The US Federal Reserve now faces the difficult challenge of implementing real-time policy in a volatile and uncertain environment, while being guided by its dual mandates of price stability and maximum employment. Mr. Richard Clarida, former Vice Chair of the Federal Reserve, delivered a keynote address at Nomura Investment Forum Asia 2022, where he spoke about monetary policy decisions, challenges ahead for the central bank as well as implications for emerging markets.
The inflation challenges
Given the tight labor market, whether the Fed’s rate hikes slow down or accelerate later this year will depend on inflation. If inflation becomes more persistent, inflation expectations start drifting up, and the risk of price stability increases, then the committee may have to move the fed funds rate into “restrictive” territory, he said.
A lot of it will come down to how much of the inflation last year and this year is going to reverse, and how much of it till now is not really inflationary but price and wage level adjustments because of a tight labor market. As a former Fed official, he acknowledged it is difficult to disentangle a price-level shock from an inflation shock, because at the time it occurs, it looks like inflation.
Implications for emerging markets
Fed tightening cycles that are associated with high inflation tend to be more disruptive to global financial conditions than when the Fed is hiking because the economy is booming, said Mr. Clarida. Historically, the adverse consequences of tightening cycles for emerging markets are more tangible in periods such as now when the Fed is tightening because of higher inflation. However, this time, these emerging markets are dealing with a double shock – there is a coordinated effort from central banks around the world to hike rates, prompted by higher energy and commodity prices as a fallout from the Russia-Ukraine conflict, said Mr. Clarida. For some emerging economies that went into this cycle without sound fundamentals, it could mean a reversal of capital flows.
He signed off on a more positive note. There is an inclination this year to overweight how much of what is being seen as persistent, says Mr. Clarida. Markets may be underestimating how quickly underlying inflation and wage data could return to reasonable levels, and then it could be surprised by how quickly underlying inflation begins to decline sequentially, he said.
To watch the full presentation, visit the Nomura Forum website (requires guest login).
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