Fed’s delayed inflation fight raises fears of excessive policy correction

Fed’s delayed inflation fight raises fears of excessive policy correction


By Howard Schneider

WASHINGTON (Reuters) – Faced with mounting evidence that loose U.S. monetary policy contributed to the outbreak of inflation last year, the Federal Reserve now risks jumping too far in the other direction with its plans to combat price pressures through persistently aggressive interest rate increases. Even with the fluctuation of the global economy.

Warning signs of excessive policy correction intensified, as the US central bank’s intention to “raise and stabilize” the benchmark interest rate overnight affected the repricing of global assets โ€” stocks and currencies fell, and borrowing costs for governments and companies soared โ€” until analysts worried the Bank was overrun. The Federal Reserve evaluates the impact of its policies.

Broad financial conditions tightened rapidly in US markets. Economists in Morgan Stanley (NYSE: ๐Ÿ™‚ recently estimated that between inflation and tighter Fed policy, dollar liquidity in the US, Europe, Japan and China has fallen by $4 trillion since March and is rapidly declining.

Michael Wilson, an equity analyst at the investment bank, wrote on Sunday that the current course “will lead to intolerable economic and financial stress.” The first question to ask is, when does the US dollar become an American problem?

The Fed raised interest rates at its September 20-21 policy meeting by three-quarters of a percentage point for the third time in a row, and signaled further significant increases in the near future this year.

So far, US central bank officials insist that nothing in the global market has changed the game plan, even as analysts analyze every circumstance in public policy makers’ comments for signs that the Fed may appear at next month’s meeting.

This tea leaf reading was on display last week when some investors interpreted Fed Vice Chair Lael Brainard’s reference to a “deliberate” rate hike as a sign that the central bank might slow the pace of tightening.

The shift in monetary policy this year was the most dramatic in decades, with the Fed’s policy rate rising a full 3 percentage points to the current 3.00%-3.25% range. While expectations released by the Federal Reserve last month showed officials are at the bottom line for a rate hike at its November 1-2 meeting, the group was deeply divided.

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Don’t run away

However, in interviews and public statements over the past week, Fed policymakers, far from worrying about turbulent asset markets, have laid out detailed accounts of what they’ve gone wrong with inflation over the past two years โ€” including mistakes in their own policymaking โ€” and intent to fix it. .

“Inflation has turned out to be more steady than we thought it would be,” Loretta Meester, president of the Federal Reserve Bank of Cleveland, said on the sidelines of a conference at the regional bank.

The list of culprits is long and includes things like unexpected changes in people’s choices about what they buy and where they work, and the inflexibility of US supply chains, over which the Federal Reserve doesn’t have much influence.

But while these developments may have caused relative shifts in prices, Meester and others at the Fed now believe that it is the combined evolution of monetary and fiscal policy over the past two years that has created the most consistent increase in the base rate level that the Fed is. Now trying to arrest.

The goal of pandemic-era fiscal policy was to create a “bridge” to help families and businesses during the coronavirus crisis. But more than $5 trillion in payments, loans and other aid, with the new stimulus in place through the spring of 2021, has led to a world-class monetary surge that has fueled purchases of the goods and services the economy is straining to provide. .

The Fed’s policy, geared toward fighting the pandemic and ensuring that American workers find a way back to jobs, has remained loose all along, with low interest rates that were supposed to encourage spending in effect only until recently.

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โ€œThe reason you see (inflation) turning out to be such an integral part of that is that … we really needed to raise our money rate, or fiscal policy has to adjust to become less accommodating,โ€ Meester said last week. At the moment “there was a feeling that the policy was not very accommodating, because it was a big pandemic shock…One of the things we learned is that the economy is actually much more resilient than people thought it would be.”

Acting otherwise would be difficult.

In March 2021, for example, when President Joe Biden’s $1.9 trillion US bailout was enacted, and the last rounds of stimulus checks were in the works, the unemployment rate was still 6%, and coronavirus vaccines were at an early stage, and inflation. I just started filtering. According to the Fed’s preferred metric, inflation was running at an annualized pace of 1.7% in February 2021, below the central bank’s 2% target.

Although it rose in March to 2.5% and continued to climb, a policy change at that point would have put the Fed in direct conflict with financial authorities who were still struggling to mitigate the economic fallout from the pandemic – an uncomfortable position similar to what the Bank of England did. Officials face major tax cuts after the new British Prime Minister Liz Truss’ government announced big tax cuts.

This would have been an extraordinary amount of insight, in an era of uncertainty and as the Biden presidency was taking shape.

“How can you not say we called that wrong? I’m not running away from it,” Richmond Federal Reserve Chairman Thomas Barkin told reporters last week in Virginia. โ€œThe implicit perspective is that this is going to be a demand-refund problem. So you have to do everything you can to demandโ€ policies to increase consumption and income.

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In hindsight, “How much do we really have to do?”

Needle moved

The Fed now faces a version of the same problem: How long does it wait for evidence that inflation, now running at more than three times the central bank’s target, is falling before adjusting for the pace of price increases or even the policy rate endpoint?

Those concerned about the sharp pace and insistence of Fed rate increases argue that inflation is about to turn, and that persistently violent increases in interest rates could push the economy toward higher unemployment โ€” currently at 3.7% โ€” and slower. Necessary growth.

Ian Shepherdson, chief economist at Pantheon Macroeconomics and one of the advocates of the view that much of the recent inflation can be traced back to rising profit margins, which he believes will reverse quickly as demand declines.

If that proves true, and oil prices do not rise again, the closely watched federal inflation gauge could collapse next year, Shepherdson estimates.

This is an argument that Brainard also mentioned in a recent research paper, stating that lower profit margins can โ€œmake an important contribution to reducing pricing pressures.โ€

But the timing is uncertain, and Fed Chair Jerome Powell said the “clock is ticking” for the central bank to show it can make headway on inflation in order to maintain its credibility with markets and the US public.

Even after listing the forces she thought could bring down inflation and mentioning “the risks associated with excessive stress,” Brainard said the Fed remained focused unilaterally.

“We have the capacity and responsibility to maintain solid inflation expectations and price stability,” she said. “We’re in this for as long as it takes to bring down inflation.”

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