Fed nerves will extend past Summers

According to Al Wojnilower, US growth will likely remain at 2 per cent for the next year or more. No wonder hardliner Larry Summers incited fears as potential head of the Fed.

This morning’s sharp rise in the Australian dollar against the US currency is not welcome news for the new government. But it is a reminder that the US has, so far, not responded as vigorously to quantitative easing as was expected. And so with Larry Summers no longer in the running to be US Federal Reserve Bank chief (Summers, one hawk down, September 16), quantitative easing may continue longer than many expected (Why the Fed's wind-back is not irreversible, September 16) – hence the fall in the US dollar.

To understand why the US suddenly became wary of the hardline Summers, the latest remarks of the veteran US economist Al Wojnilower are helpful.

Wojnilower says that for the next year and more, the US GDP seems likely to continue expanding at a sluggish 2 per cent, with employment, wage rates, profits, as well as inflation slowly increasing. The expansion, albeit slow, largely reflects the improved supply of credit, which includes faster growth in auto credit, lower interest rates and easier terms on home mortgages, as well as readily available governmental student loans.

All this stems, at least in part, from the massive purchases of Treasury and mortgage-backed securities by the Federal Reserve (QE), which has brought down long-term interest rates, and buoyed home and stock prices.

However, the recent upsurge in long-term interest rates, allegedly due to the projected ‘tapering’ in the Fed’s purchases, is already reducing mortgage refinancing (a significant source of funds for consumers) and home-building in the US, which have been mainstays in the economic upturn.

Meanwhile, offsetting QE, US Treasury borrowing has been shrinking under the weight of fiscal austerity. Some market participants were expecting a cresting of fiscal restraint, but Wojnilower says it is more likely that fiscal austerity will intensify, narrowing the deficit further. Additional sequestration is already in the law for next year and there will probably be a compromise involving further spending cuts in order to avert the impending debt-limit confrontation.

All this will affect employment hence the nervousness about stopping QE and the dumping of hawk Larry Summers as Federal Reserve chief.

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