
As the effect of the recent tax rebates continues to wear off during the months ahead, and as inflation rates remain high, I expect consumers to continue to cut back on spending. That would be a very significant development because consumer spending accounts for approximately 70 percent of the total output of goods and services in the United States.
By the way, the big uptick in inflation, as well as the substantial decline in the exchange value of the U.S. dollar, began during September of last year, immediately after the Fed started lowering short-term interest rates and significantly increased the money supply.
In other words, the Fed has largely been responsible for the significant increase in inflation over the past 10 months.
Maybe, just maybe, Bernanke will soon realize that the only way to increase consumer spending is to decrease the money supply and raise short-term interest rates.
Doing so would likely lead to a surge in the value of the dollar and would further depress petroleum prices, given that oil is priced in dollars. In turn, consumer confidence regarding future economic conditions would likely improve. History has shown that consumers tend to spend more on discretionary items whenever their confidence in the economy improves substantially.
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