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Monetary policy in uncertain times

For something that has been debated and anticipated for so long, the Federal Reserve’s quarter-point rate hike, the first since 2018, drew remarkably little attention when it finally arrived on Wednesday. The central bank, long the main player in financial markets, has had to compete as a talking point with Russia’s invasion of Ukraine and a new wave of coronavirus infections in China. The lack of response is a testament to how Fed Chairman Jay Powell had been preparing markets for the gradual tightening of monetary policy since the central bank changed tone last September.

Moderation in monetary tightening is warranted, at least in wartime. There was no need to add another shock to markets chasing the conflict in Ukraine as well as the impact of the lockdown on large parts of China, already the world’s largest economy by some standards. Energy traders are already thinking about it Ask central bankers for emergency support as the disruption of their markets risks triggering a liquidity crisis.

There was a reason to keep going. Data has been suggesting for some time that US inflationary pressures are spreading from pandemic-related shortages and global energy price hikes to domestic services. Indeed, the Fed adopted a hawkish tone in its messages, and members of its rate-setting committee said they expect six more rate hikes this year. While there is disagreement over the speed and possible endpoint of the tightening cycle, the consensus is that the US no longer needs the stimulus launched at the start of the pandemic.

There are risks on both sides of the Fed’s outlook, not least the trajectory of the war in Ukraine. Any ceasefire or even a lasting peace deal would be disinflationary – partially reversing the rise in oil prices since the invasion began – while an escalation of violence could exacerbate stagflationary pressures in the global economy. China’s Covid lockdowns could also have unforeseen effects, reducing global demand for commodities but also exacerbating supply chain problems that have pushed up the prices of some manufactured goods.

What sets the Fed’s latest forecasts apart is that the central bank seems confident it can Reduce inflation painlessly. The central bank forecasts that the unemployment rate will fall further to 3.5 percent and then stay there, even as rates rise from the current 0.5 percent to a projected 2.8 percent by 2023. Powell has previously expressed his admiration Predecessor Paul Volcker decisions in the late 1970s to aggressively raise tariffs even in the face of mass unemployment; The latest forecasts deny that such compromises even exist.

the bank of england, which increases prices took a much more cautious tone on Thursday for the third time in a row. While at its previous meeting four members of the Monetary Policy Committee dissented and called for faster rate hikes, at this meeting there was only one dissenter who said the BoE should hold on. The MPC argued that in the short term, Russia’s invasion would raise inflation at its peak, but over a longer period of time it would dampen economic activity and bring inflation down faster than the committee first anticipated.

The outlook is bleak, but the Fed certainly seems overly optimistic. It’s not clear whether it’s too confident about controlling the inflationary pressures that have built up over the past year — pressures it has consistently underestimated — or about limiting the US economy’s slowdown and the fallout from the unemployment oil shock. The rest of us can only hope the mistake they’re making isn’t too big.

https://www.ft.com/content/82e51398-999c-4277-ac6e-a2dbb4d99c97 Monetary policy in uncertain times

Adam Bradshaw

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