The Federal Reserve’s aggressive easing of monetary policy is proving surprisingly effective at blunting the blow to the US economy from tighter fiscal policy, according to economists who have been scrambling to raise their growth forecasts.
In the battle between fiscal drag and monetary stimulus, the Fed is winning
Economists had feared higher taxes and deep Government spending cuts would stunt growth in the first quarter, but a string of strong economic data has so far proven them wrong. And they mostly blame the Fed.
“Monetary policy is beginning to gain some traction here,” said Tom Higgins, global macro strategist at Standish Mellon Asset Management in Boston.
According to Higgins, if it were not for the monetary stimulus, the economy would probably be facing growth of a one per cent annual rate or less. As it is, he expects growth to come in at a 2.5 per cent pace in the first quarter.
The US Central Bank has held overnight interest rates near zero since December 2008 and has pumped about $2.5 trillion into the economy by purchasing Treasury debt and mortgage-backed bonds in a bid to foster faster growth and lower unemployment.
On Wednesday, it recommitted to buy $85 billion worth of bonds each month and said it would keep buying assets until it sees a significant improvement in the labour market.
Those actions have helped put the economy in a better shape to deal with the end of a two per cent payroll tax cut, higher tax rates for wealthy Americans and $85 billion in across-the-board Government spending cuts known as the ‘sequester’.
The easy money stance has given a boost to interest rate sensitive sectors of the economy, such as autos and housing. The commitment to easy policy also appears to be lifting business confidence, which in turn is underpinning job growth and the stock market.
Non-farm payrolls increased 236,000 in February and the jobless rate fell to a four-year low of 7.7 per cent.
“The message from the data is that in the battle between fiscal drag and monetary stimulus, the Fed is winning,” said Jim O’Sullivan, a chief economist from New York.
Stunned by a surprisingly strong report on retail sales last week, most economists rushed to raise first-quarter growth estimates.
JPMorgan pushed theirs up by an eye-catching eight-tenths of a percentage point to 2.3 per cent, while Goldman Sachs increased theirs by three-tenths of a point to 2.9 per cent.
Economic activity expanded at a meagre 0.1 per cent rate in the last three months of last year, the slowest pace since the first quarter of 2011.
Economists also said they had been mistaken to believe that businesses would retrench if it became clear deep Government spending cuts were going to take hold.