Government estimates GDP at 1.3% for the first quarter

Government reported their estimate for first quarter GDP growth and it came in very low, the lowest level in the past five years. See article from The New York Times. Here's the AP article from Yahoo! Finance.

You may be saying to yourself, well what does it all mean?

I'll tell what I think it means, and I don't think its pretty. Usually, GDP goes down and the Fed acts to counterbalance a slowing economy by loosening monetary policy, which is almost always lowering the Fed Funds Rate (The rate banks charge to each other). Usually with slower GDP growth, prices also go down, because demand goes down. So the Fed acts to "stimulate" the economy. Effectively, they are pumping more money into the system. When more money comes into the economy the value of money goes down, subsequently stimulating inflation, because when you have more of something (supply and demand), its value is lower, making the things you buy higher priced.

This time around, the Fed has another problem. Inflation already is at a level in the economy where lowering rates is not possible, because then inflation would be too high. The NY Times article points out the following:

"The slow growth was not enough to brake inflation. The G.D.P. price index, a statistic closely watched by the Federal Reserve to monitor price fluctuations, jumped 4 percent in the first quarter — the biggest increase in 16 years."

This now becomes a larger problem, because the Fed is unable to act while inflation is high and the economy must work its way out of slow growth on its own, without monetary stimuli. The Fed has to wait until inflation moderates (the economy's demand shrinks to the point where prices begin to drop) before lowering rates. Now some people may claim that we have enjoyed low rates for a prolonged period of time and inflation was low, so we shouldn't expect to rates to stay high or even move higher, inflation will moderate. However, they are missing two important factors that contributed to low inflation. The first thing is productivity growth, which has been around 4% annually for 10 years. This is unprecedented and mostly due to the integration of IT into all kinds of businesses specifically manufacturing. The second thing is globalization, which has kept prices low due to a "world price." Now that second issue will bite back and affect our market more than we would like. We are not the only ones who want cheap electronics and computers, we've helped the developing world growth their economies so now they want to buy these things too.

The reason for this is increasingly due to China and other emerging markets. As emerging markets supplied the rest of the world and grew, their own demand grew, subsequently increasing world demand for all these products and the world demand for basic materials and other commodities.

This means that although we may have slower growth in the United States, due to increased world demand, prices may not moderate. This means the most dreaded economic environment may result, stagflation...This is where inflation is high and interest rates are high. But we won't get to the point of the 70s, we'll probably work our way out of it since the economy is much more diverse. So prices will be tempered by competition due to globalization, just don't expect interest rates to go down.