Thursday, September 10, 2009

Goldman Says Deleveraging May Keep Fed Rate Low for ‘Years’

From Bloomberg:
The Federal Reserve may keep interest rates low for “many years” to help U.S. consumers and companies as they pare back debt, according to economists at Goldman Sachs Group Inc.

Sluggish spending as households reduce debt could lop as much as 2 percentage points from U.S. economic growth over the next three years, New York-based economists Peter Berezin and Alex Kelston wrote in a report released late yesterday. While not enough to threaten a long-term recovery, it may require the Fed to offset the weakness by keeping its benchmark rate unchanged through 2010, they said.

“It is hard to escape the conclusion that the Fed may need to maintain fairly low interest rates over a period of many years,” wrote Berezin and Kelston. “If you want to bring down leverage, you should keep monetary policy sufficiently accommodative to forestall a collapse in spending and a deflationary spiral.”

The Fed’s key rate is now near zero as it fights the worst recession since World War II. Keeping U.S. rates there until 2011 may represent an “attractive buying opportunity” for U.S. bonds and threaten to inflate asset bubbles in economies that tie their currency to the dollar, the Goldman economists said.

While leverage has already started declining as banks strengthen their balance sheets, the process of reversing private credit may take much longer and is only in its early stages, according to the report. One consequence is likely to be an increase in household savings and subsequent decline in consumption as a share of gross domestic product after it averaged 70 percent in the past decade, compared with 65 percent in the previous four decades, the authors said.

Historical Average

Reverting to its historical average will imply consumption growth lags behind overall GDP expansion by about 85 basis points per year, Goldman said. Beyond the next three years, that will be enough to shave the economy’s growth by as much as 1 percentage point, it said.

While many forecasters project the Fed will raise rates next year, the Goldman economists said their expectation that the Fed will hold fire may benefit bonds. Keeping borrowing costs low may also mean economies that peg their exchange rates to the dollar may ‘end up with interest rates that are too low for too long, thus raising the possibility that asset bubbles will develop,’’ they said....MORE

FT Alphaville's take:

Don’t worry about deleveraging…

… says Goldman Sachs.

The rather dramatic drop in US consumer credit outstanding has sparked yet another recovery debate, with many claiming the global economy will be unable to get back on its feet without consumers going back to their old, spend thrift ways.

Goldman analysts led by Jim O’Neill present an alternate view in a research note out on Thursday. They say the deleveraging cycle is happening but it won’t imperil long-term economic recovery. That’s not to say, however, that the guys at GS don’t think deleveraging will have any impact.

Indeed they think it could shave a couple of points off US GDP:

These are very rough `back of the envelope’ estimates. However, taken at face value, they suggest that holding everything else constant, deleveraging could shave about 1-2ppt off growth over the next three years as the US financial system recovers from the crisis, and about 0.5- 1ppt thereafter, as consumption as a share of GDP declines towards its historical average.

The point, however, is that there will be other things to offset that deleveraging:

While the calculations above are subject to much uncertainty, they do suggest that the deleveraging cycle will have a noticeable drag on growth in the coming years. This has led some commentators to suggest that the US is on the brink of a `Great Stagnation’, a period of prolonged subpar growth and high unemployment.

Our view is more optimistic . . . we see a number of tangible offsets to the deleveraging cycle over both the near term (when deleveraging will pose the greatest drag on growth) and the medium term. In the near term, continued fiscal stimulus and a slowing in the pace of inventory liquidation should help boost growth to about 3% in 2009H2 in the US, and possibly even higher.

However, the risk of a double-dip recession will likely surface once these short-term catalysts begin to fade by the middle of next year, with fiscal spending in particular likely to become a drag on growth over the course of 2010. At this stage, the economic recovery will become increasingly dependent on two factors: (1) the recovery in investment spending, and (2) the tailwind provided by buoyant growth in emerging markets.

And how does one boost investment spending and stimulate growth in consumption? Lower interest rates, of course....MORE

While another FTA post leads us to this snappy little number:

We're Deleveraging! - Swing that Debt!