Does Lower Inflation Mean a Goldilocks Economy?

Popular Economics Weekly

Graph: Calculated Risk

Consumers are being helped by consumer prices that are barely rising. The Consumer Price Index is up just 2.7 percent, and core CPI without food and energy prices up 2.2 percent in 12 months. This has kept interest rates at historic lows since the Great Recession and is the reason for an economy that is neither too hot nor too cold.

Just how long it will last is an enduring question for economists. One infallible feature of an incoming recession is sharply rising interest rates. But historically low interest rates over an extended period can also mean most consumers aren’t earning enough to boost their buying power, which in turn ‘powers’ higher prices and inflation—a sign of intractable income inequality.

The Great Recession was largely caused by Alan Greenspan’s Fed raising interest rates 16 consecutive times—a total of 4 percent—that caused all the ‘liar’ loans with negative amortization and no real income or asset verification to become unaffordable to lower-income borrowers and homeowners.

That isn’t the case today—yet. The wealthiest 10 percent—what is basically left of the middle class that has profited since the Great Recession—has a very high savings rate. But not the ‘other’ 90 percent, so that average annual incomes are rising at 2.7 percent; also the consumer inflation rate today.

Households carried a record $13.3 trillion in debt at the end of June, Federal Reserve records show. That tops the prior peak of $12.7 trillion in 2008 during the middle of the Great Recession. High debt levels, especially in mortgages, contributed to the 2008 financial panic and the severity of the recession, as I said.

But low interest rates and inflation are keeping delinquencies very low at the moment, and lending standards remain quite stringent in the post-crisis era, according to a recent Moody’s study reported by MarketWatch. As such, there’s less danger of another housing market collapse.

That is the catch. Interest rates and inflation must remain very low for delinquencies to remain ‘very low’, and that won’t last much longer with wage pressures growing, fewer workers available for hire, and the Federal Reserve saying it will continue to raise short-term rates.

Business confidence is soaring as well, thanks to the economic ‘porridge’ being neither too hot nor too cold. The NFIB Small Business Optimism Index soared to 108.8 in August, a new record in the survey’s 45-year history, topping the July 1983 high-water mark of 108. The record-breaking figure is driven by small business owners executing on the plans they’ve put in place due to dramatic changes in the nation’s economic policy.

And small businesses create most of the jobs. “Today’s groundbreaking numbers are demonstrative of what I’m hearing every day from small business owners – that business is booming. As the tax and regulatory landscape changed, so did small business expectations and plans,” said NFIB President and CEO Juanita D. Duggan. “We’re now seeing the tangible results of those plans as small businesses report historically high, some record breaking, levels of increased sales, investment, earnings, and hiring.”

So how long can such goldilocks growth last? It is the ideal condition economic planners work for, but lasts only very briefly until debt levels rise to unsustainable levels, given the inherent fluctuations and dynamism in any economy. Vigilance in looking for signs of higher interest rates and slower growth is therefore a major requirement to stay ahead of those fluctuations.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen