"Kee Points" with Jim Kee, Ph.D.

Three economic topics worth mentioning from last week involve Europe, health care, and the Federal Reserve. I’ll discuss Europe and the Fed briefly this week and health care next week - health care reform is just too big a topic to combine with others!

Europe: Back in 1999, British historian Paul Johnson wrote a piece in Forbes titled, “Why Britain Should Join America.” He made the point that Britain had much more in common with the US than with post-WWII Europe, a theme he reiterated following the June, 2016 Brexit vote (the UK referendum on whether or not to leave the European Union). In other words, he argued that Britain was fundamentally different than other “core” European countries like Germany, France, Spain, and Italy (there are 28 European Union member countries, 19 of which use the euro as their common currency). This implies that what happens in the UK isn’t necessarily what will happen in other, more European countries. So far that analysis seems to hold, as Geert Wilders, a proponent of the view that the Netherlands should exit the European Union, had a disappointing showing in the parliamentary elections there on Wednesday. France is up next, with Marine Le Pen of the National Front party, one of the four leading candidates, in favor of exiting the European Union. There will be two rounds of voting, with the first vote taking place on April 23rd, and the second vote (between the resulting top two candidates) taking place in a run-off on May 7. Le Pen is expected to make it to the second round and then get defeated. As an aside, I’ve always found the verbiage of European politics somewhat confusing, as the meaning of terms like “populism,” “far-left,” “far-right,” and “extremist,” etc., aren’t always intuitive or consistent.

Market indicators, like stock market indices (US, Europe, Emerging Markets, Global), global risk measures (e.g. St. Louis Fed Financial Stress Index), and currencies don’t seem to be expecting or pricing in a big shock like a Le Pen win and/or a potential break-up of the European Union. However, expectations are high for serious modifications of the existing governance structure of the EU. In that sense I continue to think that Nobel Laureate Thomas Sargent was on the right path in his 2011 Prize Lecture (“United States Then, Europe Now”). Sargent pointed to similarities between the early history of the US, which over a period of years abandoned the Articles of Confederation (1781) in favor of the Constitution of the United States (1788), and Europe today. That suggests a multi-year re-evaluation or “updating” of the European project, which feels like what we’re in the middle of right now [note: Scotland voted in 2014 to remain in the UK but a majority also wanted to remain in the EU, so a referendum there - on remaining in the UK - is possible as well].

The US Federal Reserve raised rates 25 basis points last week, making the Fed’s target range between .75 percent and 1 percent. This was largely expected and in-line with prior guidance from the Fed, and in fact, two more rate hikes are expected over the next 6-12 months. The Fed mentioned improving labor markets and inflation moving upward towards the 2 percent long-run target as justification for the move. The Fed statement also mentioned that the Fed will continue to reinvest the principal payments it receives from its holdings of debt securities (i.e. continue to buy securities) until “normalization” of short-term rates (somewhere in the 2% go 3% range) is well under way. That is consistent with former Fed Chair Ben Bernanke’s blog post from January (“Shrinking the Fed’s Balance Sheet”) in which he argued that the Fed would and probably should wait until rates were closer to normal before attempting to reduce the size of its balance sheet (i.e. stop reinvesting debt principal repayments in other debt securities). This ostensibly gives the Fed some ammunition or leeway to cut rates in the event that a balance sheet reduction causes problems. It’s hard to talk about the impact of small incremental rate hikes when rates have been at or near zero for so long, because there just isn’t any real historical precedent. But overall the Fed’s position is still considered to be loose or “accommodative,” because short-term rates at .75% - 1% are still well below inflation, which is closer to 2%. Think about it kind of like this: You can borrow money from me at a rate that doesn’t even compensate me for inflation, so you are really paying back less than you borrowed. It is hard to call that tightening.