Source: China Daily website
Introduction: The Federal Reserve recently announced a substantial interest rate hike , hoping to curb excess demand and find a "soft landing" for the economy. However, the historical experience of the past half century shows that the Federal Reserve has never been able to successfully control "stagflation" without paying the cost of economic recession. The Fed misjudged the inflation situation and took action too slowly. It is becoming increasingly difficult for it to control inflation without triggering a significant increase in unemployment.
As inflation unexpectedly rose in May and the risk of inflation expectations becoming "unanchored" increased, the Federal Reserve announced a substantial interest rate hike of 75 basis points at the June interest rate meeting, which was the largest rate increase since 1994. The Fed hopes to curb excess demand by raising interest rates and look for possible paths that can achieve a "soft landing" for the economy in the future. However, historical experience over the past half century shows that the chance of achieving a "soft landing" in the context of the Fed's interest rate hikes is less than 30%.
Since 1965, the Federal Reserve has experienced a total of 11 interest rate hike cycles. Among them, the Federal Reserve lowered inflation levels in three interest rate hike cycles in 1965, 1984 and 1994 without triggering an economic recession. During these relatively successful "landings", the U.S. economy has obvious things in common: first, the labor market is not very tight; second, the inflation level is relatively low and the supply chain is relatively stable; third, the interest rate level is higher than inflation. level.
Image source: Xinhua News Agency
Why are these three conditions so important? First, the relatively loose labor market means that companies can respond to interest rate increases by cutting wages, so there is no spiraling inflationary pressure on the economy. Second, lower inflation means less tightening pressure on the Fed, so monetary policy has more room to balance employment and inflation. Moreover, the relatively stable supply chain means that there is no risk of stagflation in the economy, and the Federal Reserve's monetary policy can cool the economy by curbing demand. Finally, the interest rate level is higher than the inflation level, indicating that the Fed has taken early action before the "wage-price" spiral phenomenon takes shape, rather than waiting until inflation gets out of control before starting to raise interest rates. In this case, the tightening of monetary policy will be more effective. On the contrary, the effectiveness of tightening will be more doubtful, and the cost will be greater.
Historical experience further shows that in the past half century, in all periods when the inflation rate was above 4% and the unemployment rate was below 5%, the U.S. economy fell into recession within the next two years. Former U.S. Treasury Secretary Summers pointed out this phenomenon in his latest co-authored paper.
Image source: Xinhua News Agency
In the 1970s and 1980s, the United States raised interest rates four times in response to stagflation, but each time it triggered an economic recession. Several other failed "landings" were: the recession from July 1990 to March 1991, which was mainly caused by the Federal Reserve's interest rate hikes, the superimposed savings and loan crisis, and Iraq's invasion of Kuwait; the recession from March to November 2001 , caused by the Federal Reserve raising interest rates to puncture the Internet bubble crisis, and the "9·11" terrorist attacks; the recession from December 2007 to June 2009 was caused by the Federal Reserve raising interest rates to puncture the real estate bubble, and evolved into times The loan crisis was caused by .
Compared with the conditions when the U.S. economy achieved three "soft landings" in history, the current pressure on the United States is much greater. First, the U.S. labor market is tighter than the unemployment rate suggests. In April 2022, the job vacancy rate in the United States was as high as 7%, and the turnover rate was as high as 2.9%, both significantly higher than pre-epidemic levels. The unemployment rate was as low as 3.6% in May, almost the same as before the epidemic. All these will lead to continued accelerating wage increases.
Image source: China Daily
Secondly, CPI continues to rise month-on-month, and the foundation of inflation becomes increasingly solid. The year-on-year growth rate of CPI in May 2022 unexpectedly climbed to 8.6%, which not only exceeded the expected value of 8.3%, but the monthly month-on-month growth rate also reached 1%. This shows that prices are still rising and inflation has not yet reached its peak.
Once again, the Federal Reserve misjudged the inflation situation and acted too slowly, making real interest rates negative for a long time, causing price increases to become more common, and asset price valuations to be high.
Finally, the supply chain is slow to repair and the economy faces the risk of stagflation.The supply side of the U.S. economy has been more affected, especially the instability in the manufacturing supply chain caused by the game between China and the United States. The crisis between Russia and Ukraine and the sanctions imposed by the United States and Europe on Russia have caused price fluctuations in commodities.
Image source: Oriental IC
Today, under the continuous negative impact on the supply side, the U.S. economy is facing the risk of stagflation similar to the 1970s. As mentioned earlier, historical experience shows that the Fed has never been able to successfully manage stagflation without the cost of economic recession. The Federal Reserve is trying to reduce excess demand by significantly raising interest rates to curb the impact of demand on inflation. However, the Fed's interest rate hike policy is difficult to affect the supply side. The Fed hopes to control inflation without triggering a significant increase in unemployment, and while this is a possible scenario, it is becoming increasingly difficult. The dot plot of the June interest rate meeting shows that the Federal Reserve may raise the federal benchmark interest rate to around 3.4% by the end of 2022, which is a restrictive level that is likely to cause a "hard landing" for the U.S. economy.
Of course, the specific path of future interest rate hikes by the Federal Reserve will depend on new changes in inflation and economic conditions, but the Fed will have to bear the risk of "going too far" or "not going far enough."
Image source: China Daily
