Plunged into an episode of stagflation which challenges the institution in its double mission, the American Federal Reserve, the Fed, does not budge. It is now difficult for it to justify the current pace of its support program in the form of asset purchases. Inflation in all its forms persists.
“At a press conference, the Fed chairman stressed that several members of the monetary policy committee are of the opinion that the conditions to begin to reduce the purchase of securities are met, or close to being. In this sense, a drop in securities purchases could be officially announced at the next Fed meeting, that is, the one that will end on November 3, ”said Francis Généreux, senior economist at Desjardins Group. “Once started, the decline in purchases is expected to continue gradually to end around the middle of 2022.”
At that point, the central bank’s balance sheet could reach US $ 9 trillion, or the equivalent of 45% of US GDP, analysts have already estimated.
In total, quantitative easing applied during the pandemic inflated the balance sheets of central banks in developed countries by US $ 11.7 trillion, JP Morgan calculated. At the end of 2021, this cumulative balance should reach 28 trillion, or the equivalent of 75% of the market capitalization of the securities making up the S&P 500. An increase which is not without posing a threat to public finances, has warned The Economist.
In an opinion letter published on August 26 in the Washington PostLawrence Summers, Secretary of the Treasury under President Bill Clinton, also believes that the Fed has gone too far. While the use of quantitative easing was appropriate during the 2008 financial crisis and justified at the onset of the 2020 health crisis, it is now a danger.
General inflation stubbornly hangs far above the institution’s targets and asset price inflation, with real estate and the stock market in mind, is reaching the size of a bubble. “At a time when the risks of a bubble are surely very high, the objective of the policy should not be to further inflate asset prices,” he denounces. Moreover, this support in the form of asset purchases mainly benefits those who hold them.
Inflation lasts
Fed Chairman Jerome Powell admits he can’t keep pace. And he believes that the current context of stagflation, which for several months has combined stagnation in economic activity and price inflation, will not set in permanently. The Fed had to lower its forecast for US GDP growth for 2021 to 5.9%, from 7% in its forecast published in June. But to raise its projected targets for the next two years.
The sky is darkening, however, in terms of inflation: it will be higher this year, at 4.2% against the 3.4% previously forecast, to then stabilize, but remain at 2.2%, or slightly above the Fed’s target. Its monetary policy committee, however, persists in arguing that inflation largely reflects “transitory factors”.
Thus, the famous base effect associated with the comparison with numbers atrophied by the pandemic seems to be stretching. Jerome Powell acknowledged on Wednesday that prices could continue to advance longer than expected, as the reopening of the economy continues “to face bottlenecks, hiring difficulties and other constraints, which could s ‘prove to be more important and more durable than expected,’ reads a text from Agence France-Presse.
The Fed is also paying attention to the potential for wage increases to significantly and persistently exceed levels of productivity gains, which could lead to a wage-price spiral. She therefore no longer has a choice. The $ 120 billion in treasury bills and other mortgage-backed securities purchased each month will gradually decline, to zero somewhere around mid-2022. For short-term rates, the Fed’s target will stay in the 0-0.25% range for some time, but the timing of a first hike since the start of the pandemic would be moved forward to occur somewhere around the end of 2022, according to the forecasts of the members of the monetary committee.
Lawrence Summers argued that the Federal Reserve insisted on keeping its foot on the accelerator in order to spare markets the immediate pain associated with a change of course. But the Fed has surely not forgotten the violence of the reactions on the markets in the wake of the major maneuvers beginning the end of the exceptional monetary easing, which moved from 2013 to 2014.