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2 Sep 2020

International Economy

Fed’s flexible inflation policy reinvigorates the US capital market but may produce volatility for financial markets in the future once inflation returns (Business Brief No.3882)


            Mr. Jerome Powell, the US Federal Reserve chairman, announced a major monetary policy shift at the latest Jackson Hole conference (August 27, 2020). The Federal Open Market Committee (FOMC) reached a unanimous decision in approving longer-run goals and monetary policy strategy adjustment. The shift to flexible average inflation targeting from the original fixed inflation targeting is meant to increase the flexibility of implementing monetary policy, going forward. Mr. Powell also stated that, as the US economy recovers and the unemployment rate starts to fall once more, the Fed will be in no hurry to raise US interest rates in order to maintain the inflation at a targeted 2 percent – which effectively means that inflation rate can stay above the targeted 2 percent for a certain period. This decision signals that the Fed is bent on keeping interest rates low for the time being, until the US economy and labor market have fully recovered.  

               Such adjustments to the monetary policy framework could restore vitality to the stagnating US capital market amid investors' confidence that the Fed will continue to enforce policy relaxation; wherein most of the injected liquidity will presumably find its way into the capital market. Meanwhile, the real sector may not benefit much from the added liquidity, as the state of the US economy is still fraught with risk. Nonetheless, looking ahead, if the Fed resorts to continued cash injection as means of keeping the system's interest rates low, it may backfire and act as catalyst for higher inflation in the future, eventually forcing the Fed to raise interest rates. Hence, the Fed's exit strategy could give rise to many issues down the line. Taking into account the Fed's latest interest rate hike in late 2015 after maintaining interest rates at near zero for almost 10 years, the capital market underwent a downward adjustment amid heightened volatility. Therefore, any future round of upward interest adjustment could trigger a big market selloff and generate as much market volatility as the previous such occasion.

                 ​As for the impact of such policy on the Thai economy, it is expected to primarily affect the Baht's value. The Fed's policy shift, which keeps US interest rates low for a longer duration, will likely weaken the US Dollar even further while the Baht is likely to keep strengthening. This situation could bring about challenges for the Thai policymakers in implementing its own monetary policy, and hinder Thailand's economic recovery in the forthcoming period.

International Economy