For almost all countries in the world, Corona brought a threatening collapse in their economy. The Covid-19 recession was not only particularly difficult, it was also the shortest since reliable macroeconomic statistics were available. In the United States, it lasted a full two months, according to the National Bureau of Economic Research (NBER) in Washington. It ended as early as April 2020. It helped that the governments in America as well as in Europe got massively indebted and thus secured demand and jobs. New President Joe Biden wants to take the opportunity to invest trillions of dollars in renewing the infrastructure of the United States and ensuring employment for as many Americans as possible. And the Fed has supported the recovery with unprecedented cheap money. Last August it decided to aim for an inflation rate of “average” 2.0 percent in the future – significantly more than the previous target of “below 2.0 percent”.
But now that the American economy is growing rapidly again, the question arises: Could it be that the Fed is now too generous? And isn’t a course correction overdue to prevent inflation from spiraling out of control?
The Federal Open Market Committee (FOMC), the governing body of the Fed, will discuss these questions on Wednesday and Thursday of this week. Financial market experts are certain that the Fed will neither raise key interest rates (they are currently between zero and 0.25 percent) nor cut the bond-buying program. Under this program, the Fed buys $ 80 billion in government bonds and $ 40 billion in mortgage bonds every month, pumping money into the economy. However, it will be interesting to see how the members of the Open Market Committee discuss the issue and which of them will appear in the official statement after the meeting. Perhaps it will then be possible to read out a careful correction of the course in the future.
Delivery bottlenecks for semiconductors are a burden on the economy
Some figures can be quite unsettling. In June consumer prices in the US were up 5.4 percent compared to the same month last year, the largest increase in 13 years. The causes are the increased demand but also supply bottlenecks in many sectors, for example in the semiconductor industry. Fed chief Jerome Powell admitted two weeks before Congress that “inflation was higher than we expected and a little more persistent”. Nevertheless, he considers the price pressure to be a temporary phenomenon.
There are certainly arguments for Powell’s serenity. For example the development of inflation expectations. Economists consider this to be relevant because developments that people expect for the future influence their actions today. According to statistics regularly published by the University of Michigan, American consumers believe that inflation will be 4.8 percent in a year. In five to ten years, however, it should only be 2.9 percent.
On the other hand, the cheap money policy means that mortgage loans are dirt cheap. As in Germany, this leads to a boom in property prices. The S&P Case-Shiller index for single-family homes rose 14.6 percent last April – the sharpest increase in three decades. This will create social problems because many low-wage earners can no longer afford their own homes. And if interest rates should rise again, it could lead to a financial crisis. In June, however, unexpectedly 6.3 percent fewer houses were sold in the USA, which could point to a normalization of the market.
What lessons can one learn from history?
In the debates about the right Fed policy, the question is always what lessons can be learned from history. On the one hand, there is the experience of the financial crisis of 2008, in which the Fed flooded the economy with cheap money and thus prevented a new global economic crisis. On the other hand, there is the memory of the stagflation of the 1970s, when the state went into massive debt in order to be able to finance the Vietnam War and generous social programs at the same time, and the Fed supported it. Stagflation – the combination of rising prices with high unemployment – could only be eliminated in 1979 through shock therapy, which ultimately brought the conservative Ronald Reagan to the White House. Significantly, it was not a conservative but the progressive Larry Summers – Secretary of the Treasury under Bill Clinton and advisor to Barack Obama – who warned against a repetition of the 1970s in the spring. However, he did not criticize the Fed, but asked in the Washington Post, whether President Joe Biden is not getting into debt too much and thus setting the inflation spiral in motion.
But now the Fed will be advised first. John Vail, chief strategist at Nikko Asset Management, an asset manager, said, “Markets are expecting a slight move away from extreme ease.” Then the details will be interesting.