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The challenge facing the US Federal Reserve
Dennis Morrison
Wednesday, September 19, 2007
International financial markets are experiencing another round of turbulence as the effects of the crisis in the sub-prime mortgage business show up in more institutions. Given the interconnectedness of these markets, problems that arise first in US-based institutions quickly spread to entities in Europe and Asia. In short order, central banks in the different regions are forced to intervene to bring about some measure of stability.
Huge sums have been made available by these banks, primarily the European Central Bank [ECB], the Federal Reserve Board, the Bank of England and the Bank of Japan, as liquidity support in recent weeks. Yet the crisis is continuing, and indications are that the financial markets will face more difficulties in the short term. Some easing of monetary policy can therefore be expected or, put differently, further tightening of policy which was anticipated may be delayed.
The European Central Bank has already put off an interest rate increase because of the unsettled state of financial
markets, although it is concerned about inflation pressures.
In the USA, market watchers are predicting that the Federal Reserve will cut its key interest rate in a bid to lessen the fallout in the sub-prime mortgage market. This is being proposed because of the sharp reduction in activity in the housing market and the construction industry which have been drivers of the US economy in recent years.
While US exports have been showing substantial growth and the manufacturing sector has maintained a positive direction, these have not been sufficient to offset the depressing effect of the problems in the financial markets. Indeed, consumer sentiment has declined sharply, and this is reflected in the index of leading economic indicators.
Since consumer spending accounts for more than two-thirds of US economic activity, it is therefore understandable why there would be moves to shore up the financial markets. To allow a credit crunch to spread would be to further weaken consumer confidence to the point where a recession would be triggered.
But even as the fear of an economic recession appears to be uppermost in the minds of some policymakers in the USA, the importance of controlling inflation cannot be ignored. Thus the Federal Reserve must assess the risks associated with these two factors in its actions on monetary policy. This is moreso the case as there are real threats to price stability from the spike in oil prices.
Having slipped to the US$50s range in the early months of the year, oil prices have climbed sharply in recent weeks, breaking the US$80 level a few days ago. The all-pervasive effect of oil prices on other energy sources means that inflation pressure from this vital commodity should be monitored closely in coming weeks.
The fact that world oil consumption continues to rise even as US consumption is slackening adds to the complexity of policymaking. Before the advent of the China economic miracle, which is the primary factor driving most commodity markets, a slowdown in US economic activity would have been sufficient to cool demand for oil.
The effects of the combination of financial market turbulence and oil price pressures on the leading economies will determine the actions of policymakers in the near term. Because of the economic momentum of China and other emerging economies, particularly in Asia, the overall global situation is likely to be stronger.
But economies in Latin America and the Caribbean, which are heavily dependent on US markets, could feel the impact of a slower US economy more directly.
In Jamaica's case, we will have to be watchful of any spillover effect on the US travel industry. So far this year, stop-over visitor arrivals from that market have declined substantially because of the introduction of the passport requirement. This should be less of a problem in the coming months as the backlog of passport applications is now being reduced. Indeed, over 1.5 million passports are being issued per month.
The strength of the Canadian dollar and the euro could also offer some compensating positive effect on visitor arrivals from those markets. But the heavy dependence on the US market still means that special attention must be paid to that market at a time when the US economy is under pressure.
Dennis Morrison
Wednesday, September 19, 2007
International financial markets are experiencing another round of turbulence as the effects of the crisis in the sub-prime mortgage business show up in more institutions. Given the interconnectedness of these markets, problems that arise first in US-based institutions quickly spread to entities in Europe and Asia. In short order, central banks in the different regions are forced to intervene to bring about some measure of stability.
Huge sums have been made available by these banks, primarily the European Central Bank [ECB], the Federal Reserve Board, the Bank of England and the Bank of Japan, as liquidity support in recent weeks. Yet the crisis is continuing, and indications are that the financial markets will face more difficulties in the short term. Some easing of monetary policy can therefore be expected or, put differently, further tightening of policy which was anticipated may be delayed.
The European Central Bank has already put off an interest rate increase because of the unsettled state of financial
markets, although it is concerned about inflation pressures.
In the USA, market watchers are predicting that the Federal Reserve will cut its key interest rate in a bid to lessen the fallout in the sub-prime mortgage market. This is being proposed because of the sharp reduction in activity in the housing market and the construction industry which have been drivers of the US economy in recent years.
While US exports have been showing substantial growth and the manufacturing sector has maintained a positive direction, these have not been sufficient to offset the depressing effect of the problems in the financial markets. Indeed, consumer sentiment has declined sharply, and this is reflected in the index of leading economic indicators.
Since consumer spending accounts for more than two-thirds of US economic activity, it is therefore understandable why there would be moves to shore up the financial markets. To allow a credit crunch to spread would be to further weaken consumer confidence to the point where a recession would be triggered.
But even as the fear of an economic recession appears to be uppermost in the minds of some policymakers in the USA, the importance of controlling inflation cannot be ignored. Thus the Federal Reserve must assess the risks associated with these two factors in its actions on monetary policy. This is moreso the case as there are real threats to price stability from the spike in oil prices.
Having slipped to the US$50s range in the early months of the year, oil prices have climbed sharply in recent weeks, breaking the US$80 level a few days ago. The all-pervasive effect of oil prices on other energy sources means that inflation pressure from this vital commodity should be monitored closely in coming weeks.
The fact that world oil consumption continues to rise even as US consumption is slackening adds to the complexity of policymaking. Before the advent of the China economic miracle, which is the primary factor driving most commodity markets, a slowdown in US economic activity would have been sufficient to cool demand for oil.
The effects of the combination of financial market turbulence and oil price pressures on the leading economies will determine the actions of policymakers in the near term. Because of the economic momentum of China and other emerging economies, particularly in Asia, the overall global situation is likely to be stronger.
But economies in Latin America and the Caribbean, which are heavily dependent on US markets, could feel the impact of a slower US economy more directly.
In Jamaica's case, we will have to be watchful of any spillover effect on the US travel industry. So far this year, stop-over visitor arrivals from that market have declined substantially because of the introduction of the passport requirement. This should be less of a problem in the coming months as the backlog of passport applications is now being reduced. Indeed, over 1.5 million passports are being issued per month.
The strength of the Canadian dollar and the euro could also offer some compensating positive effect on visitor arrivals from those markets. But the heavy dependence on the US market still means that special attention must be paid to that market at a time when the US economy is under pressure.