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Response to Federal Reserve meeting

Senior Economist, Silvia Dall’Angelo, responds to the latest Federal Reserve meeting:

Going into today’s meeting the Fed faced a communication challenge: it had to acknowledge recent positive news implying upside risks to the economic outlook, while also preventing an excessive market reaction leading to an unjustified tightening of financial conditions.  

In the event, the Fed managed to balance the two needs. It upgraded its short-term growth forecasts aggressively, reflecting the impact from the latest $1.9tn fiscal injection, positive vaccine rollout and upside surprises in data. However, it also restated its determination to keep monetary conditions very accommodative in the foreseeable future. In particular, the highly anticipated dot plot showed that a majority – albeit slim – of FOMC members still expected the policy rate to be unchanged at its current record-low level throughout the end of 2023. 

The guidance on asset purchases was also unchanged, suggesting that tapering is probably a story for next year. 

Going forward, the Fed will face intensifying and opposite tensions. On the one hand, the recovery will continue to need the support from easy policies  as the labour market gradually heals and inflation goes sustainably back to target. On the other hand, there is a creeping concern that the massive fiscal stimulus provided so far will lead to an overheating economy and runaway inflation. The former force will prevail for now, also supported by risk management considerations – at this stage doing too little is deemed riskier than doing too much.  

Should runaway inflation emerge down the line, the Fed believes it has plenty of tools to successfully curb it. That is, if it manages to maintain its independence in that scenario.

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