Is the U.S. Economy Worse Off than Europe’s?

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Jason Miczek/Reuters

The U.S. economy is still only muddling through, according to revised GDP numbers out by the Commerce Department. That’s bad news. But more disturbing is the accompanying dollar slump against the euro, and what it says about perceptions of our economy versus Europe’s.

The Commerce Department’s revised report on first quarter GDP showed a dowdy 1.8% growth rate and less consumer spending over that period than originally thought. Economists are calling it a “soft patch” for the first half of 2011, which,¬†without the help of the trusty American consumer, could mean less U.S. job growth and slowing global growth.

The slowdown in consumer spending, revised down to 2.2% growth from 2.7%, is especially troubling. It means that U.S. consumers are finally responding to rising gas and food prices, which puts the Federal Reserve in a tricky spot. The uptick in food and energy prices doesn’t factor into the Fed’s decision on whether to raise interest rates, since they’re not part of “core” inflation numbers. But a small chorus of Fed officials has recently been arguing that food and energy pressures can’t be ignored, because even the expectation of inflation by consumers and businesses can lead to real inflation. In such a scenario, workers and businesses begin demanding higher wages and prices for their goods in anticipation of things costing more in future.

So far, Fed chair Ben Bernanke and the Fed board have argued against this logic (hence the continued rock bottom interest rates). They think food and energy prices can only rise for so long in a weak economy before dwindling demand for stuff cuts off the rise in prices. And policymakers shouldn’t worry about what consumers think about inflation anyways, because they’re usually wrong, according to a research report out this week by the Fed Bank of San Franscisco. It finds that recent rising consumer inflation expectations (up to 4.4% a year from now from 3.0% at end-2010, according to the early-May Thomson Reuters/University of Michigan consumer survey) reflect consumers’ “excess sensitivity” to food and energy prices, because that’s what consumers buy the most. So consumers aren’t factoring in other purchases like clothing and home improvements.

But food and gas aren’t the only things making consumers inflation-wary. Amid its massive bond-buying program, a fiery debt debate in Washington, and a declining dollar, people simply don’t trust the Fed. And Americans aren’t the only ones. The disappointing first quarter U.S. growth numbers Thursday were followed by a sell-off of U.S. dollars.¬† So even as all hell broke loose in the eurozone over a potential Greek default, the euro made gains against the dollar.

That’s a sign that global investors aren’t as keen on the safehaven dollar as the Fed would expect. Until now, U.S. officials have thanked their lucky stars that the eurozone crisis has been boosting the dollar’s strength. But if Fed officials don’t do better at explaining their rationale on inflation to the public, things could take a turn for the worse. What can the Fed do to win back public favor? Set out a specific inflation target, of, say, 2%, just like the trusty old European Central Bank, to blunt the perception that the Fed has its head in the clouds.