Where is the Fed’s target for inflation going?

Serrano specifies that in the last 10 years the United States had controlled inflation and below the Fed’s target and “it has increased to levels not seen in 40 years. At the end of April, headline inflation stood at 8.3% at the annual rate, while the comparable figure for core inflation, which excludes the most volatile prices, was 6.3%”.

One of the main factors to which the chief economist of BBVA Mexico attributes the high inflation in that country is the COVID 19 pandemic, which has caused bottlenecks in global distribution chains due to port closuresas well as less availability of boats and cargo transport due to the waves of virus contagion.

Serrano explains that one of the decisions made by the United States during the most critical stage of the pandemic was to grant extraordinary support that allowed people, especially those with lower incomes, to minimize the economic impact of the health crisis. Nevertheless, in his opinion, the fiscal and monetary stimuli “lasted longer than necessary”, and that impact has been transferred to the increase in pricesthe main reason is that it is very difficult to foresee “the economic damage that the pandemic could cause”.

It is very difficult to know how far behind the curve the Fed is and how much more to tighten monetary policy

Likewise, the head of BBVA Research for Mexico considers that the high inflation in the United States is also a consequence of the “Russia’s aggression against Ukraine that has resulted in high increases in energy and food prices”. Serrano details that when faced with a scenario in which it is difficult to determine both the supply factors -such as the pandemic and the Russia-Ukraine war-, as well as the demand factors that refer to economic support, “it is very difficult to know how so behind the curve the Fed is going and how much more should monetary policy be tightened: underdoing it can result in even higher inflation and more difficult to control and doing too much can push the US economy into a recession.”

For Serrano, the biggest challenge for the Federal Reserve is to lower inflation without generating a recession or “provoking disruptions in the financial markets.” But he points out that history has shown from past experience that trying to lower inflation to these levels ends up causing an economic contraction and explains that the Fed is probably acting appropriately with its decisions and allowing it to control inflation without a recession, although the risks are high.

The economist details that among the main factors that could benefit the measures adopted by the Fed are the accumulated savings equivalent to 11% of the Gross Domestic Product (GDP) achieved by families in the pandemicas well as the recovery of the United States labor market “in a situation of strength, with an unemployment rate of 3.7%, which, although higher than the 3% prior to the pandemic, is a low level from the perspective of the last 20 years”.

Serrano points out that there is still room to tighten monetary policy without being too restrictive, which is why he considers that the Federal Reserve will continue to raise the interest rate “by half a percentage point in each of its next two meetings, taking the rate to 2.75 % at the end of this year and between 3.5% and 4% at the end of 2023”. However, he warns that to achieve a better inflationary behavior, the US economy will at least slow down and for the Mexican economy it will mean experiencing some negative effects in his recovery.

The article was published in El Financiero on May 12, 2022 and can be viewed at this link.

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