Where are we going? Where we come from? Let’s talk about the United States Federal Reserve
It was not easy for a country like the United States to achieve the creation of its central bank. In a sense, its creation was a necessary evil that was grudgingly accepted. It took several tries. But finally, succeeded because the alternative was not working. The idea was resisted for a long time, fearing a very great concentration of power and centralization. However, not having a central bank proved to be a very bad option. Because the period before the creation of the US Federal Reserve was characterized by currency instability, bank runs, and boom-bust cycles.
Most libertarians (so numerous in the crypto space) oppose the idea of a central bank. In this case, it is thought that the free market can perform the same function in a decentralized way. History, however, has shown us that this is not entirely true. The benefits of the free market obviously have their limits. There is no developed country without a central bank. And I dare say that this is no coincidence. Of course, the opposition is always right from the stands. Of course utopias are perfect in the imagination. However, modern practice has chosen to have a central bank, because that is what has worked best. TRUE. Conservatives disagree with this last statement. But the conservatives have failed to convince the majority that a system without a central bank is better than the current one. Thus, reform is not on the table. What we have is what it is.
- Inflation: Why not reducing it further will not be so easy?
What you have now in the United States is a central bank with a decentralized structure. Independent, but in the Government. Autonomous, but supervised by Congress. It is an institution with a double mandate: maximum employment and price stability. It only focuses on one of these commands at a time. Because the task of promoting both mandates at the same time is practically impossible thanks to the contradictory natures of the two missions.
What happened during the pandemic? During the pandemic, the economy came to a standstill due to lockdown measures. That generated a great economic contraction. This abrupt drop in demand produced a serious deflationary scenario. Which, in turn, produced a drop in income and a dramatic rise in unemployment. In this context, the Federal Reserve was forced to reduce credit costs, placing rates at zero and buying debt (public and private). And that was done to increase demand.
The effect? Well, one of the effects of this was a boom speculative in financial markets. So at this time, a rather particular situation was formed. The “real” economy in crisis, but Wall Street partying. Because all this liquidity (out of the blue) first benefited Wall Street. Similarly, fiscal spending was also increased with all assistance programs. Apparently, The population used a large part of this money to invest in the stock market, buy cryptocurrencies, buy consumer goods, and consume digital products.
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Initially, what we really had was a deflation problem. That is the reason for the stimuli. However, over time, complications arose. The global productive apparatus proved to be more fragile than thought as it could not be reactivated at the required speed. Failures in the production and distribution chains caused supply problems. And this ended up exerting strong inflationary pressures. Which became a great challenge for monetary policy. Now it turns out that the demand is excessive in relation to the supply. Inflation got out of control and reached unacceptable levels. Therefore, it is now necessary to rebalance by reducing demand. The Federal Reserve, then, was forced to change course in a surprising way. As interest rates rise, credit costs rise. Then the demand goes down. In this way, it is intended to restore balance.
Notably, the Federal Reserve has no control over fiscal policy, nor does it have power over supply. His influence is limited to his power as a lender. During the pandemic, he focused on combating unemployment with liquidity injections. At the moment, his priority is to reduce year-on-year inflation to the 2% target by tightening the currency.
The ideal scenario would be to reduce inflation to the target causing as little damage as possible. This is what is known as a “soft landing”. Or, put another way, what you want is to reduce inflation without causing a recession. It doesn’t take a genius to know that this will not be easy to achieve. It is true that the production and distribution chains are healing. It is true that the excess demand is diminishing. And it is true that we have come a long way in the fight against inflation. However, it seems rather premature to claim victory. Many things must go right for this ideal scenario to be achieved. Many things can still go wrong. And unfortunately, when many things can go wrong, usually something does. He does not want to fall into pessimism. It is just that It seems to me a mistake to underestimate the complexity of our current situation. It is best not to count the chicks before hatching.
- Crowd Psychology: Why Do Markets Tend to Exaggerate?
The US job market is still too tight. And inflation in the service sector (due to labor costs) will not be easy to bring down without more aggressive monetary tightening. In fact, from now on, the Federal Reserve will most likely continue to raise interest rates. The market expects a further increase of 0.25% for the next meeting in March. The reaction of inflation remains to be seen with a rate close to 5%.
It will be enough? Unfortunately, we don’t know yet. It all depends on the data. AND I am afraid that it is still too early to assume that inflation will fall like low-hanging fruit to anticipated levels (ie 5%). Right now, the market is pinning all its hopes on this scenario. However, we don’t always get what we want. When it comes to forecasting, it’s never a good idea to think in absolute terms. Lor better is to think in probabilities. We bet on the probable. We prepare for the improbable.
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It may interest you:
- Inflation: Why not reducing it further will not be so easy?
- The scrutiny after FTX. What awaits us?
- Crowd Psychology: Why Do Markets Tend to Exaggerate?