The average person has always been confused by daily fluctuations in the stock market, however, the events of the past few weeks also have speculators and brokers confused. Everyone was waiting for an announcement from the US Federal Reserve Bank (the Fed), to be accurate its Federal Open Market Committee (FOMC) lead by Janet L. Yellen. The stock markets have been bouncing up and down, from the Asian market through Europe and back to the Dow Jones.

But what exactly has caused this “mess”?

It can all be traced back to the global financial crisis of 2008, when the world market, which was so interconnected, declined sharply after the bankruptcy of just two mortgage companies. It had been long feared, and the domino effect worked. And what do we know about dominos? Standing them in line is actually a lot harder than knocking them down. The Fed’s first step in rebuilding the dominos was to shrink the interest rate on government bonds. That means people who were afraid of investing in the market didn’t have the chance to invest in “safe” government bonds. In a way, they were forced to invest in the market, so the flow of capital wouldn’t stop. This increased job opportunities and the flow of money also increased US inflation. But this happened years ago. The economy and especially the investors were impatient with the Fed and its “patient” policy. The economy of the US has strengthened since 2008 and now looks stable, however, the dominos are ready to fall again. The unemployment rate has dropped down to 5.7% and there are already plans for action which might drop this even further, which is an outstanding result in the OECD club. One thing is notable: Short-term unemployment is the same in Europe. So, the question is if higher interest rates in Euro-pe work then why doesn’t it work in the US? The simple reason is that the long-term unemployment rate is seemingly higher in Europe since workers in Europe can register for unemployment benefits for very long periods, while it is only possible in the US for 26 weeks on average. So it might seem that unemployment rates are better in the US, but further improvements are needed, a fact that Ms Yellen hasn’t failed to stress as well.

The GDP reached 2.2% annual growth in the fourth quarter, which frankly saying, is a good result, however, it is not even close to the Clinton years. But since there hasn’t been any monetary emission, inflation hasn’t risen from the near 1%, which worries Ms Yellen, since the targeted inflation rate is 2%. The FOMC has acknowledged the accomplishment of the US economy in the past few years, however, it is not convinced about the sustainability of this rise. The rise in the market segments is not balanced and the employment rate could be better, not to mention the stagnating inflation rate. Business fixed investment is advancing, while the recovery in the housing sector remains slow and export growth has weakened.

Then a statement from the FOMC announced that they were dropping the word “patient” from their monetary policy, yet they were unsure about when they might raise the interest rate. It depends on the development of the US economy in the next quarter. They noted the possibility of a new monetary policy approach in June, but they stressed that this is not a promise, just another possibility which could be explored, meaning that if everything goes well and in two months inflation reaches the targeted range, then they might reconsider their decision in June. However monetary decisions don’t come to effect for 18 to 24 months, so the remaining patient has its risks.

This is not an entirely new approach to monetary problems. In the past, the Fed has been criticised over its passive approach, but they have never wanted to make the same mistake they did in 1937. The question now isn’t whether the Fed will raise interest rates, but rather when. There are many complicating factors including falling oil prices, the variable costs of other energy resources and the measures and actions of other countries. None of them is certain, however there is lot of speculating going on: some note that the dollar has fallen greatly in recently, having its biggest weekly drop since 2011, because the FOMC reduced projects for interest-rate hikes; other think-tanks suggest that the drop in the price of the dollar is only a correction of the market, since in the past few months the dollar was getting stronger against other currencies. Speculations are getting even more intense, and the Fed is still not willing to change its monetary policy in the near future. However, one thing is for sure: inflation is well below the Fed’s target of 2% and has fallen in the past year. The dollar is strong. In recent months, American exports have been sliding. A rate increase will reinforce all these trends, with knock-on effects around the world. It may put the brake on America’s economic recovery. The Fed has little to gain from tightening its policy, but a lot to lose.


Originally published in Közgazdász, Hungary’s oldest university newspaper

Leave a Reply

Your email address will not be published. Required fields are marked *