The last meeting of the US Federal Reserve (Fed) this year maintained interest rates in line with market expectations. However, unlike what happened previously, the Fed had, in the interpretation of monetary policy trends, offered a more optimistic forecast on the US economy. It hinted that the cost of borrowing may remain unchanged for a long period of time, expecting the economy to grow moderately in the coming election year and the unemployment rate will remain low. This also means that the Fed’s monetary policy trend is changing. The latest Fed economic forecasts show that 13 out of 17 policymakers expected to keep interest rates unchanged at least until 2021. The other four policymakers expected to raise interest rates only once next year. Their view is opposite to the view of common investors of lowering interest rates. This is indeed worthy of attention.
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The reason is that the new economic situation has caused the Fed to change its motive for interest rate cut. Fed’s chair Jerome Powell has previously expressed in the first interest rate cut that “rate cut is a mid-term adjustment”. The recent development shows that this view has returned to reality. Powell said at a news conference after the policy meeting that despite the continuous risk of the global situation and development, the US economic outlook remains good. At the same time no policymaker will think a rate cut next year is appropriate. The Fed estimates that the United States’ gross domestic product) GDP will grow by 2 percent next year and by 1.9 percent in 2021. This shows that the Fed believes after a turbulent year, the US economy has achieved a “soft landing”, so the significance of future interest rate cuts to stimulate the economy is no longer important.
However, the direction of the US economy is still not clear. This is the reason why the Fed’s monetary policy has entered an “observation period”. The Fed points out that as the US-China trade war continues and inflation remains sluggish, it is necessary to monitor closely global risks. In addition to the external uncertainty brought about by the US-China trade friction, the more important factor worthy of observation by the Fed is US inflation rate. Employment and inflation should have been consistent in the Fed’s policy goals. However, in recent years, the divergence between inflation and employment is the reason why the Fed has difficulty in making decisions and this is also the reason for much of the criticisms against it. The latest data show that the unemployment rate in the United States in November fell by 0.1 percent point from the previous month to 3.5 percent, the lowest point in 50 years. But the inflation rate is still lower than the Fed’s target. The core US November Consumer Price Index (CPI) index shows that it is 2.3 percent, similar to October’s CPI index. The core PCE index tracked by the Federal Reserve was 1.6 percent in October and the estimate for November was far below the policy goal of 2 percent. The median forecast of the Federal Reserve is that the unemployment rate is expected to remain at the current level of 3.5 percent this year. It will only rise to 3.6 percent in 2021. Inflation is expected to climb to only 1.9 percent this year, showing the inflation rate and low unemployment rate remain out of touch. Does persistent low inflation mean insufficient demand? This has left the Fed confused and worried.
Therefore, this type of departure also put the Fed in an awkward situation and unable to act. BlackRock’s global report also shows that, given the performance of US data, the Fed may not interfere with the interest rate policy for a long time, even throughout 2020. The stability of the labour market means that the net increase in employment can last for a long time and there is no need to worry too much about any substantial slowdown in the economy.
This “structural” contradiction of the US economy has made the Federal Reserve afraid to act for quite some time, which may be the reason why it “observes the trend of the US economy”. Powell stated “We have realizsed that the unemployment rate can be kept fairly low for a considerable period without putting unfounded upward pressure on inflation.” In fact, these forecasts also suggest that the Fed still expects the interest rates are to remain loose. Some analysts believe that at least by 2022, interest rates will fall below the Fed’s estimated neutral level of 2.5 percent that the Fed will neither stimulate nor inhibit. Moreover, the Fed continues to inject liquidity into the market to ease the tension and to realise the regulation of market interest rates.
However, unlike the better employment situation, there are signs that the US economy may slow down because of cooling consumer spending and continued decline in corporate investment. Forecasting firm Macroeconomic Advisers estimates that the fourth-quarter GDP of the US will prove to have slowed to 1.8 percent. According to The Wall Street Journal, the Oxford Economic Research Institute believes that the latest data shows that the US economy will not fall off the cliff immediately, but economic activity will further weaken in the next few months. These structural contradictions of the US economy also mean that the Federal Reserve cannot have clear expectations about the direction of the US economy, and there is no way to have a clear outlook on monetary policy.
As the Fed ’s monetary policy enters the phase of “wait-and-see”, it is expected to affect the policies of the eurozone and other countries, gradually relaxing the pace of global monetary easing, in addition to relaxing the increasingly negative interest rate environment. In this context, promoting structural reforms will increasingly be on the policy agenda.
Chan Kung founded Anbound Think Tank in 1993. He is now Anbound chief researcher and is one of China’s renowned experts in information analysis. Most of Chan’s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
Wei Hongxu, graduated from the School of Mathematics at Peking University with a Ph.D. and in economics from the University of Birmingham, UK, in 2010. He is now a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Anbound was established in 1993 and specialises in public policy research.