Fellow Shortrunners,

     On Tuesday, the Federal Open Market Committee, the monetary policy arm of the US central bank, convened to discuss the future of the interest rate target.  The Fed decided, as expected, to leave interest rates unchanged.  On Thursday, the European Central Bank and the Central Bank of England followed suit in their respective territories.  Nonetheless, there is rampant speculation among economists that such actions may not be the best choice for the ailing European economy.

     The FOMC's decision to leave the Federal Funds rate unchanged masks a large deal of activity taking place at America's central bank.  In particular, Fed economists have become extremely active in trying to create transparency as to the course and direction of monetary policy.  Using press releases and public speeches, the Fed governors have been attempting to send the market messages beyond their simple interest rate decisions.  One of the more direct efforts has been to publicly warn of the danger of deflation (falling price levels).  The most recent press release which accompanied Tuesday's interest rate decision made it clear that while the US economy was weak, the main danger the bank was faced with was not growth or inflation, but deflation.

     One of the most recent additions to the Board of Governors is academic Ben Bernanke, whose previous research has put him, in the eyes of the market, in support of policies such as inflation targeting (choosing a low level of inflation, say 2%, and then attempting to maintain that level).  Bernanke has also researched possible unconventional tools that could be used to prevent deflation and a Japanese style recession.  His recent appointment, may then be partially an attempt to ease market fears.  By informing the market that they are prepared to do more than the Japanese central bank has done, the Federal Reserve is attempting to talk away deflation.

     To date, monetary policy in the US has been much more accommodative than in Europe, despite the fact that both regions are suffering economic weakness.  For this reason, most economists are expecting stronger recovery in the US than in Europe.  Europe's currency, the Euro, continues to reach new highs, and is up over 20% this year on the dollar.  This swing is likely to fuel improvement in the US current account balance and thus support US businesses and manufacturers.  It is also likely to weaken some of the already struggling European economies, including the largest and one of the weakest, Germany.

     A portion of the blame lies with the European Central Bank.  In forming the ECB, the architects of the institution wanted to maintain credibility built by years of hawkish activity at the Bundesbank (the former central bank of Germany).  Following WWII and reconstruction, the German population's memory of hyper-inflation created the desire for a very conservative central bank.  Following in these footsteps, the ECB has set a direct inflation target (rather than a hybrid goal of price stability and economic growth as in the US).  As a result, some economists argue, the ECB may be acting unduly harsh during the current economic slowdown.  Given low capacity utilization around the world, slack demand, and a falling oil price, it is not exactly clear why the ECB fears inflationary pressure at a time when the Euro is gaining strength internationally and the US is clearly bracing for the possibility of deflation.

Economic Releases
The data section provides charts and data for the most important economic indicators.

ISM Non-Manufacturing Sector: 50.7%
Release Date: 5/05

• In April, the ISM reported a rebound in the service sector of the US economy.  Jumping from 47.9% in March to 50.7%, the ISM non-manufacturing sector is good news for an economy attempting to skirt a recession on the heels of a war. 

Wholesale Inventories: 0.5%
Release Date: 5/06

• During March, wholesale inventories rose 0.5%.  Sales were up 1% during the same period.  Rising sales figures are good news for US manufacturers who are looking eagerly to the falling dollar to help stave off another recession.

Consumer Credit: 0.6%
Release Date: 5/07

• Spurred by rising non-revolving debt growth, total consumer credit outstanding in the US rose by $900 million during March.  The gains were moderate in size, and the release did not make a big stir on Wall Street.

Jobless Claims: 425,000
Release Date: 5/08

• Jobless claims dipped back down closer to the 400,000 mark last week but are still indicative of a weak labor market.  There does not appear to be much of any sign that in the immediate post-war economy there is going to be significant new hiring.  Businesses are still cautious and many appear to be still in the process of cutting back. 

ECRI Weekly Leading Index: 121.8
Release Date: 5/09

• The ECRI Weekly Leading Index improved to 121.8 last week from 119.4 the week before.  Economists for the ECRI this week echoed the Fed's deflationary fears.  At the same time they pointed to a recovering but weak US economy.

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Issue #152

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