Perspective to reduce inflation… In the recent economic situation in the US, it is wondered how the tightening of monetary policy will create a balance between the general situation of economic activity and prices. In fact, in general, this dilemma seems to have prevented the Fed from raising interest rates more aggressively than currently envisioned. If the Fed has to make a distinction between inflation it can reduce and inflation it cannot reduce, and of course, there will be more adverse pressure to tighten policy or not to tighten this decoupling. It will be criticized for raising interest rates little or late when inflation is rising, and for increasing it excessively when the economy is slowing down.
How at risk is economic activity? Of course, the Fed should analyze the factors it can control while raising interest rates. Increasing the interest rates will undoubtedly reduce credit activity, create a cooling in demand and cause prices to be cut due to the decreasing demand in interest-sensitive sectors. When this effect occurs, how far will inflation fall? This is the main point, because if we consider that inflation has a self-sustaining systematic (it rises very easily when rising, falls hard when falling), will we encounter a secondary structural inflation? This is why we still have the perspective of raising interest rates when the economy is at risk of slowing down. It is necessary to increase the interest rates without falling into a recession.
The latest economic data shows supply challenges worsened in April. While the labor supply weakens, price pressures remain high. The main implication from the ISM surveys was that progress on the bottlenecks stagnated, if not reversed between the war in Ukraine and the deadlocks in China. Growth fears in China increase the risk of exposure to the effects of global stagflation. As you can see, it is actually difficult to maintain the balance. The wider imbalance between demand and supply continues to limit the pace of production in the economy and put upward pressure on inflation.
Conclusion? It seems that the CPI will continue to be under increasing pressure on the axis of lagging cost reflections. Even an inflation that shows signs of easing will remain high enough in this environment, drawing an image of being disconnected from the interest phenomenon that affects savings. The Fed's actions may not do much to directly relieve inflation related to supply chain pressure, but a tighter policy environment could slow consumer demand and help supply catch up. Until supply chains move more smoothly, we're unlikely to see a significant drop in price growth.
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