World economy likely to suffer more from US Fed's inflation fight

 

Jerome Powell and his colleagues expect a further hike in interest rates later this month.

• Fed Chairman Jerome Powell and his allies will probably have to raise unemployment significantly higher to achieve their 2 percent inflation target



The US and world economy is likely to suffer more from the Federal Reserve's fight to get inflation under control, according to a pair of papers scheduled for presentation at a renowned economic conference this week.

According to a paper prepared for the September 8-9 Brookings Institution conference, Fed Chair Jerome Powell and his colleagues will probably have to raise unemployment high enough to hit the 2% inflation target. A second study warns of the dangers for developing countries due to rising US interest rates and a strengthening dollar.


While a soft landing of the US economy is still possible, it is only achievable under the most contingency scenarios, Johns Hopkins University professor Lawrence Ball and International Monetary Fund financial analysts Daniel Leigh and Prachi Mishra wrote in their paper.

Taken care of policymakers' figure - - expansion will get back to focus while joblessness scarcely above 4% - - is legitimate just under genuinely hopeful presumptions," he said.


Separately, former IMF chief economist Maurice Obstfeld and Princeton University's Haonan Zhou see problems ahead for many emerging markets and developing economies as the dollar climbs in response to higher US rates.

Those economies are particularly vulnerable due to increased debt by the public sector and businesses during the pandemic, much of it in dollars, he said.

"Danger signs are already flashing," he wrote. "A contractionary period of the worldwide monetary cycle is presently in progress."

If the Fed fails to control inflation, other risks are mitigated, however, the duo wrote. This would be disruptive to the global economy in the long term and could erode the dollar's role as the world's leading reserve currency, Obstfeld and Zhou said.

Ball and his co-authors attributed the overshoot of inflation to President Joe Biden's $1.9 trillion US rescue plan, which they said contributed to the tightening of the labor market. Different variables incorporate inventory network shocks and rising energy costs.

Powell and his colleagues are widely expected to raise interest rates later this month as they try to rein in high inflation without crashing the economy into recession.

In his last forecast round in June, he anticipated doing the same.

Inflation was projected to fall to 2.2% by the end of 2024 from 6.3% in July, while unemployment rose to 4.1%, which is now 3.7%, according to their average prediction. Policymakers will update those forecasts at their September 20-21 meeting.

"Reducing inflation may require higher unemployment than the Fed estimates," Ball and his co-authors said.

The Brookings Papers on Economic Activity is a semiannual conference of top academics in Washington, to which many Nobel laureates have contributed since it began in 1970.

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