Gone is the cycle-free 1990s economy in favour of a return to the business cycle
The US business cycle is dead. Or at least that's what a good number of economists believed up until a year ago, just before the stock market bubble burst and pulled new economy enthusiasts kicking and screaming back to reality.
The new economy wasn't a fantasy, just not the tectonic shift in the workings of economics and investment many thought was afoot.
Now the business cycle of old is back in play and, for that, we may have Alan Greenspan to thank.
The Fed has been reducing rates to save the economy from recession and the campaign has been the most aggressive of the Greenspan Fed; rather than moving in gradual quarter-point steps, it has been cutting by half-points. It has surprised markets by acting between scheduled FOMC meetings.
Did the Fed inadvertently kill the cycle-free Goldilocks economy of the 1990s?
'Interest rate changes have been accelerating at a dizzying pace,' says David Ranson, an economist at HC Wainwright & Co Economics in Boston.
'As a result, the economy is now going to swing from boom to bust and back again.'
In many ways, the 1990s resembled the 1960s for the US economy. To varying degrees, both periods boasted brisk growth, low inflation and significant equity market gains.
What set the 1960s and 1990s apart was the absence of the business cycle. Another common thread between the two episodes was a lack of Fed activism, Ranson points out. A coincidence?
In the six years between September 1992 and September 1998, the Fed altered short-term rates by a total of 400 basis points, resulting in an average of roughly 60 basis points per year. This period of relative Fed inactivity coincided with the longest and most prosperous US expansion on record.
The 1960s saw a similar period of passivity at the Fed. In the years since September 1998, the central bank has changed rates by 500 basis points, an average of 180 basis points per year. Coincidence or not, the first decade of the new millennium is beginning to look a lot like the boom and bust cycles of the 1970s and 1980s.
The result could be more cyclical economic growth and stock performance with lower growth and returns than in the 1960s and 1990s. Volatility is on the rise. Bonds yields have snapped up and down more violently than many of today's market professionals have seen before.
So have economists' predictions about the outlook for the economy. Earlier in the year, many forecasters thought the US would fall into recession, only to predict an economic rebound as the year unfolded. Today, many are stepping away from expectations for a return to solid growth and again looking for continued slow growth.
The Fed doesn't get all the blame for the volatility in interest rates. Some goes to the fact more households are investing on their own than ever before.
Some blame must go to the information arms race. Interest rates also are gyrating these days because few, including the brightest minds at the Fed, have any real sense of where the US economy is headed.
A convincing case can be made that activism on the part of the central bank gets most of the blame.
The Fed-created instability is raising eyebrows on Wall Street and bringing furrows to the brows of long-time Fed watchers. The central bank may add even more uncertainty in the years ahead.
An analogy for what's happening in the economy these days might be found in physics. It's the phenomenon of 'resonance,' and it's the reason why armies don't cross bridges in step. Resonance compounds an initial vibration with additional vibrations, which eventually may destabilize the bridge. In the same way, when the Fed's interest rate moves are transmitted to the economy, they can magnify its oscillations, precipitating an ever more volatile business cycle.
The Fed has little choice in the matter, some argue. With markets more efficient and information more plentiful than ever before, making monetary policy has become more complicated.
Part of the challenge is using an old, blunt instrument like the federal funds rate in modern times.
How does one influence an economy that's in some ways driven more by stock prices than interest rates?
The Greenspan Fed is running an ad hoc monetary policy, making it harder for market analysts and investors to sense where interest rates are headed. And that's a big reason for the rise in uncertainty in markets.
While no one believes the Fed has an easy job, US households and businesses are better served when the central bank fosters stable economic conditions, not volatile ones.
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