19 May 2022
Evan Alfred
There are two questions regarding Federal Fund Rate Hike: Stagflation or economic stability?
Stagflation markers are appealing. In a standard economic textbook, rising inflation that is dismantled by rising federal fund rate would be causing slow economic growth and recession. Although the Federal Reserve has reasoned the rate hike for price stability, the history of the economy says otherwise. From 1991 to 1993 Paul Volcker era, Federal Reserve had done the same maneuver to tackle inflation. The conditions were almost the same as the current situation. The current economy is shocked by the Russian invasion of Ukraine. As an impact, the US has sanctioned Russia by stopping the demand for their oil. At that time, the world was also shocked by the Gulf War. The oil price shock had caused a decrease in the Industrial Production Index from 63,18 to the lowest level of 60,5. But the Fed had succeeded in curbing the inflation rate. The inflation rate was down by more than 2%. The hike in the Consumer Price Index as an impact of the oil price shock is no surprise. However, the economy needs to remember the recovery stage of the economy post-covid*. The global economy has faced a lag during the Covid-19 lockdowns. This has created a fragile purchasing power within society as an impact of decreased wealth creation. However, since COVID-19 has been curbed in most countries, the global economy could be seen improving since then. People are starting to work in their offices (or Hybrid) and they could go out to dine in a restaurant. Nonetheless, the war in Russia has changed all of that. The Brent Crude price has set a record high since 2015. The war has disturbed the process of economic recovery post-pandemic stage. The rise in Brent Crude Oil price would mean transportation cost for shipping is substantially higher than before. With higher transportation costs, a firm would be forced to increase the price as the cost structure is higher than before the war. Increasing price would impact maintaining a stable margin within the income statement of the most firm. Other firms with inadequate supply chains would increase the price to cover expenses from higher transportation costs.
With this situation, the economy needs a lower value of money to boost the economy. The lower value of money means firms could borrow money at a lower interest rate. Aside from that, the lower interest rate would reduce fear in the financial market as all firms predicted lower spending in 2022. A lower interest rate is crucial for economic spending. With the increased interest rate in this situation, the risk of default in corporate and household loans is getting high. The higher default risk would be generated by multiple risks that firms faced from war, consumers' purchasing power that has not fully recovered, oil price, and COVID-19 variants. In contrast, ordinary people also face similar risks to firms in general. People would have a rising gas price for their cars and a rising price of food to be put on the household table. Supply chain disruptions also contribute to the rising price of food as commodity price surges drastically in this supply uncertainty. This causality in supply chain disruptions as a result of war creates market uncertainty even higher.
*Covid era in this article occurs when the international countries have not implemented vaccines and the majority of industries applied for work from home.
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