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Strong commitment to reduce inflation

Mar 26,2023 - Last updated at Mar 26,2023

Strong commitment to the goal of reducing inflation is evident in the US Federal Reserve's (Fed) FOMC latest statement of March 22, 2023. The statement begins with a discussion of recent indications of modest growth in spending and production, clearly indicating that the economy is expanding, although not at a rapid pace. It also confirms the existence of a healthy labour market, with job gains being strong and the unemployment rate remaining low. However, the statement also notes that inflation remains high, which could be a cause for concern. The US banking system is described as sound and resilient, but recent developments related to the collapse of three US banks may necessitate more tightening of credit conditions, especially for households and companies, which could affect economic activity, employment and inflation. However, the extent of these effects is uncertain.

One of the main strengths of the statement is that it provides a balanced overview of the current state of the economy by highlighting positive and negative developments. The statement acknowledges the uncertainty regarding the potential impact of recent developments related to the collapse of three banks on the economy. However, the committee confirms that it is still very concerned about inflation risks, despite all the criticism leveled at the impact of the Fed's decisions. It is interesting to note that the latest FOMC decisions were unanimously voted on by all committee members.

As for the most prominent weaknesses in the statement, it does not provide specific details about the current economic situation or recent developments that affect the committee’s decisions. It also does not provide a clear timetable for when further tightening of monetary policy may be appropriate, leaving that to future developments and events; this is understandably acceptable.

To address these concerns, the committee decided to raise the target range for the federal funds rate by a quarter point to 4.75 per cent — 5 per cent, with the goal of maximising employment and achieving inflation at the 2 per cent target over the long term. The Fed chooses to raise interest rates as a way to fight inflation because it is a more direct and effective tool to control the supply and demand for money in the economy. 

However, the Fed also uses the open market tool by reducing the size of its portfolio of Treasury securities, agency debt, and mortgage-backed securities, with the aim of absorbing liquidity from the market and reducing demand, thus reducing inflation rates. The statement stresses that the committee is firmly committed to returning inflation to its 2 per cent target. It must be remembered that many global factors drive inflation to rise, and these factors are outside the control of the monetary authorities in any country.

The statement indicated that when determining the extent of future increases in the target range for the Fed funds rate, the committee will take into account the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity, inflation and economic and financial developments.

It should be noted that the Fed controls the three tools of monetary policy — open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, while the Federal Open Market Committee is responsible for open market operations. Using all three tools, the Fed influences the demand for and supply of balances held by Federal Reserve Bank Depository Institutions, and in this way changes the rate of federal funds.

Changes in the federal funds rate are expected to trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and ultimately, a host of economic variables, including employment, output, and commodity prices and services.

 

The author is a board member of Jordan Deposit Insurance Corporation.

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