19 April 2024

How the Fed Has Already Made Its Policy Mistake

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The Federal Reserve may already have made a monetary-policy mistake and paved the way for the next U.S. recession. As some economists such as former U.S. Treasury Secretary Lawrence Summers warn the Fed will err if it raises interest rates in December, Paul Mortimer-Lee of BNP Paribas SA is taking a different tack as he argues it may have already blundered by not hiking sooner.

“The die may already be cast and the path to the next recession may have been taken,” Mortimer-Lee, BNP Paribas’s chief economist for North America, told clients in a report last week. His worry is that by waiting for the unemployment rate to fall to 5 percent, as it did in October, the Fed has delayed too long to achieve a soft-landing. That level is already around the 4.9 percent rate Fed officials reckon pushes up prices, but that estimate could be too low and a recent pickup in wages suggests joblessness could already be beneath the inflation trigger, he said.

The fact the economy is already growing faster than its long-term trend means monetary policy may be overly easy and will stay so if the Fed carries out its pledge to increase rates gradually, raising the risk of an overheating, he said. As for inflation, weak investor expectations for it may be hard to rally given the strengthening dollar, meaning higher rates will only intensify such bets.

The upshot is that with joblessness likely to bottom out below its current level, stabilizing inflation may ultimately mean the Fed has to tighten policy enough to boost joblessness by half a percentage point, an amount typically big enough to cause a recession, said Mortimer-Lee.

The Fed may have been better off raising rates a year ago when economic growth and the labor market were stronger, manufacturing was less of a drag, emerging markets were in better shape, oil prices were higher and financial conditions were softer, Mortimer-Lee said.

Click here to access the full article on Bloomberg Business.

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