Federal Reserve: a new monetary policy and new challenges to revive the US economy

The new monetary policy of the Federal Reserve to exit the Covid crisis: increasing inflation in exchange for economic growth and greater employment, in practice rates at 0 for years and the purchase of bonds to finance new fiscal policies. But the risk is great.

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The Federal Reserve left interest rates unchanged in the last meeting before the US elections: the cost of US money therefore remains stationary between 0 and 0.25%. This is the interest that US banks pay when lending money to each other and that determines the interest on loans and mortgages, as well as the yields on Treasury bonds and other investment securities: low rates favor credit expansion, the aim is to support the economy. The Fed announces it will leave rates close to zero until maximum employment is reached. Rates are expected to remain at current levels for the next three years, at least until 2023.

The new monetary policy of the Federal Reserve

Unlike the ECB, the US central bank has a dual role, not only controlling inflation but also supporting employment and economic growth. A few weeks ago, the Federal Reserve announced that the control of inflation takes a back seat to employment and economic growth: this change is obviously due to the Covid crisis and the need to support the economic recovery. Also because US and European inflation will certainly not start growing again in the medium.

The Fed’s new monetary policy provides that inflation may also exceed the ideal target of 2 percentage points to “compensate” for periods in which consumer prices were below the target. In addition, the “preventive” squeezes in response to falls in unemployment have been effectively canceled. In practice, the new course implies keeping rates at zero for years.

Pursuing an increase in inflation to support economic recovery is nothing more than exchanging inflation for greater economic growth and more employment.

Investors speculate that future fiscal stimuli will be financed by further purchases of bonds by the Fed: a potentially risky hypothesis, but without which the risk of a downward spiral for the economy could be even higher.

The Federal Reserve’s forecasts on the American economic recovery

Federal Reserve forecasts indicate that in 2020 the US economy will shrink by 3.7%, with an unemployment rate at 7.6% and inflation at 1.2%. For 2021, the rebound in GDP is estimated between 3.6 and 4.7%, less than the 4.5-6.0% expected in June.

Governor Jerome Powell said “the economic recovery will depend significantly on the evolution of the virus. The health crisis will continue to weigh on economic activity, employment and inflation in the short term, and poses significant risks to the economic outlook of the country in the medium term”, then he added that “The recovery has been faster than expected, but activity remains well below pre-pandemic levels. The unemployment rate remains high, with millions of people out of work especially among women, African Americans and Hispanics”.

Powell also strongly emphasized that the US economy may need further government aid: “The crisis is severe and it will take some time to return to previous levels. Strong inequalities and low social mobility are holding back growth, we need that prosperity is shared but we do not have the tools to do so, it is up to politics”.

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