Does U.S. Monetary Policy Change with the Robustness of GDP? Explaining the Outlook for Interest Rates

Economic Indicators

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In recent years, the health of the economy and the containment of inflation have become focal points for central banks.

The President of the Federal Reserve Bank of San Francisco, hereafter referred to as the San Francisco Fed President, has shared his perspectives on this intricate issue.

Let’s explore how monetary policy impacts inflation and the trajectory of the economy, drawing insights from his statements and contemplating the outlook for future policies.

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■ Containing Inflation and Economic Trajectory

The San Francisco Fed President suggests that the progress in containing inflation depends on the robustness of the economy, with the possibility of an inevitable increase in policy interest rates in response to its trajectory. Specifically, if inflation rates remain stable and the labor market and Gross Domestic Product (GDP) growth sustain strength or stability, there is a heightened likelihood of once again raising policy interest rates.

For instance, in a scenario where inflation remains stable, this may indicate a robust economic performance. A vibrant labor market and consistent GDP growth could necessitate an increase in interest rates to maintain economic stability. Under such circumstances, the containment of inflation becomes essential for sustaining economic equilibrium.

Conversely, if inflation continues to decrease, and the path towards 2% remains evident, the San Francisco Fed President suggests the possibility of considering different interest rate policies. This implies that in a situation where inflation has not reached the targeted 2%, the necessity for raising interest rates diminishes, and there might even be a contemplation of adopting a more accommodative monetary policy.

■ Restrained Nature of Policy Interest Rates and its Confidence Level

While the San Francisco Fed President views the current policy interest rates as sufficiently restrictive for guiding inflation towards the target level, he acknowledges a lack of high confidence in this assessment. This recognition stems from the understanding that, while interest rates are effective in controlling inflation, the uncertainty regarding future economic conditions makes it challenging to hold a high level of confidence.

For example, even if it is assumed that the current policy interest rates are effectively curbing inflation, the increasing uncertainty about future economic conditions makes it difficult to maintain confidence. As the impact of interest rates fluctuates over time, a flexible approach to policy adjustments based on future economic data is deemed necessary.

Emphasizing the need for maintaining a flexible stance, the San Francisco Fed President highlights that policymakers must scrutinize the latest economic data to inform future interest rate decisions. Given the volatility of economic indicators, a flexible approach allows for adjustments that can lead to the realization of an optimal monetary policy.

■ Evaluation of Inflation and the Significance of Core Index

The San Francisco Fed President underscores his focus on the core index of the service sector, excluding housing, when evaluating inflation. This core index, excluding housing, is considered a more accurate reflection of inflation, closely mirroring the general cost of living.

For instance, excluding housing costs allows for a more accurate evaluation of inflation that aligns with the day-to-day realities of general consumers. Noting that the core index has not decreased as much as other indicators, the San Francisco Fed President is actively seeking an appropriate response to inflation for the overall economy.

However, while the core index is deemed crucial in evaluating inflation, the recognition of the importance of considering multiple factors, including housing, is also highlighted. Since inflation is influenced by various factors, a comprehensive and accurate monetary policy requires the consideration of a broad range of data.

■ Conclusion

As evident from the perspectives of the San Francisco Fed President, the dynamics between inflation and monetary policy are intricate and mutually influential elements. Adjusting monetary policy in response to the trajectory of the economy is essential, demanding flexibility and careful data analysis. Future monetary policies will likely be comprehensive, taking into account not only inflation rates and economic indicators but also a diverse array of factors.

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