THE legal mandate of the US Fed is to preserve domestic price stability and improve employment. However, he sees no role for the Fed in maintaining global economic stability. It is up to each country to prepare and cross the tides. Although the U.S. dollar-centric global financial system after World War II granted the United States a de facto role as lender of last resort, this legal mandate and contradiction of reality emerges when the domestic U.S. economic environment n is out of step with global economic conditions. The challenge facing the world today once again focuses on this dilemma.
On May 12, US Federal Reserve Chairman Jerome Powell warned that getting the country’s inflation under control would not be easy. The credit tightening process could cause economic difficulties, and it cannot guarantee a “soft landing”, i.e. bringing the inflation rate down to 2% from the current 8.3% in April while maintaining a strong labor market.
Most economists expect the US inflation rate for 2022 to be around 6.5-7%. Last week, the Fed Fund rate rose half a percentage point to 0.75% to 1%. Markets expect the rate to rise another half point in June and continue to rise four more rounds through the end of the year. Depending on the outlook for inflation and the amount of interest rates at the four remaining Fed meetings, the end of the 2022 Fed Fund rate is estimated to be between 2.25% and 3.5%.
Many people criticized the Fed for not raising the rate and stopping its bond purchases early when signs of inflation intensified in the second half of last year. Powell said he wasn’t sure what difference it would have made had the Fed acted early. Yet he stressed that restoring price stability is now his number one policy goal, because the economy does not work for anyone without price stability.
The US economy is going through an unusual period with many flashpoints including unsustainable wage growth due to a tight labor market, inflation due to a supply disruption triggered by a confluence of factors such as the trade war with China and the Russo-Ukrainian War. . Additionally, the monetization of the historically high federal budget deficit of $5.90 trillion in fiscal years 2020 and 2021 has created demand for assets that is driving up inflation.
In 2021, U.S. home prices rose 18.8%, the biggest increase in 34 years of data and well ahead of 2020’s 10.4%, according to the S&P CoreLogic Case Index. -Shiller US National Home Price Index.
Resolving so many underlying inflationary forces will likely take some time, and the current outlook for US inflation is uncertain. While most economists predict a maximum Fed Funds rate of 3.0% to 3.5%, some forecasts as high as 5% have surfaced.
Transmission mechanisms of inflation from one country to other countries
Any inflation problem in a major economy has a ripple effect on other countries. There are two main transmission mechanisms for it to go overseas.
The first is through the current account trading channel. A large economy is often a major exporter of goods and services. Therefore, a higher domestic price will push up its export prices to other countries and raise the price level of importing countries.
The second is through the channel of capital account fund flows. The currency of a large country is often a reserve currency and a billing currency in commerce, and these functions create the natural demand for the currency of large countries. When the central bank of a large country raises its interest rate, funds from other countries may flow into it to earn a higher return and weaken the currencies of other countries due to larger outflows. The movement of capital prompted other countries to raise their rates to match the larger country’s higher rate to preserve domestic liquidity.
The United States is not the largest exporter of goods today, and its inflation-linked exports do not affect most other countries through the trade channel. The US dollar, however, remains the primary global reserve and billing currency; thus, US inflation casts a shadow over other countries.
This wave of global inflation has a markedly different characteristic from previous episodes. Developed countries are leading the rise in prices. In April, inflation in the United States was 8.3%, that of the European Union 7.5%, that of China 2.1% and that of developing countries such as the Philippines and Indonesia by 4.9% and 3.5%, respectively. Many economists have postulated that excessive quantitative easing by developed countries in the pandemic is the cause of the headache.
In a well-functioning global economy, the reserve and billing currency is supposed to be the anchor of price stability. Renowned international currency expert Barry Eichengreen has speculated that new monetary arrangements will rise after the current crisis by moving towards more regional currencies in bilateral trade and foreign exchange reserves. This decision could minimize the undesirable ripple effect of US or European monetary policies on other countries.
PH in relatively good position, but staying alert is important
Governor of the Central Bank of the Philippines (BSP), Diokno, cited several reasons to believe that the country can withstand the pressure on the exchange rate from rate hikes in the United States.
The first is the lower reliance on external debt: although public debt has reached over 60% of GDP, 70% of which is denominated in pesos, and the foreign currency denomination is only 30 %.
Second, the large gross foreign exchange reserve of over $108 billion as of March 2022. In addition, the steady annual inflow of $30 billion from foreign workers and another $30 billion from BPOs cushion the trade deficit of 43 billion dollars in 2021.
Third, the performance of the peso against the US dollar is in line with other regional currencies. As of May 10, the peso has fallen 2.5% against the US dollar year-to-date, while the Indonesian, Thai and Malaysian currencies have fallen 2%, 4% and 5.2%, respectively. .
Behind the improvement of the country’s financial conditions. Some issues deserve close monitoring. The first is the significantly higher trade deficit in the first quarter of 2022, $13.9 billion compared to $8.3 billion in the same period of 2021, a sharp increase of 67%. The country’s current account deficit will reach 4.5% in 2022, a multi-decade high. The second is the foreign ownership of the Philippine Treasury. Some foreign funds have been known to invest in domestic bonds of developing countries in recent years to earn higher income when the 10-year US Treasury rate hovers below 1%. This holding could collapse as US rates rise and trigger a surge in exits.
The BSP is expected to increase interest at its May 19 meeting with better than expected first quarter GDP growth of 8.3% and inflation accelerating.
The current wave of global inflation has hit two commodities particularly hard, energy and food. Inflation on these two commodities disproportionately hits the poor and is politically sensitive. It should be noted that monetary policies help dampen the demand side of inflation and minimize imported inflation. Yet problems with these two essentials are more often related to supply. The supply-side problem in economics is often the Achilles’ heel of developing countries in their development efforts.
US inflation has become everyone’s problem, and how to mitigate its negative impact is a test for their economic managers.
Dr. Henry Chan is an internationally renowned development economist based in Singapore. He is also a visiting senior researcher at the Cambodian Institute for Cooperation and Peace and an associate researcher at the Institute for Integrated Development Studies (IDSI). His main research interests include global economic development, Asean-China relations and the fourth industrial revolution.
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