Unpopular Opinion: The Fed’s Interest Rate Hike Is Good News.
The Fed is looking to regain its credibility.
The Fed has finally decided. It wants to show that it is not letting inflation slip away, whereas it gave the impression until now that it was not taking the risk of inflation seriously. After starting a cycle of interest rate increases in March 2022, the Fed has surprised by raising them by 0.75% in one go to 1.75% on June 15, 2022:
This unexpected increase is the right response to overly dynamic consumption and could deflate financial bubbles.
The rise in interest rates is a good response because, unlike what happened in the eurozone, the lifting of sanitary measures did not lead to a fall in the consumption of goods in favor of services. Services still account for 60% of total US household consumption compared to 65% at the end of 2019. The manufacturing sector has therefore remained under pressure, as has freight transport.
At the same time, dynamic demand, slowing immigration, and “The Great Resignation” have put the labor market under pressure and triggered the price-wage loop. The Fed is therefore looking to cool this demand that is not normalizing. It plans to continue to raise its key rates to 4%. According to the models of several economists, the price to pay would be a recession in the United States at the end of 2022 and the beginning of 2023.
By showing that it is capable of arbitrating in favor of unemployment, the Fed is returning to a monetary policy dedicated to price stability. For the first time since the 2008 crisis, it is prioritizing inflation deceleration at the expense of short-term growth and employment. In addition, the Fed has begun to sell the sovereign bonds it held as well as the financial assets pledged against real estate loans. This stops the Fed from artificially altering stock, bond, and real estate prices and pushing savers, business owners, and investors to take risks. By surprising, the Fed is seeking to regain its credibility as a central bank, whereas it had been playing the role of firefighter arsonist like other central bankers in recent years.
Above all, the Fed shows that it is still possible to free oneself from governments and the temptation to intervene in all areas of economic policy. Credibility is essential because it improves the effectiveness of the monetary policy. This means that the sacrifice in terms of unemployment will be less important for the same inflation objective. In addition, economic agents will continue to plan their behavior, because long-term interest rates will react like short-term ones. This visibility supports growth.
Finally, without being part of the credibility paradox that considers that low-interest rates aggravate financial imbalances, the increase in the cost of money could deflate bubbles and force savers and companies to be more selective. The government will also have to improve its ability to prioritize its interventions and evaluate their effectiveness.
This selectivity could lead to better productivity and thus to an acceleration of medium-term growth. It is reassuring to see the most influential central bank return to the fight against inflation. It is reassuring that the most followed central bank is getting out of the manipulation of stock and bond prices as soon as it can. The growth prospects of real economies should emerge stronger as the Japanese counter-example illustrates.
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