The Economy Observer
2 September 2020
Trying to make sense of US economic policies
When success seems worse than failure
Last week, the US Federal Reserve (US Fed) gave a clear verdict through its actions. Amid the ongoing debate on global
inflation, the Fed seems to have chosen its side – ‘inflation is not an imminent threat.’ Not only has the Fed replaced
inflation by employment (or growth) as its primary mandate, but has also relaxed inflation target. It now seeks to
inflation of 2%
Not surprisingly then, the divergence between the real economy and the
stock markets has widened further, with the latter conquering new all-time highs.
In this note, we have penned down our thoughts on ‘Why the US Fed seems oblivious to the growing divergence
between the stock market and the real economy?’ We argue that by pushing the stock markets higher, the Fed is trying
to create a positive ‘wealth effect’ for American households, whose exposure to equities is as high as ~45% of the total
financial assets – the highest in almost past half the century and also the highest compared to any other nation. With
the US Monetary Policy being totally aligned with its Fiscal Policy, there is only one clear objective – making Americans
feel prosperous and wealthy. Overall, it appears that the US policymakers are all-out now to lead better recovery.
These economic policies are expected to lead to one of the four exhaustive possibilities: (a) lower growth with lower
inflation, (b) higher growth with lower inflation, (c) lower growth with higher inflation, and (d) higher growth with
The first scenario qualifies as an ‘economic failure’, which would lead to Japanification of the US economy. The second
possibility, though most desirable, in all probability is the least to occur. The third option – also called ‘stagflation’ –
would take the world economy back to the horrors of the early-1980s. The fourth option, which ironically also qualifies
as the ‘success of economic policies’ would bring forth the worst possible nightmare by potentially pricking the massive
bubble in the financial markets, including debt markets.
As of now, we believe that the first option (economic failure) is most likely to materialize – higher inflation is not on the
cards in the foreseeable future. However, any signs of higher inflation or of economic policies leading to higher growth
could create immense pressure in the financial markets with the outcome being worse than the one associated with a
scenario of failure.
US Federal Reserve has changed its long-term goals and strategy…:
Mr. Jerome Powell, Chairman of the US Federal Reserve (the US Fed), created a stir
in the financial markets last week – the US Fed promoted ‘employment’ as it
primary mandate and ‘inflation’ is now secondary. Further, the secondary mandate
has been relaxed with the FOMC now seeking to achieve an ‘average’ inflation of 2%
With no clarity on ‘over time’, speculations are rampant. Abundant
reports are claiming that the first rate hike may come after 5-10 years, and it may
take as many as 42 years (in 2060s) – based on an assumption that the US Fed
decides to iron out the lackluster inflation witnessed since Jan’07.
By pushing inflation down
on its priority list, the US
Fed appears to have chosen
its side on the inflation
debate and it certainly does
not see it as an imminent
By pushing inflation down its priority list, the US Fed appears to have chosen its side
on the inflation debate and it certainly does not see it as an imminent concern.
Growth or employment is now the top target for the US Fed, which indicates that
the rates – irrespective of the definition of ‘over time’ – would certainly remain low
for much longer than previously anticipated.
Nikhil Gupta – Research Analyst
– Research Analyst
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