The data on important indicators for the US economy
show improvement in July compared to the second half of June. The economy is
doing fine one month and the trend also reverses every one month which may mean
that interest rate hike decisions is affecting the spending decisions, to say
whenever the economy shows signs of improvement and the Fed comes close to a
rate hike spending goes down and when it delays the indices improve again.
Expectations about interest rate hike are important for the outcome because
whenever people expect higher real interest rate, since inflation is low a
nominal increase in the rates would increase real interest rate and savings,
and lower spending would lower the price-level, but the Fed has committed
higher inflation and a higher real interest rate would lower spending and the
prices, opposite of the Fed’s policy. The Fed is trying to catch a train before
the time by increasing the interest rates which would again work to lower
inflation in the future too. A higher interest rate means lower demand and
prices. Communicating the direction of the economic-policy is important to make
people conscious about the change which makes them to act rationally. How can
people expect inflation when the monetary policy is working to curb it before
time by increasing savings and lowering spending? The signals are misleading.
Nonetheless, if the Fed communicates that it would keep the interest-rates
unchanged till inflation leads to wage demand hike after full-employment, it
may increase spending and economic-growth because inflation is still half the
target and is also expected to remain low due to benign global commodity prices.
Brexit would further lower global demand, trade and investment and prices. The
Fed is trying to find the full-employment level which it thinks it is closer
but wages hike demand is yet to become visible to prove that we have reached
full-employment, but low inflation is also responsible for weak wage demand. To
increase wage demand and spending and growth the Fed may choose to remain
accommodative till the economy actually starts overheating. The fear that the
Fed may miss rate hikes at the right time is overdone because the economy is
getting updated data every month and the reaction time would be much less, so
to think that we are behind the curve is useless and not true. If the Fed waits
for inflation and rate-hike that would do well to communicate clear that
inflation would signal a rate hike and a lower inflation means delay in the
rate hikes which might increase spending, both consumption and investment, by dis-incentivizing
savings through low interest rates. The Fed manages interest rate by
controlling money-supply which increase/decrease demand and supply and decide
the level of inflation/disinflation/deflation, but from a policy perspective
lower prices are more viable because they increases real wages and real exchange
rate which increase domestic demand and also the demand for exports. Low prices,
higher savings and low interest rate might be good for investment and supply,
and, higher real wages and real exchange could be good for demand, consumption
and exports. The Fed’s policy to control inflation before time signals controlled
prices, not inflation. It is working against its own inflation targeting, by
hints of rate hikes…
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