He also said that interest rate will continue to rise gradually over time and Fed will keep a close eye on the continuing economic growth.
The testimony clearly confirmed that the direction of the chairman’s monetary policy is fitted to the conventional view of maintaining low inflation and stable economic growth, while giving relatively little weight to stock price volatility.
If Powell’s choice of conventional policy is right on the spot, the US economy will continue to expand steadily on the next couple of years at least. On the other hand, if stock prices are actually driven by speculative bubble, the Fed will lose the opportunity to contain a bubble by not promptly taking the necessary preemptive action.
Hence, the successful outcome of his immediate task depends on the fact that this long period of rising stock price is actually based on the improvement in economic fundamentals instead of a speculative bubble. Powell’s recent testimony indicates that he is more likely to agree with the strong economic fundamentals explanation and thinks that the sharp drops in US stock prices in early February were just trigged by stock-market adjustment – a volatility shock. This means that the Fed is not likely to move quickly to the pace of a monetary tightening soon.
The US stock market then responses immediately and positively to the news. However, there are still many hurdles that may pull back the US stock market from a sustainable bully-stock-market, for instance:
First, the recent tax cuts will only add 0.8 percentage points to average annual economic growth over the next decade as estimated by the US Joint Committee on Taxation. Such additional growth undoubtedly fails to justify the claim to those proponents of tax cuts as an engine of strong economic fundamentals.
Second, opponents of tax cut argue that such policy will adversely intensify the existing inequality problem. It remains to be seen how rising inequality will affect strong economic fundamentals
Third, as a saving-short economy, the continuing bully-stock-market and rising equity price may continue to increase US borrowing of surplus saving from abroad. Hence, the extension of an accommodative monetary policy may lead to higher household debt to GDP ratio.
Credit-supply expansion, not economic fundamentals, might be the real driving force of rising aggregate demand and economic growth. If this is really the case, then the current accommodative monetary policy won’t be justified by strong economic fundamentals as perceived by Powell.
Contributed by Professor ARAYAH PREECHAMETTA, lecturer at Faculty of Economics, Thammasat University.
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