As ever, the US Fed stimulates optimism but not much growth
Indeed, a paper by James Stock and Mark Watson finds that monetary policy has little to do with the substantial drop in output volatility, and everything to do with good luck. The authors attribute as much as 90 per cent of the economy’s improved stability to good luck – or the absence of large adverse shocks – rather than the economy’s dynamic response to these disturbances. The very same conclusion has been reached by various respected academics, which undermines central bankers’ current God-like status.
Those who remain unconvinced, and continue to believe that central bankers are miracle-workers and not ordinary mortals, should take a close look at the rhetoric that emanated from the higher echelons of the Federal Reserve before the crisis struck. They championed the financial innovations that precipitated the crisis, and were blind to structured finance’s soft underbelly. Further, once the crisis struck, they consistently underestimated the potential size of the shock.
The Federal Reserve did prevent a repeat of the 1930s, but the monetary policymakers have been consistently surprised by the economys underwhelming response to unconventional stimulus. Indeed, the Fed wizards believed in the summer of 2010 that economic growth would be between 2.9 and 3.8 per cent for the full calendar year, and between 2.9 and 4.5 per cent in 2011. The actual outcomes were a disappointing 2.4 and 1.8 per cent respectively.
Investors need to appreciate that in spite of extraordinary monetary stimulus, the current economic upturn is the most uninspiring in post-war history.
Indeed, output growth has averaged just 2.2 per cent over the 12 quarters since the recession’s nadir in the summer of 2009 – or less than half the average pace of growth registered during the three-year periods that immediately followed the previous 10 post-1945 recessions – while the current unemployment rate is still above all but three of the prior recession peaks.
The economy’s good luck ran out when the financial crisis struck, and the Federal Reserve is not a miracle-worker, and simply does not have a silver bullet that will return the economy to a more robust growth trajectory. Meanwhile, the structural headwinds behind the lacklustre growth performance, exposes the economy to adverse shocks. Welcome to the “Great Stagnation”.