The FOMC (Federal Open Market Operation Committee) met October 26, as it does every six weeks. Each meeting is followed by a press conference a week after, given by the Federal Reserve System’s Director of the Board of Directors, currently Jerome Powell. During this press conference, Jerome Powell gives a report on the decisions made by the FOMC. This is also the opportunity for the journalists to ask questions about the FED’s stance on monetary policy.
In his last report presented November 1, 2023, Jerome Powell gave an idea of what will be the FED monetary policy for the end of 2023 and the beginning of 2024. The major idea was, the FED “has significantly tightened the stance of monetary policy.” The interest rate will remain high, between 51/4 and 51/2. The objective is to continue fighting the inflationary pressure that started during the first quarter of 2021 until achieving the 2% of targeted inflation rate. 2% is the long run average inflation rate. When the economy moves away from the target, this points out some economic instability.
The two major tools used by the FED are an increase in the interest rate and a decrease in the FED holding of securities. Since the beginning of the year 2023, the FED has sold more than $1 trillion in securities. The federal funds rate has increased from 0.08% to 5.33% from February 2022 to October 2023, representing a 65.62% growth rate. We all know, and Jerome Powell said it, a high interest rate plays a negative role on the economy, discouraging investments, consumption and pushing up the unemployment rate, what in short means an economic recession. Such an orientation in terms of monetary policy brings to the following question: Why would the FED implement a monetary policy that would lead to an economic recession? To answer this question, we need to understand how we got to a situation that requires a restrictive policy.
When COVID-19 hit in 2020, the governments of the advanced economies, including the US economy implemented expansionary monetary and fiscal policies to support the economies and limit the economic crisis, due to COVID-19. These expansionary policies took the form of low interest rates, economic stimulus packages to support consumption, and support companies.
The results were rapid and high economic growth rates. By mid-2021, the real GDP growth rate achieved 6% for the global economy and 5.9% for the US economy, results never achieved over almost 40 years for the US (7.2% of economic growth rate in 1984) and never achieved almost over 50 years for the global economy (6.4% in 1973). Such high economic growth rates in advanced economies, and in particular the US economy, usually come with high inflation rates and can create bubbles, as we experienced it in 2006, what led to the 2007 and 2008 financial and economic crisis, called the great recession. In such a situation it is said that the economy is overheating. A high inflation rate, way above the 2% target and a low unemployment rate, below the 5.3% of long run average of unemployment rate are signs of an overheating economy. The US inflation rate reached 8.9% in September 2022 and is 3.3% today due to the contractionary policy started in 2022. The unemployment rate is 3.8%, still below 5.3%.
A too low unemployment rate means the companies’ demand for labor is higher than the supply of labor, which has an upward pression on wages.
The expansionary monetary and fiscal policies implemented to inverse COVID-19 negative impacts on the economies have produced positive and rapid effects. The economies grew too fast, leading to an overheating economic situation. Therefore, the governments had to reorientate their policy and undergo a contractionary monetary policy to cool down the economies that grew too fast and way above the pre-pandemic previsions. Thus, for the US, the FED current contractionary monetary policy aims to bring down consumption and investment to a lower level, which necessarily will lead to a recession. The long run objective of the FED is to reach an economic growth rate that ensures a stable inflation rate at 2%, and the US long-run average unemployment rate.
The economic growth rate in October was 4.9%, still too high according to the FED, because above the 2.1% predicted. For the coming years, the FED’s prediction in terms of economic growth rate is 1.5% in 2024, and 1.8% in 2025 and 2026.
What does this mean for companies? It’s certainly not the time to think about expanding and investing in capital goods. It is time to think about optimizing their resources, managing their costs, and increasing productivity. Maybe some companies, especially those in the sectors most affected by the economic recession, may think about diversifying. The sector of durable goods has seen a decrease in purchases. The households choose to postpone their purchases of durable goods due to the economic climate. In addition, buying treasury bonds at a high interest rate could be a good investment for companies.
What about the households? The consumer confidence index, the consumer present situation index and the consumer expectation index have all decreased over the past three months due to the uncertainty brought by the effects of this contractionary monetary policy and the long-lasting effects of COVI-19 in some aspects of the economy, but also by other global situations like, the effects of the war between Russia and Ukraine and in the Middle East. However, the household’s perceptions about their family’s finances are good, what would encourage an increase in expanses to keep the moral up. In such context, it would probably be wiser for the household to think about saving as much as they can, and invest in CD, with high 5% of interest rate.
Yet, the previsions are made for better economic outlook around 2026, but the FED will keep monitoring the economic indicators to see if more adjustments are needed. The inflation rate is expected to stabilize at 2% in 2026 what would lead back to a healthier economy. In the meantime, we need to prepare for more turbulence.
