The Institute of International Finance (IIF) said that the United States Federal Reserve should think about shifting away from its aggressive monetary policy operations now that financial conditions have become much more restrictive to bring inflation down.
According to research that was released on Friday by an organisation located in Washington, D.C., this emphasis on spot inflation and other statistics has conditioned markets to respond aggressively to occasions in which data releases are materially different from the consensus.
Spot data is derived from actual prices, and the International Monetary Fund stated that historically, monetary policy has always been forecast-based. Policymakers target inflation two years in advance, and spot data is derived from actual prices.
This forecast-based approach has, at least to some degree, given way to the reaction to spotting inflation and other data, according to what it claimed, as a result of the high spike in inflation in the United States.
“Financial conditions may have already tightened sufficiently to bring inflation down on a two-year horizon,” the economists from the IIF said. “Therefore, reacting to spot data may raise the risk of a hard landing.”
“It is, therefore, preferable to not respond too much to the ongoing data flow…this is the reason why a Fed shift to a slower pace of hikes is necessary for September.
Consequently, it is better not to react too much to the existing data flow. A shift in this direction would also be consistent with the assumption of longer-term inflation.”
One of the reasons why spot data carries risks was also noted by the IIF, and that was the most recent US jobs report and the sharp surge in reaction from the dollar.
Despite widespread forecasts of an economic downturn, the number of jobs in the United States continued to rise at a robust pace in July, adding 528,000 new positions.
The IIF stated that the transition had begun “full display” in June when Fed chairman Jerome Powell connected the acceleration of Fed rates to higher-than-expected inflation for May as well as rising inflation expectations.
“Because of the dramatic tightening of financial conditions, particularly in the housing market, and the more fundamental trend of data becoming noisier throughout the Covid recovery, it is not entirely clear to us that high-frequency data surprises carry much information, according to economists working for the IIF.
They stated that the Federal Reserve should “pivot,” or lower the pace of monetary policy tightening going forward since it is “time for the Fed to pivot” toward placing a larger focus on predictions rather than on spot data.
The United States reported in July that its economy had contracted for a second consecutive quarter, which is considered a “technical recession” according to the definition that is most commonly followed.
This was caused by record-high inflation as well as aggressive interest rate increases by the Federal Reserve, which hit businesses and housing demand.
After inflation climbed again in May, jumping 8.6 per cent on an annual basis, the central bank increased interest rates by three-quarters of a percentage point, which was its third increase in three months and the largest since 1994. This came as a response to the data showing that inflation had increased.
The interest rate is increased by 0.75 percentage points by the US Federal Reserve.
The pace of inflation, on the other hand, slowed down in July, which came as a relief to many Americans due to the decline in the cost of gasoline.
Fannie Mae, a mortgage association, reported this week that consumer confidence in the housing market has reached its lowest level since 2011. This mark has not been seen since 2011.
Last month, the International Monetary Fund issued a warning that the risk of a global recession is “rising sharply” as a result of a combination of shocks.
These shocks include the effects of the conflict between Russia and Ukraine on the eurozone, uncertainty in China related to the Covid-19 pandemic, and the sharp tightening of financial conditions in the United States.
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According to a report published by the IIF on May 26th, the previous estimate for the growth of the global economy in 2022 was set at 4.6 per cent.
The new estimate is 2.3% growth. It also lowered its growth prediction for the eurozone this year from a previous estimate of 3 per cent to 1 per cent, stating that it was making a “recession call.”
