Central-bank doctrine holds that monetary tightening operates with a long and variable lag (often 12-18 months), and that the target interest rate must rise above the expected future inflation rate for some period. Inflation in 2023 is expected to be around 4%, according to the Blue Chip forecast; below 3%, according to the bond market; and almost 5%, according to consumer sentiment surveys.
Optimists are expecting modest additional Fed rate hikes from the current 4.25-4.5% level. The Fed envisions a peak of 5.1%. But hopes for some easing toward the end of next year receded this month with Fed Chair Jerome Powell’s suggestion that rate cuts (back toward 4.1%) will not come until 2024. And even that schedule presupposes significant progress toward the Fed’s 2% target. Such “soft landings,” with minimal job losses, are historically rare.
The even bleaker outlook for many other economies will compound the difficulty of engineering a soft landing. Against the backdrop of anemic growth or outright recession from China and Europe to developing countries in Latin America, Asia, and Africa, the dollar’s continued strength is bad news for US exports.
Once the new Congress convenes on January 3, Republicans will likely block most of US President Joe Biden’s initiatives, especially on spending, which will take fiscal pressure off the Fed’s inflation fight. They will do their best to limit the passage of new regulations, and to step up oversight of executive branch agencies.
House Republicans will pass their own conservative fiscal and domestic agenda and try to get the Senate to take up bills that will expose the Democrats’ embarrassing positions on issues such as illegal immigration, crime, spending, and the like. Senate Democrats and Biden will ignore most and reciprocate, and all major legislation is likely to stall. At the end of the day, that may be a good thing, given the current Congress’s dubious legislative record, which has already proved far too costly for whatever modest benefits it provides.
This article was provided by Project Syndicate.