The United States Federal Reserve Chairman, Ben Bernanke, is upbeat about the US economy though the market is not convinced. That is because there are contradictory signals and it is uncertain which way the economy will really move.
The major threat was inflation which had prompted Allen Greenspan, former chairman, to increase the interest rate which earlier had been sliced down to one per cent in 2001 to prevent recession. As the economy revived and inflation emerged the interest rate was raised in steady installments to 5.25 per cent. The object was to deliberately slow down the economy without however letting it to collapse.
It is undoubtedly difficult to arrive at a rate of interest that will keep the economy on an even keel. That is because the impact of interest rate takes time to be felt in the real economy though its repercussions in the financial and capital markets are instantaneous. Inflation had persisted and peaked at 4.7 per cent in September 2005. In the next 12 months it remained well above three per cent but tapered off to 1.3 per cent by October.
It took nearly two years to change the behaviour of the economy. The first activity to be hit by the rate increase was housing. Total construction for October dropped one per cent from September and sales of new one-family houses 3.2 per cent. Business sales shrank, production of durable goods declined and inventories piled up. However new orders for manufactured goods were up 2.6 per cent and the market for labour was tight with unemployment down to 4.4 per cent and wages up by 2.4 per cent over the past 12 months.
The hidden driver in the US economy is the improvement in productivity. That is what keeps the GDP growing. In the third quarter growth was 2.2 per cent, nearly 0.6 per cent more than what was anticipated earlier. In spite of the fall in production, corporate profits were 30 per cent higher in the third quarter, though in the first two quarters the improvement was less than 20 per cent.
Apparently there are mixed trends for the present but the overall direction appears to be downward. Possibly the last quarter would reflect the state of the economy more clearly. The market is unhappy with the trends which has placed the short rate of interest much above the long rate. The dollar is weakening against the euro as also against Asian currencies. If the interest rate is not reduced it is likely that the US economy will lose steam further..
The slowdown in the US economy has world wide repercussions. The rate of growth in a number of countries, mainly China and Japan, depends on their exports to US and as such they may slow down along with the US. We do not depend on exports as much and of the exports only a fifth go to the US. As such the impact of US slowdown on our growth will be small.