The Daily Update - 'Why Do Economic Expansions End?' Part III

Western central banks face extraordinary challenges in unwinding their 10-year experiment with unconventional monetary policy that has left them with trillions of dollars of financial assets on their balance sheets and real policy rates still near zero. The Fed, as the first mover, will bear the brunt of these challenges for many reasons. First, Americans are led to believe that low interest rates are good for whatever ails the economy. This myth persists despite ample historical evidence that low interest rates in fact are destabilising once they no longer serve to stimulate domestic demand. That perverseness clearly has been the case over the past few years; according to several studies, the effectiveness of QE has waned, while debt levels at home and abroad have continued to soar. Recall that the Federal Reserve’s foremost mandate is to mitigate systemic risk – a point that Chairman Powell has reiterated of late. Ultra-low real interest rates undermine this goal.

Second, the Fed’s policy of negative short-term interest rates clearly favoured banks and debtors at the expense of savers. The unfashionable phrase for these circumstances is ‘financial repression’. At full employment, financial repression of saving, which is the only sustainable source of funding for investment, is detrimental to long term growth. Indeed, the most common cause of recessions and financial crises is excessive consumption (either public or private) at full employment; the inevitable overheating and debt accumulation prove to be the Achilles Heel of expansions. In that context, the huge tax cuts enacted in early 2018 were a giant step in the wrong direction.

Most members of the FOMC seem to recognise this dilemma with two subtle changes in their latest outlook at the December FOMC meeting. First, the median forecast for inflation was lowered to match the Fed’s target rate of 2%, implying they did not anticipate the need for overshooting on the policy rate. Second the median long-term growth rate, which is tantamount to their estimate of potential growth, was raised to 1.9%, or closer in line with projected real GDP growth. And third, the central tendency for the fed funds rate in the long term declined to 2.75%, or little different from the current level of 2.5%.

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.