Tags: Krugman | Fed | economy | recovery

Krugman: Fed Talk Reduces Chances for Recovery

Tuesday, 25 Jun 2013 07:55 AM

By Michael Kling

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The Federal Reserve's tapering talk makes economic recovery more difficult, writes New York Times columnist Paul Krugman.

By Krugman's reckoning, the Fed has been the "good guys," trying to improve the economy and reduce unemployment — in contrast to Washington. Although the Fed isn't doing enough, at least it realized that unemployment is the economy's fundamental problem.

That's all changed now, writes the Nobel Prize-winning economist.

Editor's Note:
 
'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.

By hinting that it is eager to wind down its monthly bond purchases, the Fed has convinced investors that short-term rates will soon increase. That prompts rates to rise, which, in turn, weakens growth.

Rates have increased since tapering talk began, with the 10-year Treasury rising from 1.7 percent two months ago to 2.4 percent.

"We’re still very much living through what amounts to a low-grade depression — and the Fed’s bad messaging reduces the chances that we’re going to exit that depression any time soon."

Four years after the official end of the recession, the economy remains far from full employment. Unemployment has dropped mainly because many people have dropped out of the labor market after giving up on finding a job.

"Given this grim reality — plus very low inflation — you have to wonder why the Fed is talking at all about reducing its efforts on the economy’s behalf," he says.

Why are Fed officials talking of taper?

They may be starting to agree with critics who say quantitative easing (QE) risks blowing bubbles, Krugman notes.

"But I hope that’s not true, since whatever damage low rates may do is trivial compared with the damage higher rates, and the resulting rise in unemployment, would inflict."

More likely, Krugman says, the Fed is succumbing to political pressure. Critics on the right have long been accused of debasing the dollar and setting the stage for higher inflation. Exhausted from the long-running attacks, Fed officials might be eager to wind down QE and grasp any slightly favorable economic news.

The economy has remained so lackluster basically because many policymakers forget that job creation is their most important task, according to Krugman.

"Until now the Fed was an exception; but now it seems to be joining the club. Et tu, Ben?"

With higher rates, consumers will pay more for mortgages, which could decrease demand for homes and hurt homebuilders. Higher rates could also lower demand for loans from small businesses. On the other hand, The Associated Press noted, an improving economy could encourage businesses to borrow more.

Economists believe rates will probably not rise much more unless the economy substantially strengthens, the AP reported.

Editor's Note: 'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.

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