US: rate hikes slowed the actual economy over time.

As a result of expansionary fiscal policy and robust balance sheets for both corporations and households, the slowdown in the economy that has occurred as a result of the rising interest rates has been less severe than anticipated. The consequences of the tightening of monetary policy are gradually becoming more apparent.

This economy in the United States appears to be defying the laws of gravity. It is proposed that there are three explanations. To begin, fiscal policy encourages economic activity. There has never been a time when the deficit was this big and unemployment was this low. Companies then took advantage of inflation to increase their profits and took on debt at fixed and extremely cheap interest rates during the epidemic caused by the COVID virus.

Consequently, “interest expenses in relation to corporate profits have never been so low,” as the previous sentence put it. According to Maxime Darmet, an economist at Allianz Trade, businesses are even net savers, and they invest their wealth in Treasury bonds, which offer them 5% interest. Last but not least, the fact that the balance sheets of businesses and households, which had accrued savings during the pandemic, are still solid helps to eliminate the possibility of a recession occurring in the immediate term.

On the other hand, according to Anton Brender, chief economist at Candriam, “the rise in rates has had a significant impact on economic activity for approximately a year.”

Increasing rates are communicated to the economy through a number of different means. The first is the real estate market. Despite the fact that the majority of households in the United States are in debt at fixed rates, the number of new buyers is decreasing as a result of the increase in the cost of credit. According to Ruben Nizard, an economist at Coface, “Housing sales fell by forty percent between the end of 2021 and the end of 2022 and stabilized at approximately this level for the duration of this period.”

With regard to the consumer side of things, “some households are beginning to suffer.” The analyst continues by saying, “We are seeing an increase in the default rate on bank cards and motor vehicle loans.” The rate of unemployment is still very low, coming in at 3.7%, but the labor market has become more flexible, in part because of or as a result of the tightening of monetary policy. As of the end of 2021, there were two job openings for every unemployed American; however, the ratio has since decreased to only 1.4 positions for every person looking for work. Furthermore, the number of resignations has reverted to the level it was at before the Covid intervention.

Additionally, life is a little more challenging for enterprises as well. A number of factors, including the crisis that struck regional banks in March 2023, have contributed to the fact that the most recent numbers from the Federal Reserve indicate that bank credit is no longer expanding year-on-year. The contribution of credit to growth is not anticipated to be significant this year, as stated by Ruben Nizard.

Therefore, there are indications that activity is being restricted. There is still the question of whether or not they are sufficient for the Federal Reserve to begin decreasing interest rates in the months ahead. It is too early, and there is no need to release the brakes, according to Larry Summers, an economist who served as Secretary of State for the Treasury under Bill Clinton. Summers is sure for the following reasons. According to his argument, which he made on Twitter over the weekend, the nation is currently experiencing full employment, inflation is still above the target of 2%, and current growth is higher than cruise speed.

On the other hand, Claudia Sahm, a former economist at the United States Central Bank, believes that there is an immediate requirement to reduce the cost of financing. She defends the position that the Federal Reserve runs the risk of substantially hurting the economy the longer interest rates remain high.

The United States economy has made a speedy recovery from the epidemic; nevertheless, the surge in demand has put a strain on supply chains and led to a steep increase in prices. As the Federal Reserve (the Fed) continues to tighten monetary policy and COVID economic relief initiatives come to an end, it is anticipated that the economy will slow down. This will drive core Personal Consumption Expenditure (PCE) inflation down to the Fed’s medium-term target of 2 percent by the end of 2023. If inflation continues to be more persistent than anticipated, the Federal Reserve will be forced to tighten monetary policy even further, which will further impede the economy.

IMF’s yearly review of the economy of the United States focuses on the policies that are required to bring inflation back to the medium-term objective that the Federal Reserve has set. The majority of workers’ wages have not been able to keep up with inflation, which has resulted in a considerable reduction in the purchasing power of households and a large amount of suffering. Despite the fact that global events have had an impact on the growth in the cost of gasoline and food, the costs of a wider variety of goods, such as housing and transportation, have also experienced significant increases. It is possible that these price hikes will linger for a long time if they are not stopped. Based on our analysis, we have come to the conclusion that the Federal Reserve ought to take prompt and decisive action in order to combat inflation and bring about price stability.

During the course of this year, the Federal Reserve has raised its policy rates by 1.5 percent, and it is anticipated that they will be raised by an additional 2 or 2.5 percent in the months to come. It is also reducing the amount of Treasury bonds and mortgage-backed securities that it has in its possession. As a direct consequence of this, the cost of borrowing money has shot up dramatically. As an illustration, the typical fixed rate on a mortgage with a term of thirty years has already increased from three percent to somewhere between five and six percent since the beginning of this year. While this is going on, the government is reducing spending because a variety of support programs that were implemented during the pandemic are coming to an end.

The growth in consumer spending is expected to be slowed to approximately zero by the beginning of the next year as a result of these policy steps, which will alleviate the strain on supply chains. On the other hand, increasing mortgage rates will bring to a decrease in house values, which have experienced significant growth throughout the pandemic. Last but not least, a decline in demand will bring the unemployment rate up to approximately 5 percent by the end of 2023, which should result in a decrease in salaries.

As a whole, we anticipate that the core PCE inflation rate will return to roughly 2 percent by the end of the year 2023, and that the rate of economic activity will decrease from 3.5 percent in the first quarter of this year to 0.6 percent by the end of the subsequent year.

The developments in the economy of the United States will be influenced by global issues such as the ongoing pandemic, the ongoing conflict between Russia and Ukraine, and the possibility of a resumption of shutdowns in China. When inflation remains high for an extended period of time, there is a greater possibility that inflation expectations will rise, which will then have a ripple effect on both wages and prices. In such scenario, the Federal Reserve would have to adopt more forceful measures to bring inflation under control, including increasing interest rates and maintaining them at higher levels for a longer period of time. This would result in an even greater decrease in growth and an increase in unemployment.

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