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After trade war progress, the Fed should cut interest rates, boost its QE holdings and lower the dollar’s value to boost the US economy

South China Morning Post

發布於 2019年10月15日00:10 • David Brown
  • The Federal Reserve should not only cut interest rates, but up its quantitative easing holdings, thus driving down the dollar. This, and a trade war ceasefire, would not only boost the US economy but the global economy and trade as a whole
US Federal Reserve chairman Jerome Powell speaks during a press conference after a Federal Open Market Committee meeting in Washington on July 31. Photo: AFP
US Federal Reserve chairman Jerome Powell speaks during a press conference after a Federal Open Market Committee meeting in Washington on July 31. Photo: AFP

The world may be turning a corner on the US-China trade war, but spare a thought for Federal Reserve chairman Jerome Powell. Deal or no deal on the trade front, Powell has a lot to juggle, considering President Donald Trump's demands for lower interest rates while the slowing US economy needs new stimulus measures.

It may be a bad idea submitting to political pressure to cut US rates, but the Fed can ill-afford to tinker at the monetary margins while the economy is treading water. Time is running out; the Fed has plenty of options but needs to use them fast.

The Fed continues to fall short on what's needed to get the US economy back to full strength. The latest announcement, that it is due to start buying short-dated Treasury bills, is unlikely to set the world on fire, especially since the Fed insists the move is nothing more than a technical smoothing operation to iron out some short-term liquidity glitches.

It has stressed it's not a resumption of quantitative easing (QE), the programme of bond buy-backs and money-printing which helped jump-start the US economy after the 2008 crash. If so, it is wasting a valuable opportunity.

The Fed has to use more gumption to get the economy moving up a gear. Much lower interest rates, more QE and a weaker US dollar could easily pull the economy out of the doldrums of 1-2 per cent growth and into a more favourable 3-4 per cent range.

Source: New View Economics
Source: New View Economics

The Fed used this blueprint for recovery to great effect after the 2008 crash and shouldn't shy away from using it again. The only strategic mistake was tightening too soon back in 2015, and now the Fed needs to make up for lost time.

There are certainly grounds for hitting the accelerator again and shifting the policy bias back to more aggressive accommodation. Economic confidence is languishing, growth potential is below par and serially low inflation shows potential deflation risks remain in the US economy. The Fed must do all in its power to ensure inflation sticks to its 2 per cent target over the long term.

How the Fed is keeping the US dollar strong

The Fed needs to cut interest rates from around 2 per cent to closer to zero while, at the same time, cranking up its QE stockpile back towards its earlier US$4.2 trillion peak, reversing its recent rundown of bond holdings to US$3.6 trillion. It could even do more.

And instead of purchasing shorter-duration securities, the Fed should focus on buying longer-dated Treasury and corporate paper to signal an ironclad determination to get long-term yields and borrowing costs down to boost demand.

Significant interest rate cuts and a return to QE would definitely send powerful signals to currency markets for a much-needed weaker US dollar.

The near 12 per cent rebound in the dollar's trade-weighted value since early 2018 has been the equivalent of a 3 per cent hike in US interest rates, which has had adverse consequences for US manufacturing. A more competitive dollar would do wonders for stronger export-led US recovery.

Lower US interest rates, easier credit conditions and a weaker dollar would be good news for US growth, but also provide an invaluable boost to world trade, global demand and China's economy, too.

At a time when global tensions remain fraught, the US would be making a major contribution to global stability, helping to heal the rift between Washington and Beijing in the process.

Trade war resolution or bust " that's the choice right now for US and China

If the US and China can settle their differences and the trade war ceasefire holds, it's a huge opportunity for global growth and world financial markets.

If the two greatest superpowers go one step further and can cooperate more closely on future policy stimulus, global growth has a good chance of bouncing back above 5 per cent in the next two years.

Remember though, the world economy has been badly damaged by the trade war and still needs much more monetary stimulus from the US and China to heal the wounds.

David Brown is the chief executive of New View Economics

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.

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