Economic Slowdown: Fears Of Recession And Inflation Looms After The Release Of The White Paper; US Stocks Crash

"When America Sneezes, the World Catches Cold," as the saying goes, the world economy is exactly in this position in today's volatile economic scenario due to the supply chain crisis, volatile labor market, and various types of conflicting situations in different countries, particularly in Europe. 

One of the reasons for the world's bleak economic situation is that the United States Federal Reserve is constantly raising interest rates to tame acute inflation within the country; because the US dollar is the world's reserve currency when the Federal Reserve raises interest rates, all economies around the world raise interest rates of their subsequent currencies to insulate their own currencies imminent fall. 

In the United States at this time, the Federal Reserve is not in the mood to reduce the interest rate on an immediate basis because the possibility of acute inflation and recession is increasing with every passing day. 

Recently a white paper written by the former federal reserve chainman, Frederic Mishkin, and co-authored by economists Stephen Cecchetti, Michael Feroli, Peter Hooper, and Kermit Schoenholtz, advised the present chairman, Jerome H. Powell, to look ahead and act preemptively. 

The authors provided no evidence to back up their claims, and the claims they made are mostly hypothetical and difficult to implement. The authors present a very simple model that connects interest rates, economic slack, inflation, and inflation expectations. They used the same model to forecast inflation for 2021. 

According to the writers of this paper, the central bank should abandon its new policy framework adopted in September 2020. That change implemented “average inflation targeting,” allowing inflation to run hotter than normal in the interest of more inclusive employment recovery. 

They are simply putting forth the "Volcker Disinflation" theory. Paul Volcker was appointed chairman of the Federal Reserve in 1981 to combat the country's acute inflation when the country was in the midst of its second brutal bout of double-digit inflation in less than a decade. Gas prices were through the roof, and mortgage rates were sky-high, preventing many middle-class people from purchasing homes. The job market was also weak, with unemployment exceeding 7%. The country was in full crisis mode. 

He then used shock therapy and chemotherapy to restore the old glory of the US economy, and he succeeded in doing so. 

However, while the 2023 inflation is not as bad as the inflation of 1978-1982, it is the worst inflation the United States has seen in decades. 

In an effort to tame inflation, which had reached its highest level in 41 years, the Fed has already implemented a series of interest rate hikes.

According to the white paper, the Fed must engineer a recession in order to control the country's inflation. Therefore, after the release of this paper,  the market reacted wildly and a crash occurred in all sectors: the Dow Jones, S&P500, NASDAQ, and others all fell precipitously; investors lost billions of dollars in their investments. 

Therefore, Fed Governor Philip Jefferson responded to the report, stating that the current situation differs from previous inflationary episodes. He pointed out that the current Fed has more credibility as an inflation fighter than some of its predecessors. He opposes aggressive interest rate hikes and Volcker's policy at the same time. 

Condition of the US economy:  

According to newly released data, the US economy is in poor shape. The US economy is slowing after the government revised Q4 GDP down from last quarter's 3.2% to 2.7%. Previously, the projected growth rate was 2.9%. 

The Federal Reserve expects more inflation in the coming months, indicating that the central bank still has work to do to reduce prices.

According to the data released by the commerce department last Friday, the core personal consumption expenditures price index rose 0.6% month on month and 4.7% year on year. Wall Street had predicted readings of 0.5% and 4.4%, respectively. 

The headline inflation increased by 0.6% month on month and 5.4% year on year respectively, compared to 0.2% and 5.3% in December last year. 

Consumer spending also rose more than expected as prices increased, jumping 1.8% for the month vs. the estimate of 1.4%. Adjusted for inflation, prices rose 1.1%.

Personal income increased 1.4% after adjusting for inflation, exceeding the 1.2% estimate. Personal savings increased as well, rising to 4.7%. 

All of these numbers point to accelerating inflation in the coming days, and the world must brace itself for further Fed rate hikes. Inflation fears also drive US stocks to the worst weekly loss in two months. 

The world cannot escape this sluggish period until conflicts, the supply chain crisis, and labor market volatility are resolved.