Predicting the future of any economy is a balancing act on a fragile wire. While many major economies appear to be faltering, the big question in the corridors of power is whether America will continue to grow. Experts’ opinions vary and rest on the delicate balance of the Federal Reserve’s (Fed) monetary policies.
The behavior of inflation plays a crucial role. Although it has decreased, inflation still remains at high levels (3.17% in July). Unlike the European Central Bank, whose sole objective is price stability, Fed President Jerome Powell faces the challenge of weighing not only inflation, but also maximum employment and financial stability.
While they share similarities, it is important to understand the difference between the nature of inflation in the United States and Europe. In Europe, inflation has been largely driven by supply-side issues, while in the US inflation is mostly a demand issue. Geopolitical tensions (struggle for supremacy with China and war in Ukraine, among others) and the reorganization of globalization are having inflationary supply effects, both in Europe and the United States, with increases in the prices of many raw materials and manufactured products. But in Europe we have problems with energy supply, the main cause of European inflation – largely dependent on Russia until very recently –, which they do not have in the United States. Thanks to hydraulic fracturing technologies, the United States has become a net exporter of natural gas and is the world’s number one producer of oil (although it still needs to import some of it).
In terms of demand, part of the inflationary pressures in both cases come from excess savings during the pandemic and increased consumption when it ended. But in the United States, an extremely low unemployment rate (3.5%) is added as the main reason for the increase in prices. Factors such as restrictive immigration policies due to covid, as well as the “great resignation” that has occurred after the pandemic, in which many young people leave work to live life, leave jobs to fill and put pressure on the raise salaries and wages.
Political decisions add complexity to this analysis. The more than $2 trillion infrastructure, green transition and semiconductor manufacturing public spending programs approved by Congress will have inflationary effects and represent a historic break because fiscal expansion measures of this magnitude have never been adopted before with unemployment rates so low. On the other hand, the agreement in the United States Senate of May 31 on the extension of the Federal Government’s spending ceiling until January 2025 does not hide the urgent need for fiscal consolidation (of a heavily indebted Federal State) , through the increase in taxes and, above all, the reduction of expenses (defense, social security and health). In addition, the Fed’s balance sheet has multiplied tenfold in the last decade, without anyone knowing for sure what effects this situation may have on inflation and long-term growth.
Even with a maze of uncertainties, the U.S. economy remains the most resilient, productive, and innovative in the world. Starting from similar dimensions 15 years ago, today it almost doubles the GDP of the eurozone. The per capita income of the poorest state of the 50 that makes up the USA ($40,461 in Mississippi) is equal to that of France and much higher than that of Spain ($29,350).
The Federal Reserve has raised interest rates ten times since March 2022, from 0% to 5.25%. However, the transmission to prices of this aggressive monetary policy has been slow due to the savings generated during the pandemic and the increase in consumption of services, which are less likely to be financed than goods. It has had an effect on the bond yield curve, disrupting small banks such as Silicon Valley Bank, but it has not affected household consumption or business spending and investment.
Jerome Powell will speak today Friday in Jackson Hole. It’s looking for a soft landing, so it will likely have to keep rates high until the economy cools. Will it succeed without triggering a recession? Today, it seems so.
