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The Economy Gets “One Cheer”…and Then Nothing

MarketWatch gave last week’s GDP report “one cheer”. And that cheer was not loud or long lasting. The report was good, on the surface. The economy expanded 2.8% in the fourth quarter…the fastest pace in a year and a half. That, on its own, is good. But the devil is in the details of the report, and the gain may prove to be short-lived.

The problem is that 2/3 of the increase in GDP was the result of an inventory build…meaning businesses have accumulated excess stock. It’s good that they made a lot of product, but it’s not good that they couldn’t sell all of it. And a pick-up in economic growth doesn’t look all that great when it is supported by inventory stockpiling.

And final sales slowed to a modest .9%. Final sales are a gauge of demand…and .9% is just not strong enough. If businesses can’t sell what is sitting in their warehouses, production is going to slow.

And in an indirect way, the US economy also got one (very weak) cheer from the International Monetary Fund. The IMF lowered its outlook for global economic growth…and the US was the one country that didn’t have its forecast cut. But the fund only expects the US to grow 1.8% this year.

If the economy got one cheer from the GDP report, and maybe one from the IMF, it didn’t get any from the Federal Reserve. Fed officials cut their forecast for US economic growth to 2.2 to 2.7% for this year, from 2.5 to 2.9% previously.

And with that, the Fed pledged to keep short-term interest rates at basically zero at least through late 2014…that’s 18 months longer than previously promised. Along with that, for the first time, the Fed set an explicit “goal” for inflation, with a target of 2%. That is a little higher than the previous implicit target of 1.5 to 2%. It did not set a target for the unemployment rate.

The Fed has two objectives. It has a dual mandate to ensure price stability, and maintain maximum employment. And the challenge to balancing the two is the fact that increased employment naturally comes at the expense of increased inflation.

So last week’s new ‘explicit goal’ means that, basically, the Fed is willing to trade higher inflation for jobs. The Fed is not exactly targeting inflation, its simply saying it’s willing to buy employment with slightly higher prices levels if that’s what it takes.

The Fed also laid the groundwork for more stimulus, saying that the committee “recognizes the hardships imposed by high and persistent unemployment in an underperforming economy, and it is prepared to provide further monetary accommodation”.

So while the Fed may not have shouted an economic “boo”, it certainly didn’t echo a cheer.

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