U.S. Treasury Secretary Yellen is still shouting that U.S. inflation can fall to 2% this year, and Fed Chairman Powell, who has repeatedly insisted on inflation for the time being, has long changed his mouth, and the entire Fed has begun to release the bank to speed up the pace of interest rate increases and balance sheets, scaring the US stock market to collapse at the beginning of the year. Now the market just wants to know if the Fed will still do it for them, will it love them again? What is the Fed's calculation? Will there be a painless way to bring inflation down and ensure economic growth?
In the case of a sharp fall in the market and the shareholders are numb, we may as well make a bold guess, as if it is a boring person on the way down.
At the Jan. 11 hearing, Powell told the U.S. Senate Banking Committee that tightening monetary policy "really shouldn't have a negative impact on the job market."
The views of Fed policymakers have left economists debating the dots dating back decades about the link between interest rates, employment and inflation. In other words, exactly how the central bank's toolbox works, and for now, what determines the course of inflation.
Fed officials are walking a tightrope. Policymakers are responding to demands from the masses to curb 40-year high inflation in the United States; Attempts are also being made to avoid hitting workers with their historic bargaining power in the face of a hot labor market.
Easing the impact of austerity policies on the economy requires the Fed to manage public inflation expectations
The inflation expectation theory of mainstream economics since the 1980s has provided a solution that may alleviate inflation. The idea is that if a central bank can convince businesses and consumers that it will maintain low and stable inflation, then it doesn't have to do much policy; That's because residents' expectations of where prices are headed are considered an important driver of inflation itself. If workers' inflation expectations don't rise, they won't demand higher wage increases to make up for their lost purchasing power; Nor will they rush out to buy things in anticipation of rising prices, thus avoiding rising prices from spiraling inflation.
According to the theory, the Fed made a big mistake in the 1970s: it lost control of the public's inflation expectations in the United States, so much so that to curb inflation it had to raise interest rates sharply, which led to a recession and millions of people losing their jobs. Emi Nakamura, a professor of economics at the University of California, Berkeley, said: "One thing we definitely learn from history is that once you adjust people's expectations, they become very entrenched, so it's hard to go back in the opposite direction and adjust."
Now, the Fed's preferred inflation indicator, the core PCE price index, has exceeded the 2% target and is close to 6%. As a result, policymakers are also determined not to put the Fed in that position — managing expectations of the public. For now, though, they can be relieved that indicators that broadly track inflation expectations have risen, but not as much as prices have risen.
U.S. Core PCE Price Index Annualized Quarterly Rate (%)
Fed officials believe that the inflation outbreak of the past year was driven by temporary factors related to the epidemic, a view shared by Wall Street forecasters. In 2020, the U.S. government printed trillions of dollars and distributed them directly to Americans' bank accounts, sharply stimulating consumer demand, while supply chains affected by the epidemic struggled to keep up with growing demand, and soaring prices became a fact. Many economists expect inflation to largely return to normal by the end of 2022 as households consume excess cash and as the pandemic subsides to ease supply chains.
Still, economists worry that high inflation could eventually affect expectations, which in turn could prevent inflation from falling back on its own. Nakamura argues that so far, the Fed has been very successful in controlling the current situation: there are some special, possibly temporary, factors that have driven inflation in the short term, but in the long run, people should continue to believe in the Fed.
This is exactly what the upcoming rate hike cycle is meant to guard against. The rate hike is not about lowering current inflation, but to ensure that current inflation doesn't turn into future inflation — that is, the Fed needs to manage the public's inflation expectations.
In fact, former Fed Chair and current U.S. Treasury Secretary Yellen knows this all too well, having said more than once that the rise in inflation will stop this year, and on Thursday she said that inflation is expected to fall to 2% by the end of 2022, "If we succeed in controlling the epidemic, I expect inflation to fall during this year and is expected to return to normal levels of about 2% by the end of the year." ”
But perhaps Yellen is simply overconfident in inflation expectations because she is no longer a monetary policy maker. Last year, Powell and a number of Fed officials also repeatedly emphasized that inflation is only temporary, and when they were repeatedly punched in the face by the data, they finally could not hold on, realizing that only verbal management expectations were ultimately unreliable, or needed to take something real out to calm the market, so they immediately turned eagles and began to release the signal that the Fed wanted to tighten monetary policy. Perhaps that's one aspect of why the Fed is turning hawkish.
If you reason with this reasoning, the Fed may not really have to raise interest rates 3 times this year in the future, perhaps only relying on verbal flickering to scare the market, it is enough, such as you can raise interest rates once, and then verbally tough, let the market mistakenly think that there will be interest rate hikes at some time, and then the Fed did not raise interest rates, and when the "wolf is coming" is shouted more, the market does not care. And once the clever market realizes that the Fed will still be at the bottom of the stock market, it may be going to rise again.
In addition, there is a big problem. While economists and central bankers are convinced that inflation expectations are a major cause of inflation beyond short-term price fluctuations, no one really knows exactly how these expectations are formed, let alone how interest rate decisions affect inflation expectations. Julia Coronado, founder of MacroPolicy Perspectives, said: "It is completely unclear whether inflation expectations will affect price-setting behavior in any stable or observable way."
In a discussion paper published in September, Fed senior economist Jay Jeremy Rudd slammed the idea that expectations were pushing inflation higher, causing a stir. (The newspaper also issued a disclaimer stating that this was rudd's own view and did not represent the view of the Fed Board of Governors.) )
A more realistic indicator – the job market
It has long been thought that monetary policy can influence inflation through another, clearer channel: the job market. When the unemployment rate falls, the supply of available labor decreases, pushing up labor prices. Businesses then seek to raise prices to offset higher wage costs. To curb inflationary pressures, central banks could reverse this process by raising borrowing costs across the economy, which would dampen business demand for workers and dampen wage growth. The decline in spending power, in turn, limits the amount of fees that businesses charge for their products.
Powell and future Fed Vice Chairman Brainard argue that the tightening policies planned by Fed policymakers are gradual and may only raise interest rates by a few percentage points; This is in stark contrast to the tightening policies implemented by then-Fed Chairman Paul Volcker in the early 1980s, when the Fed raised the federal funds rate above 20 percent. They say the U.S. economy is growing so fast that it can withstand some slowdown — the U.S. is effectively already in "maximum employment" as unemployment falls below 4 percent for the first time since the pandemic began in December, wages rise rapidly, and job openings hit new highs.
John Jay College Professor of Economics J.W. Mason doubts that the Fed can manage to quell the pressure on rising prices without harming the labor market. "The Fed cannot reduce inflation in a direct, painless way," he said. You have to reduce demand in some way or you have to reduce the cost of output – otherwise it won't have any impact on prices. ”
Seth Carpenter, chief global economist at Morgan Stanley, said the Fed's tightening policies this year could slow the decline in unemployment, but wouldn't have much of an impact on inflation until next year. By then, inflation is likely to have largely disappeared on its own.
Carpenter noted that most empirical models' projections of the impact of monetary policy on the economy suggest that fed policy needs to directly affect inflation and that the cycle of implementation of policies needs to extend beyond this year; If the Fed does raise rates 3-4 times this year at market prices, there is a good chance that the US inflation rate at the end of 2023 will be slightly below the Fed's target.
This article originated from Zhitong Finance Network