The Fed signaled yesterday that it would probably maintain rates close to zero until sometime in 2014, a revision from a previous statement targeting 2013! All this is good because stimulus is still very much needed but it doesn't really help when you find yourself in a "liquidity trap". The economy is far from being out of the woods, the debt burden as a percentage of GDP continues to rise, fuelled by a budget deficit that shows no sign of shrinking whilst growth sputters, putting pressure on the government to adopt a more drastic austerity plan. This sort of pattern is endemic across a large number of the developed economies and most particularly in the Euro-zone that is facing its biggest challenge to date.
In Europe, heavy handed austerity measures have been force fed to the more "sickly" members of the Euro-zone. It is hoped that by doing so, the deficit will shrink and eventually turn into a surplus which should help reduce the mountainous pile of debt and, in turn, cut the overburden of borrowing costs. Austerity does have a major drawback in that it stifles growth, so the question becomes: will the shrinkage of the deficit through austerity have a greater impact on debt than the economic slowdown resulting from the same austerity?
Patience is a virtue but if we take history as a guide, these highly unpopular measures have never survived long enough. They are more likely to be traded in for some form of financial repression down the road.
