The Federal Reserve will be forced to take action to curb inflation after its new policy is announced, said David Weisbrot, chief economist at Capital Economics.
Weisbrots main point is that it will be extremely difficult for the Fed to keep interest rates low for longer than a year if inflation remains high.
Weisbrouts view is that inflation will rise and eventually exceed 2% and a fall in the cost of living will cause prices to fall, making it more difficult to achieve an increase in interest rates.
So, the question is whether inflation will reach or exceed 2%.
Weisbrouts latest estimate is around 1%.
But it will take a lot of work, because the Fed has been tightening monetary policy in recent months, he said.
We are still in uncharted territory.
“We are now in unchartered territory with regards to inflation, but it’s very difficult to tell whether we’ll be able to stay there.
The real question is how much longer inflation will keep on climbing, and how much more likely will we be to have a prolonged period of elevated inflation, with the Fed tightening policy,” Weisbrets analysis says.
A big difference between the Fed and the central banks of Europe and Japan, is that the Fed is willing to go with a gradual increase in rates to stimulate economic growth.
In that context, inflation is much more difficult.
On the other hand, in the US the Federal Open Market Committee is likely to announce its new monetary policy on Wednesday, the Fed’s chair Janet Yellen said on Monday.
The Fed is expected to raise rates as soon as June, while the Fed Board of Governors is expected later this month to announce an extension of the target range for the federal funds rate.
It’s a bit of a chicken-and-egg situation.
If the Fed raises rates at the end of June, the rate hike will probably be seen as good news by economists and households, and a temporary boost to inflation.
If rates are held down for months, the impact on inflation is probably negative.
If rate hikes are announced in June and July, that will probably cause a temporary period of lower inflation, since households will have to spend more to keep up with inflation.
But if rates are not raised in June, that may lead to a temporary rebound in inflation, causing a further decline in the unemployment rate.
In either case, the central bank will be very reluctant to start a rate hike when it is uncertain of the impact the hikes will have on inflation, Weisbridts conclusion says.