The Federal Reserve Points recently pointed to an interest rate hike coming in March. This is good news for consumers who have been waiting for a rise in interest rates to boost their wallets. However, it may be bad news for the economy as a whole. According to a recent report, consumer prices jumped 7.7 percent in October and wage gains were well above the Fed’s 2% inflation target. If the Fed’s monetary policy continues, this could send the economy into a recession.
Consumer prices rose 7.7 percent in October
It’s no secret that the US is struggling to control inflation. Despite the Fed’s recent interest rate hikes, the inflation gauge remains at a decades-high level.
A new report from the Labor Department showed that the consumer price index grew by 7.7 percent in October. That was a slight improvement from a year earlier but below economists’ expectations.
While the annual inflation rate decreased from 8.2 percent in September, it was still the highest since January. The increase in inflation is a major concern for the Biden administration.
Inflation pressures remain strong thanks to the high cost of housing and rising health care costs. Last month, the price of shelter increased the largest one-month gain since August 1990.
Housing prices rose slightly less than expected in October. Economists expect that the rate of increase in the next few months will be much slower than last month’s increase.
Other services also rose strongly in November, with the index for recreation and education increasing by 0.7 percent and 0.4%, respectively. Despite the positive data, the pervasiveness of price increases is a major challenge for the Fed.
As a result, the Fed recently raised interest rates by 0.75 percentage points. This move is intended to keep inflation under control. Although the annual inflation rate fell, it is still the highest in 40 years.
With the unemployment rate at a four-year low, a tight jobs market, and a robust payroll growth, investors are hopeful that the Fed will be able to ease its interest rate hikes. Nonetheless, it’s important to note that higher borrowing costs will limit investment.
Another source of pressure on the US economy is the rise in gasoline prices. Prices for fuel oil jumped 19.8 percent in October. Gasoline was the biggest contributor to the overall increase in prices in October.
Energy prices rose 17.6 percent in the past 12 months. The core CPI, which excludes volatile energy and food costs, climbed 6.3% in October from a year earlier.
Food prices rose 0.1 percent in October. Prices for fresh fruit, vegetables, and meat slowed in October.
Wage gains are running “well above” what would be consistent with the Fed’s 2% inflation target
Despite recent improvements, the US labor market remains one of the biggest risks to inflation. Especially in the service sector, where wages make up the bulk of the cost structure, many workers are struggling to pay for necessities like food and rent.
The US Federal Reserve Points has taken a laser-like approach to its labor market and its policies in recent years, in part to keep inflation from getting too high. But the Fed has been unable to consistently reach the target of two percent. That is why it increased its rate projections for the remainder of the year, and is likely to increase its rate again in December.
Nevertheless, Fed policy makers have noted that wage growth has been running well above the two percent mark for a while now. And Powell has said the Fed is “strongly committed” to bringing that rate down.
In fact, the Fed has identified several areas in the economy where it should be doing more to slow down inflation. Specifically, it wants to reduce the pressure on companies to raise prices, and it wants to boost labor supply to avert layoffs.
Meanwhile, the Fed wants to avoid inflationary spikes in the housing and goods sectors. It is also weighing other factors, including labor force participation and demographics, which are affecting the rate of inflation.
The Federal Reserve Points may continue to tighten its monetary policy until signs of inflationary weakness are seen, or until the labor market shows some signs of cooling off. Even so, the most recent unemployment report from the Labor Department suggests the unemployment rate is still too high.
Although the labor market has been a major hurdle for the Fed, it is also one of the last dominoes to fall during a recession. Consequently, a sustained decline in wage growth would be needed before a major policy change could be implemented.
According to the Atlanta Fed, average hourly earnings rose 5.1% in the third quarter. This is a very solid number, though much less impressive than the Fed’s goal of 2% inflation.
Unanticipated shocks to the global economy
One of the biggest challenges for governments today is rekindling supply-side growth drivers. However, there is more to it than simply getting back on track. Firstly, governments need to ensure a durable policy normalisation. This involves setting macroeconomic objectives that are in line with central bank mandates. Second, they need to create sufficient room for manoeuvre to accommodate a myriad of economic uncertainties. Finally, they need to ensure that they can achieve those goals in a timely manner.
Getting back to the business at hand, the best way to do this is to develop and maintain an ample monetary and fiscal buffer. These buffers allow macroeconomic policy to deal with unanticipated events. The most important challenge is to deliver on these goals and avoid the risks of stagflation, which is a real-time threat to economic stability.
Aside from the obvious, a number of other factors impacted on the performance of the global economy in 2018. From the war in Ukraine to a pandemic that affected all regions of the globe, these and other non-economic forces shaped the past year. For the most part, the global economy was on a roll, although the year ended on a sour note.
While the Covid-19 pandemic had a big impact on the world economy, it was the emergence of an Omicron variant of the same virus that really did the business. As a result, the global economy was hit with a slew of economic and financial effects. Some of the most significant were in the form of higher commodity prices and a stronger Euro. In particular, the increase in European natural gas prices was a staggering eight times larger than pre-pandemic levels.
It may be too late to prevent stagflation, but it is clear that we are in for a bumpy ride. Fortunately, many oil exporters have the benefit of a higher state-owned enterprise revenue, which can help alleviate some of the imported price pressures. However, in terms of policy, the road to stagflation lies ahead of us.
Fed’s restrictive monetary policy could send us into a recession
Federal Reserve Chairman Jerome Powell has a pessimistic outlook on the future. He said that the Fed needs to use more restrictive monetary policy to cool down the economy.
As a central bank, the Fed has a dual mandate to pursue price stability and maximum employment. But, the two objectives aren’t always compatible.
The economy’s maximum employment goal is a broad-based goal that can fluctuate with changes in the labor market and the economy’s structure. When the Fed sees a shortfall in employment below the maximum level, it considers a wide variety of indicators. Its definition of a “shortfall” is subjective.
In the past, the Fed has pursued low interest rates and stable prices. This was the approach used during the Great Recession, when the economy suffered a massive drop in output. Following the crisis, the Fed adopted non-traditional tools to help the economy recover. These included open market operations, a discount rate, and reserve requirements.
However, these tools are blunt and difficult to adjust. They also operate with a lag. Consequently, the Federal Reserve Points has developed other tools, including large-scale asset purchases, to support the economy.
In March of 2020, the Fed initiated an aggressive quantitative easing program. This put downward pressure on longer-term interest rates. Since then, the economy has recovered from its recession, although GDP has declined in the first and second quarters.
Recently, Fed policymakers have begun stating a goal of achieving two percent inflation. In the long run, it is possible to achieve this goal without causing a recession.
But, it will be necessary to tolerate a high inflation rate to reach the goal. High inflation often translates into a higher cost of living, which raises the risk of a recession.
A rapid increase in interest rates would likely reduce consumer demand, lowering the demand for goods and services and thus leading to a lower cost of living. Higher interest rates also deter consumers from borrowing.
For example, higher borrowing costs could discourage businesses from investing and boosting production. Ultimately, this could lead to a reduction in demand, lower production, and a weakened economy.
