UNITED STATES (VOP TODAY NEWS) – The successful transition from monetary policy with anti-crisis management to credit conditions, consistent with sustainable economic growth and price stability, requires exceptionally correct forecasting in the short term – and a good deal of luck.
This hint of intervention by the higher powers should emphasize the complexity of the “normalization” of monetary policy, which for 6 years must deal with catastrophic systemic problems in the sphere of financial services and in the real economy.
The US has gone through this period since December 2007, when the Fed began to widely introduce preferential funds to save the unsustainable banking system, until the second half of 2013, when the borrowing of banks in the Fed returned to pre-crisis levels.
But even then banks were very insecure about taking risks in their core business of consumer finance. They needed to restore the destroyed capital structures, acquiring risk-free securities of the US Treasury, while non-banking structures noted the growth of consumer loan portfolios by 6%.
Difficulties of transition?
However, purely monetary monetary policy was a relatively simple task during the long process of economic recovery.
Against the backdrop of lower wages and prices in conditions of slow demand, production and employment, the money supply needed to be expanded through conventional and non-traditional tools to stimulate bank lending to households and support investment in business, reducing the cost of capital.
Judging by how the Fed manages its own balance sheet, it still remains a major political issue. Last month, the M0 monetary base remained 2.9% higher than the level of the previous year, and its average volume in February was $ 30.3 billion higher than in the previous month.
What are the figures showing us the way in which the Fed determines economic activity and price dynamics? They reflect official statements by the Fed that there are no pressure factors on the labor market and the commodity market that threaten inflation. The Fed seems to be reassured by the fact that its preferred inflation rate – the main level of the basic PCE price index – remained stable in January for 4 consecutive months at 1.5%, well below the target of 2%.
It seems that traders on the bonds agree. The Treasury yield curve has significantly decreased, as the yield on 10-year bonds reached a maximum of 2.92% in the middle of last month.
This is a good example of a problem faced by monetary policy in an attempt to stabilize the growing economy in a stable and non-inflationary way of growth.
Indeed, the current position of the Fed implies that demand, productivity, employment in the labor market and the overall level of inflation of prices will be at the same level as the Fed wants to keep them until the middle of next year.
Why? Because the US monetary policy operates with an average gap of 6 quarters, that is, 6 quarters will pass before the change in interest rates will affect aggregate demand and price stability.
What is the state of the US economy?
The policy parameters that we are now observing reflect the Fed’s forecasts that economic growth over the next year and a half will keep price inflation within the target range of 0-2%.
But what happens if this forecast turns out to be wrong and price growth accelerates in the coming months? Recall that last week, many were worried by the fact that the PCE index showed a monthly increase of 0.4% in January, after it remained virtually stable over the previous 3 months.
The answer is that the prices for bonds will fall and the Fed will continue to accelerate the rate hike until it sees that the economy is slowing. But by the time the Fed sees signs of a decline in activity and a weakening of inflation, the economy may enter a tailspin as a result of the slow recessionary impact associated with an increase in interest rates that goes beyond the necessary policy restrictions.
This was observed at the turning points of the business cycle. And it is this that made one of the most eloquent conclusions about monetary policy: booms and downturns stem from the persistence of easy or restrictive credit conditions not at the moment when the economy needs them.
What will the Fed do?
True believers in monetary policy will be told: stop destabilizing the economy by activist policies, because you do not know where the economy is at the moment when you change politics. Even less do you know where the economy will be, when these changes will affect demand and inflation in 6 quarters.
The best thing you can do is to establish the growth rates of the money supply on sustainable levels and keep them there.
This is a simple statement based on the rules of monetary policy that brought Milton Friedman the Nobel Prize in Economics in 1976. The version of this procedure based on the growth of monetary aggregates was introduced by the Federal Reserve in October 1979 and canceled because of impracticality in 1982 g. due to problems caused by financial innovations.
Investment thoughts
Currently, the Fed keeps the monetary base 2.9% above the level of the previous year, because it believes that the economy will continue to grow in the coming months in accordance with the goal of maintaining price stability, defined as a core inflation of 2% or less.
To some observers, this will seem rather a bold assumption. Consumer prices are growing at an annual rate of 2.1%, and import prices for the year in January rose by 3.6%. Tariffs on imports make the situation even worse.
At a more general level, Washington’s intention to move from a free trade regime to mutual trade will inevitably lead to an increase in price tensions in the economy caused by highly expansionary monetary and fiscal policies that far exceed its potential and non-inflationary growth.
Prices for US bonds will fall. Shares will resist, in part because corporate profits will benefit from lower wages and stronger growth in Europe and East Asia.
