A soft landing

The employment and earnings numbers for the US economy during December suggest that the tide may be turning as far as growth performance is concerned. The number of non-farm jobs rose by 167,000, somewhat higher than expectations and significantly higher than the job gains in October (86,000) and moderately above the November numbers (154,000). Although the vast majority of observers still believe that 2007 will be a year of slower growth than 2006, it is very likely that estimates for the current year will be revised upwards in the early months, eventually resulting in a relatively small difference. This moderate slowdown will, of course, be accompanied by lower inflation, the consequence of both the anti-inflationary monetary policy that the US Federal Reserve has implemented over the past couple of years and the softening in oil prices. The trade deficit, the one dark spot that many people see on an otherwise sunny macro-economic situation, will remain large, but it is unlikely to widen, as the lower growth rate translates into a smaller appetite for imports.

Assuming that this scenario pans out during 2007, it will provide a very strong endorsement of the Fed's ability to manage the macro-economic cycle within a relatively narrow range of oscillation. Seventeen successive hikes of 25 basis points each in its benchmark federal funds rate, implemented from July 2004, underscore both the efficacy of such minute changes in the instrument and the ability to decide when it is appropriate to stop. Given that 2006 was Ben Bernanke's first year as chairman, there was some scepticism about the latter capability but, clearly, a combination of institutional and individual judgment seems to have resulted in what will turn out to be the softest of soft landings. This is obviously good news for the US.

It is also very good for the rest of the world, particularly the large emerging economies which export so much to the US and are, therefore, vulnerable to a sharp slowdown in that economy. China, the biggest of them all, has a buffer in the form of a rapidly growing domestic market, but for the smaller Asian and Latin American economies, imports by the US are a critical counter-balance to small domestic markets. The ability of the Asian region as a whole to grow at 7 per cent is in no small measure due to the sustained demand for its products in the US. As India's exposure to the US""it is the largest single buyer of goods and a dominant market for service exports""grows, it becomes increasingly vulnerable to the US business cycle and will get some relief from the Fed's ability to manage the soft landing. This should improve growth prospects for 2007-08, so it may well turn out that the global economic momentum and softer oil prices help India to barrel along at more than 8 per cent GDP growth.

A strong message that these countries must take from the US is the critical importance of financial markets in making the execution of monetary policy both effective and relatively risk-free. Efficient markets take the minute change of 25 basis points and transmit it through the yield curve and other channels of arbitrage into significant changes in the growth and inflation rates. If things seem to be going wrong, the instrument is easy to reverse. The efficiency of the process obviates the need for the use of blunter instruments, whose impact is more difficult to predict and to reverse.