Good News on Economic Spectrum: Fed’s Rosy Outlook & Factors

The Federal Reserve opted not to cut interest rates in its recent meeting, signalling optimism about the economic trajectory. Chairman Jerome Powell emphasized the positive state of the economy during the Federal Open Market Committee (FOMC) meeting. While rates remain steady at 5.25-5.55%, the unanimous FOMC vote indicates confidence in the declining inflation trend over the past six months.

We interviewed economist Jeffrey A. Frankel and James W. Harpel, Professor of Capital Formation and Growth at Harvard Kennedy School, to gain insights into the Fed’s strategy and the current state of the U.S. economy.

Powell’s “Risk Management Mode” Explained

Powell mentioned that Fed rate hikes might have peaked for this cycle, but the Fed remains cautious. Frankel explains that the Fed is carefully balancing the risks of inflation and unemployment. They want to ensure that inflation remains consistently below 2% before considering rate cuts.

The Fed is not in a rush to cut rates, despite market speculations about upcoming cuts. They need more evidence that inflation is firmly under control before making such a move.

The Fed doesn’t have a specific benchmark in mind but is looking for a sustained trend. They closely track the Personal Consumption Expenditure deflator (PCE deflator) as a key measure of inflation. The Fed wants to see this measure decrease.

However, their decisions are influenced by various factors, including economic growth and the unemployment rate. A recession or other unexpected events could alter their stance.

Economic Expectations and the Fed’s Response

The markets expected rate cuts to begin in the spring, but the Fed’s recent stance suggests that rates might remain higher for a longer duration. The Fed’s December statement indicates the possibility of rate cuts later this year, depending on economic conditions.

Regarding Powell’s statement about a soft landing, Frankel believes it depends on one’s definition. He suggests that, to some extent, the U.S. has already experienced a soft landing. However, the absence of a precise definition leaves room for interpretation.

U.S. vs. Europe: Resilience Factors

Frankel discusses why the U.S. economy has been more resilient compared to Europe despite higher interest rates and inflation. He attributes this resilience to the U.S. effectively managing supply chain disruptions and achieving favourable supply shocks.

He also points out the role of immigration in the U.S., which has boosted the labour force and contributed to economic growth. Immigration has alleviated demographic challenges and allowed for continued growth with lower inflation.

The Overall Economic Outlook

In conclusion, Frankel highlights that the U.S. economy has performed remarkably well across various indicators. Despite initial scepticism, recent economic data have convinced many observers of this positive trend.

The Fed’s challenge remains striking the right balance between managing inflation and supporting growth. Looking ahead, the favourable supply shock and effective Fed policies have positioned the U.S. economy in a stable position.