WASHINGTON: The US-led war against Iraq has come to an end but a bounce in the American economy that many hoped would follow is so far just that – a hope.
With a clean read on post-war prospects likely to be still months away, economists remain divided on whether uncertainties connected to the run-up to war or deeper economic ills are mainly to blame for the weakness the economy has shown so far this year.
But even optimists took to heart a hint last week from the US Federal Reserve Board that it might cut interest rates out of worry that inflation may fall if slack in the economy is not pulled taut.
“It’s our belief the economy is really poised to bounce fairly significantly over the second half of the year and that further easing at this point would be a mistake, which is not to say the Fed is not going to do it,” said Kim Rupert, senior economist at MMS International.
In a statement tantamount to a declaration that its decades-long battle against inflation had come to an end, the Fed warned last week that there was a chance, albeit small, of an “unwelcome substantial fall in inflation”.
The Fed is worried that a sharp slowing of inflation from already low levels heightens the risk that the economy could tip into an outright deflation, a potentially crippling condition in which the overall level of consumer prices tumbles.
Core inflation, which excludes volatile food and energy costs, has hit 37-year lows by some measures and economists say it will likely slow further until a firmer recovery takes hold and businesses renew hiring and put idle capacity to use.
“It’s clear that the Fed would like to see some above-trend growth and that takes time,” former Fed vice-chairman Alan Blinder said.
Analysts said the Fed’s statement suggested its patience in waiting for the economy to firm was wearing thin.
The central bank has already cut interest rates 12 times since early 2001, bringing overnight borrowing costs to a 41-year low of 1.25%.
“Unless there're signs of a recovery, particularly in the labour market, I think they’ll probably move at the next meeting,” Harvard University professor Jeffrey Frankel said, referring to the Fed’s June 24–25 gathering.
Frankel said while most recent data remained tainted by war, he saw no sign of a post-Iraq bounce. “It doesn’t feel right to me,” he said.
“If it was just the resolution of uncertainty holding businesses back, I would think they might have started hiring workers,” Frankel said. Instead, the government’s latest report on initial filings for jobless benefits showed claims still stubbornly above 400,000, a sign of labour market stagnation.
Adam Posen, a former New York Fed researcher now at the Institute for International Economics, offered a similar view.
“If it was really war-based uncertainty, we would have seen a big move in stock and bond markets,” he said, adding that the Fed appeared to agree that more than war was at play.
Fed chairman Alan Greenspan suggested that was the case in comments last Thursday that touched on the reluctance of businesses to commit to new spending projects.
“I think a goodly part of the caution is indeed the aftermath of this whole corporate governance issue,” he said, referring to a string of accounting scandals. – Reuters