Weekly The Generation, Year 1, Issue 16
December 19, 2023
US economic growth, still racing at a potentially inflationary pace as other key parts of the world slow, could pose global risks if it forces Federal Reserve officials to raise interest rates higher than currently expected.
The Fed’s aggressive rate increases last year had the potential to stress the global financial system as the US dollar soared, but the impact was muted by largely synchronised central bank rate hikes and other actions taken by monetary authorities to prevent widespread dollar funding problems for companies and offset the impact of weakening currencies.
Now Brazil, Chile and China have begun cutting interest rates, with others expected to follow, actions that international officials and central bankers at last week’s Jackson Hole conference said are largely tuned to an expectation the Fed won’t raise its rate more than an additional quarter percentage point.
While US inflation has fallen and policymakers largely agree they are nearing the end of rate hikes, economic growth has remained unexpectedly strong, something Fed Chair Jerome Powell noted in remarks on Friday could potentially lead progress on inflation to stall and trigger a central bank response.
That sort of policy shock, at a moment of US economic divergence with the rest of the world, could have significant ripple effects.
After the pandemic shock and the inflationary rebound that had most countries raising rates together, it’s normal now for policies to diverge, Cleveland Fed President Loretta Mester told Reuters on the sidelines of the Jackson Hole conference on Saturday.
GLOBAL DIVERGENCE
Fed policymakers will deliver a crucial update to their economic outlook at a Sept. 19-20 meeting, when they are expected to leave their policy rate unchanged at 5.25% to 5.5%. If inflation and labour market data continue showing an easing of price and wage pressures, the current forecast for just one more quarter-point increase may hold. Yet Fed officials remain puzzled, and somewhat concerned, over conflicting signals in the incoming data.
Some point to weakening in manufacturing, slowing consumer spending, and tightening credit, all consistent with the impact of strict monetary policy and cooling price pressures. But gross domestic product is still expanding at a pace well above what Fed officials regard as the non-inflationary growth rate of around 1.8%. U.S. GDP expanded at a 2.4% annualized rate in the second quarter, and some estimates put the current quarter’s pace at more than twice that.
The contrast with other key global economies is sharp. The euro area grew at an annualized 0.3% in the second quarter, essentially stall speed. Difficulties in China, meanwhile, may drag down global growth the longer they fester. Growth, albeit slow, has continued, and inflation has fallen, an overall dynamic not dissimilar to that of the US.
US fiscal policy is driving some of the difference with $6 trillion in pandemic-era aid still bolstering consumer spending. A recent investment push from the Biden administration is supporting manufacturing and construction. China may also play a role, economists say.
TOO STRONG FOR COMFORT?
The longer the US economy outperforms, the more Fed officials wonder if they understand what’s happening. A recent improvement in productivity, for example, could explain how inflation continues falling even as growth remains strong.
Under current Fed thinking a period of below-trend growth is needed to drive inflation sustainably back to the 2% target. Key inflation measures are currently more than twice that.
Most officials do think the economy will slow, as tight policy and stringent credit are more fully felt and pandemic-era savings are spent down. Consumer loan delinquencies are starting to rise, and the restart of student loan payments could upend services spending less affected by Fed actions so far.
