Primary Global Economic Risks
The Federal Reserve Board (Fed) has three primary objectives: 1) maximize employment, 2) stabilize prices, and 3) moderate long-term interest rates. In general terms, the Fed is currently achieving its goals, though it may do so only in the very short-run without a revised approach. Around the corner, two significant, overall risks may face the U.S. economy: 1) stagflation and 2) the ongoing fall of asset prices. Regarding stagflation: with interest rates (short and long-term) hovering at historical lows the past 7 years (2009-2015), stagflation could now result from a marketplace saturated with cheap credit, where goods have been overbought (pushing prices higher), and spending slows - all the while underemployment continues at a rate of approximately 14% (Statista, 2016). Regarding falling asset prices: the dollar's strengthening over the past 2 years (2014-2015) means dollar-based holdings stand to move substantially lower over the next few years. Importantly, this dollar-based adjustment would magnify any cyclical correction already in effect from the past 7 years of stock and bond price increases.
Monetary Policy to manage short-term risks – a flexible approach
To revise its current approach, here are a few monetary policy considerations for the Fed in the short-run:
Slowing dollar appreciation – this helps exports and, in turn, domestic employment. It also counteracts inflation, one of the core characteristics of stagflation.
Maintaining a healthy balance of trade – if the dollar’s appreciation is moderated or even leveled, a “normal” trade balance is more achievable. The U.S. will continue to be a service and consumption economy so trade imbalances will continue; however, they can be improved upon through healthy dollar pricing.
Monitoring credit markets for liquidity – The Fed has already injected around $13 trillion of cash into the economic system in the U.S through its QE programs. Now liquidity must be managed to achieve goals #1 and #2 above, and to ensure the distribution of credit in the U.S.’ service and consumption economy.
Adjusting short-term rates upward slowly and steadily – The dollar will have its down quarters. When it does, a slight and steady upward bump in short-term interest rates can maintain a normal yield curve but return cash yields to a historically more normal range. Under this approach, it could take years to move the Fed Funds rate to 2-3%
Fiscal Policy to manage crisis – a permanent approach
In the midst of the 2008 credit crisis, the U.S. Treasury was authorized to purchase assets from financial institutions to help improve balance sheet quality in the financial sector. This program, dubbed “Troubled Asset Relief Program” (TARP), was successful in 1) helping to stabilize financial institutions affected by the credit crisis, and 2) generating a profit for the U.S. Treasury (Tracy, Steinberg, & Demos, 2014).
Today, the best policy proposition we can offer is the addition of a TARP-style Bank Credit Reserve for large banks, particularly those subjected to the post-2008 “stress testing.” Such a reserve from the Treasury would:
provide banks with short-term, emergency funds (with high interest payback for U.S. taxpayers),
further incentivize big banks to manage their capital ratios successfully, and
reassure the American people that Policy Makers aren’t just interested in finding the next problem through “stress tests,” but offering practical solutions to avert calamity.
Integrating Monetary and Fiscal Policy
Post-2008 stress testing is already occurring through the Fed’s oversight of member banks, only without tools available to either it or the U.S. Treasury to deal with the results. Therefore a TARP-style credit line approved by Congress (to authorize the U.S. Treasury to issue emergency credit on a revolving basis) would proactively manage future catastrophes in the financial sector – before they begin. Further, this TARP credit facility would mean comfort to the financial sector and confidence to investors. It could also offer a balance in the policy-making burden between fiscal (Congress) and monetary (Fed), helping the Fed meet its objectives with less scrutiny on its every move.
For more information or to schedule a meeting, contact Aaron Kolkman, CFP®, AAMS® at: (877) 664-2583 or firstname.lastname@example.org.
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The Risk Manager (Spring, 2016)
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The Capital Market and Liquidity
Current FAQ: Informing the public about the Federal Reserve. (2015). Federal Reserve Board. Retrieved from: http://www.federalreserve.gov/faqs/money_12848.htm
Tracy Ryan, Julie Steinberg and Telis Demos (19 December 2014). The Wall Street Journal. Bank Bailouts Approach a Final Reckoning. Retrieved from: http://www.wsj.com/articles/ally-financial-exits-tarp-as-treasury-sells-remaining-stake-1419000430
Gallup (2016). Statista. Underemployment Rate from January 2015 to January 2016 (by month). Retrieved from: http://www.statista.com/statistics/205240/us-underemployment-rate/
THE RISK MANAGER delivers intelligent, actionable content related to managing primary financial risks throughout the Life Cycle of Wealth. It can assist the reader in applying advanced financial concepts to a given situation with a well-informed and financially conservative viewpoint. The ultimate purpose of this work is to bring the reader less uncertainty and a greater ability to achieve life goals.
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