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John Waelti: Uncertainty, interest rates, and stock prices
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It could be better, and could be worse - the economy that is, as we begin 2016. It was worse, a lot worse, when President Bush handed over to President Obama the worst economy since the Great Depression of the 1930s. It was not only the worst since the Great Depression, but in danger of total collapse, threatening to take the world economy down with it.

So now the economy is improving, however gradually. Job growth has increased and unemployment is down. Some states are doing better than others, Minnesota much better than Wisconsin and Illinois, for example. Some regions, particularly in rural areas, are lagging. Until very recently, wage growth has been non-existent.

The improving economy has even resulted in a reduction in federal deficits, both in dollars and relative to the total economy.

A continuing drag on the economy continues to be growing inequality of income and wealth. Stagnation of income growth for the vast majority of American labor explains much of the pessimism of Americans on the economy. Even the same Republicans who had been chastising Democrats for "waging class warfare" for merely citing income inequality now proclaim to recognize it as an issue, although blaming it on a convenient scapegoat, President Obama.

Apart from preventing total economic collapse, a significant improvement has been in the stock market. The S & P 500 has tripled from its trough of 2009. Although fluctuating severely in 2015, markets have ended 2015 where they were one year ago. Though soft as this is written, they are near historic highs.

Many ordinary Americans have seen an increase in their net worth through stock ownership in their retirement funds. That's commendable; however, the vast majority of stocks are owned by a small percentage of wealth holders. Higher stock prices, however welcome, have disproportionately benefited America's wealthiest.

The Congress, having abandoned its responsibility to implement a responsible counter-cyclical fiscal policy, has left macro-economic stabilization up to the Federal Reserve System, the "Fed." That brings us to monetary policy as implemented by the Fed, and its relation to the economy.

The rationale of the Fed's low interest rates is to make it easier for consumers and businesses to borrow money, creating an expansionary effect on the economy. While the vast majority of economists, myself included, agree that this is the correct course of action, the Fed is not without its critics.

President Truman famously wished for a "one-handed economist," as economists are known for saying, "but on the other hand...." While I can understand Harry Truman's frustration, there is a reason for stipulating, "on the other hand...." It's because that's reality; it's the nature of economics. One person's expenditures are another person's income. While there are economic policy measures that are for the greater good, there are usually some downsides and, certainly, risks along the way.

Let's take the Fed's correct expansionary monetary with low interest rates. Low interest rates, while making borrowing easier, work to the disadvantage of savers, especially those who depend on interest on fixed income investments.

A possible risk of an expansionary monetary policy is inflation, a risk that critics of the Fed have not been hesitant to express. However, that criticism has been overly hyped, and surely was a risk worth taking in the effort to stimulate the economy. While some prices have risen, many remain low, particularly gas prices that are so important to so many people, and are another "on the other hand" situation.

High crude oil prices bring prosperity to the oil patch, creating employment. They bring revenues to states like Louisiana, Texas and Alaska. On the other hand - sorry - high gas prices act as a tax on consumers, diminishing expenditures on other items. Falling gas prices enable consumers to buy other items. With these lower crude oil prices we are already seeing reduced employment in the oil patch, and states like Alaska might even have to find other sources of state revenue.

Back to the Fed: In addition to hand-wringing over possible hyper-inflation, its critics have railed about uncertainty and alleged "secrecy" of Fed Chair Janet Yellen. These charges of secrecy are ridiculous. Chair Yellen has been forthright and open about intentions compared to previous chairs, especially Alan Greenspan, who raised gobbledygook and obscurity of the English language to an art form.

Yellen has long assured us that the intention was to keep interest rates low until the economy improves, and then raise rates only gradually. As she promised, the federal funds rate was increased a mere .25 percent in December. The increase was forecast and has surprised nobody. That mere .25 percent is a gradual increase, as the economy is increasing only gradually.

So, what are the risks? Probably not a lot in this case. The conventional wisdom expressed by Wall Street gurus is that the booming stock markets were because of the Fed's expansionary monetary policy. The accepted wisdom is that with low interest rates on bonds and other fixed income instruments, stocks have been a more desirable investment. And, as interest rates rise, investors will drift away from stocks and find bonds to be more attractive.

All else equal, this makes some sense. However, with an improving economy, not all else is equal, namely, the economy. With an improving economy, one would expect corporate profits to rise, and hence the value and price of stocks of those more profitable corporations. As verified by history, the link between interest rates and stock prices is very loose. Besides, as we can see from this week's events, there are other factors affecting stock prices.

So what is the Fed to do? It needs to thread the needle between raising interest rates as the economy improves, but not so fast as to restrict borrowing and having to backtrack and lower rates again.

That's a tricky process. We can't predict its ultimate effect on stock prices because we can't predict the future.

- John Waelti of Monroe, a retired professor of economics, can be reached at His column appears Fridays in The Monroe Times.