Missouri

Monetary Policy Must Serve The Real Economy Not Just Financial Markets

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Missouri

Forget all the fantasies about neutral interest rates and production gaps. It is easy to answer the two main questions facing the Federal Reserve, but it is difficult to answer: Is the most powerful central bank in the world ready to return monetary policy to the real economy, not to the financial markets? And can it do it in an organized way?

These questions are not yet well understood by the market, and for good reason. From their point of view, a market that will not follow the Fed is extremely expensive. However, even if they are ultimately correct, the market may have less influence on monetary policy than in recent times.

Everyone knows the context of the current situation. For a long time, monetary policy was largely chosen jointly by the market. The incident began innocently with the intention of the central banks to compensate for the damage caused by the economic recession to the recovery of the market. With the achievement of the goal, large-scale liquidity injections and minimal interest rates have become a habit.

The Fed has repeatedly been forced to use a strong liquidity weapon against asset devaluation, even though there is no risk of market shock and instability. Sometimes such "non-traditional" mechanisms meet the needs of the real economy. But this was often not the case.

As children eager to buy more sweets, they expect the financial situation to ease when markets smell of instability. This expectation has turned into perseverance. Instead, the Fed simply tried to outrun it in response to market volatility.

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Central banks weren't blind to unhealthy interdependence. Current Fed and European Central Bank heads Jay Powell and Christine Lagarde have tried to bring about dynamic changes at the start of their government. However, they fail and are forced to take a bad turn, which makes markets feel justified in pursuing a tougher and softer policy.

However, today the market's two-decade dominance over monetary policy is more threatened than ever by persistent high inflation.

Against the backdrop of accelerating inflation, which has severely affected living standards, shattered future development prospects and harmed the most vulnerable segments of society, the central bank has no choice but to abandon market considerations.

The situation is particularly dire for the Fed, which has been in the grip of a general inflation mismatch for much of the past year and has been reluctant to act decisively late in acknowledging that price volatility has entrenched itself below the its control.

However, this is a problem given the lengthy negotiations and the way the Fed's response has narrowed the path to systematic deactivation. In other words, the difficulty of reducing inflation without the undesirable loss of economic prosperity has only increased. To do this, the central bank had to initiate a policy change a year ago.

If the Fed now approves the aggressive interest rate hikes that markets are expecting, there is a risk that prices will tighten further, starting with a 50 basis point hike at the next major policy committee meeting on 3-4. May. As the Fed drags the economy into recession, this trend will lead to further policy mistakes.

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However, if the central bank does not provide market value, it could further undermine the credibility of its policies. This will reduce inflation expectations, which will continue until 2023, although there will be no inflation problems.

Complicating matters is that these two options could lead to some degree of financial instability in the US and elsewhere. Worse, and this is probably the most likely outcome over the next 12-24 months, as the Fed could tighten and then tighten again.

The Fed may see such a sharp rise, but it will prolong the stagnant trend, weaken its institutional position and be unable to radically change monetary policy in favor of the real economy. And for those who see it as a win on the market, this will likely be the best transition time.

It is time to bring monetary policy back to the service of the real economy. At this final stage, the process is not automatic and regular. But the choice not to do so would be more problematic.

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