May 5, 2022
image source,Archyde.com
A jogger runs past the Federal Reserve Building in Washington, DC, USA
On May 4, the Fed decided to raise interest rates by 50 basis points (0.5%) at its May interest rate meeting, and announced that it would officially begin to shrink its balance sheet on June 1. This rate hike is the largest move by the U.S. since 2000.
However, Fed officials have repeatedly released signals on sharp interest rate hikes, coupled with St. Louis Fed President Bullard’s possibility of raising interest rates by 75 basis points, the market is even worried regarding a larger interest rate hike. The final 50 basis point rate hike was in line with market expectations, and stock markets in many major markets around the world rose.
At the press conference following the interest rate meeting, Federal Reserve Chairman Jerome Powell (Jerome Powell) made a rare direct statement that the Fed is currently not considering a single 75 basis point rate hike rhythm.
Helpless
Including the United States, the global economy is still gradually emerging from the shadow of the new crown epidemic. At this stage, lower interest rates are actually needed to stimulate economic recovery.
Specifically, when the Fed raises interest rates, the addition is the federal funds rate. This rate is the rate at which U.S. banks and banks lend money to each other.
If this rate rises, the rate at which banks lend to businesses or individuals will also rise, reducing the money supply and lowering inflation, thereby cooling the economy.
Conversely, if the interest rate is cut, the interest rate on bank lending will be lower, and the cost of borrowing money will be lower, which will stimulate business and personal lending, and generally speaking, the overall economy will be stimulated and become more active.
image source,EPA
Fed Chairman Jerome Powell initially predicted that inflation would be “transient.”
The Fed adjusts this rate to achieve one goal – to maintain maximum employment and price stability in the United States. Cut interest rates when the economy is weak to inject more liquidity into the market and stimulate the economy. Raising interest rates when the economy is strong reduces the money supply, lowers inflation, and prevents the economy from overheating.
This has also become one of the most important monetary tools, coupled with the hegemony of the US dollar, the Fed raising or cutting interest rates will have a direct or indirect impact on the global economy. For example, following this rate hike, Hong Kong followed suit, and India and Australia also raised rates.
The Fed also operates on this logic. The United States was hit hard by the 2008 financial crisis. In order to increase the money supply and boost the economy, the Federal Reserve once cut interest rates to 0-0.25%. This ultra-low interest rate was maintained for seven years. At the end of 2015, the Federal Reserve started a three-year interest rate hike channel, raising interest rates nine times in a row.
After the outbreak of the new crown epidemic, the Federal Reserve cut interest rates in an emergency in March 2020, dropping to 0-0.25% at one time, and interest rates returned to the zero interest rate era at the end of 2008, and maintained for four years until a small 25 basis point interest rate hike in March this year.
The pain of inflation
According to the above principles, in the current economic recovery, the Fed should cut interest rates or keep interest rates low, but choose to raise interest rates. Powell also bluntly stated the reasons behind it, “Inflation is too high, and we understand the difficulties it creates… We are moving quickly to bring it back down.”
The United States is experiencing the highest inflation in 40 years, with the year-on-year increase in the consumer price index (CPI) in March this year hitting the highest level since December 1981, up from 7.9% in February. Prices have been rising, and inflation has been above 6% for six consecutive months, well above the Fed’s average target of 2%.
When inflation remains low (2-3%), economists call it the “lubricant” of the economy, because a small increase in prices can lift entrepreneurs’ incomes, spur them to invest further, and increase economic vitality.
Most economists also have a 2 percent inflation target, and a large deviation from this target for a long period of time is considered dangerous. Therefore, for the Fed, which plays the role of the central bank, how to control the high inflation has become a top priority.
Sustained high inflation has also become a growing political issue for U.S. President Joe Biden, who faces the test of midterm elections.
But he conceded that the supply shock from the Ukraine war and the blockade of Chinese oil companies presented officials with a daunting task — and might force them to act more aggressively than ever to curb demand.
Many economists believe the Fed was too slow to respond to high inflation. Thomas Hoenig, a senior fellow at the Mercatus Centre at George Mason University who has worked at the Fed for nearly 40 years, told the BBC that the Fed and most of the world’s central banks are far behind inflation increase.
image source,EPA
On the New York Stock Exchange, a trader looks at a screen showing news of the Federal Reserve’s decision to raise interest rates.
After this rate hike, it means that the Fed charges banks to borrow from 0.75% to 1%. Higher borrowing rates help fight rising prices, because it will reduce people’s demand for products such as cars and houses – — These are the two major drivers of U.S. inflation, which this time around has been much longer and stronger than Fed officials initially expected.
“Correct mistakes with mistakes”
While Honig thinks the Fed is slow to raise rates, he also warns that hitting the economy with very large rate hikes is “trying to correct that mistake with another mistake,” and the U.S. economy will pay quite a bit for it. big price.
In other words, a sharp rate hike by the Fed also risks triggering a sharp economic slowdown, especially when new challenges arise, such as the Russia-Ukraine war, and China’s capacity problems due to lockdowns.
“It’s a narrow path that they (the Fed) have to walk, and it’s going to be a very difficult task,” Donald Kohn, an economist who served on the Fed’s rate-setting committee, told the BBC.
It is worth mentioning that in terms of fiscal and financial policies, the policy orientations of China and the United States are exactly the opposite.
image source,EPA
China’s ongoing lockdown measures will take a toll on the economy (pictured, people line up to buy food at a store in Beijing).
Recently, Chinese officials have stated in a series of meetings that regarding the operation of the macro economy, it is necessary to “truly revive the economy in the first quarter, take the initiative to respond to monetary policy, and maintain moderate growth in new loans.”
The People’s Bank of China has also made it clear that monetary policy must take the initiative to respond, new loans must maintain moderate growth, vigorously support small, medium and micro enterprises, firmly support the development of the real economy, and keep the economy operating within a reasonable range.
The reason behind this is not difficult to understand. China’s prices have not been as high as the United States, but the continuous epidemic in Shanghai, Beijing and other places has made the economic outlook in the second quarter sluggish and requires loose monetary policy to stimulate.
However, the opposite policy orientations of China and the United States have also brought new challenges to China. Zhao Xijun, co-dean of the China Capital Market Research Institute of Renmin University of China, said that the Fed’s interest rate hikes will increase the value of US dollar assets, which will easily lead to the outflow of Chinese funds. China’s loosening of monetary policy means that the interest rate gap between the RMB and the US dollar will be further narrowed, which will bring certain challenges to maintaining the balance of payments capital flow and the stability of the RMB exchange rate.
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