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In the long run, once the U.S. economy returns to full employment, the economy returns to normal operation, and inflation and interest rates return to normalization, the U.S. must solve its fiscal problems.
On March 23, local time, Fed Chairman Powell stated at the hearing of the House Financial Services Committee that with the “unprecedented” support of the U.S. Congress and the Federal Reserve, the U.S. economy has “substantially improved.” However, he warned that the US economic recovery is still “far from complete.”
Powell reiterated that the Fed will begin to gradually reduce the scale of asset purchases when it sees further substantive progress in the full employment and inflation goals. It has not yet begun to discuss when to start shrinking the balance sheet.
Since 2021, U.S. bond yields have continued to rise, triggering investors’ concerns about liquidity and inflation, which in turn led to a substantial adjustment in the global market. At the same time, the US Congress recently passed a new round of economic relief bills of up to 1.9 trillion U.S. dollars, and market expectations for inflation have continued to rise.
In this regard, Mark Zandi, chief economist of Moody’s Analysis, pointed out in an exclusive interview with a reporter from 21st Century Business Herald that the US economy is still struggling under the new crown virus pandemic, the unemployment rate is still high, and the inflation rate is still lower than that of the Federal Reserve. Therefore, it is wise for the US government to continue to provide substantial financial support.
Zandi emphasized to reporters, “As the US economy grows, we may face high inflation, but this phenomenon will not last long.”
In addition, Zandi told reporters that if interest rates rise, U.S. stocks are likely to see a correction in the near future. He suggested that investors “must be more cautious and do their homework.”
U.S. short-term interest rates may continue to approach zero in the next two years
“21st Century”: After the latest interest rate meeting, the Federal Reserve announced that it would keep interest rates unchanged and maintain the current pace of asset purchases. Why has the Fed not adjusted its monetary policy?
Mark Zandi: The Federal Reserve has made it clear that it will not raise interest rates and short-term interest rates until the US economy reaches full employment, that is, everyone returns to work. This means that the unemployment rate should be close to about 4%, and the current unemployment rate is much higher than 6%, so we still have a long way to go from the expected goal.
In addition, the Fed stated that it will not raise interest rates until the inflation rate continues to remain above the target of 2%. This inflation target will still take some time to achieve. Therefore, I don’t think the Fed will raise short-term interest rates in the near future.
“21st Century”: Do you think the current monetary policy of the Federal Reserve is reasonable?
Mark Zandi: Yes. Although we have made a lot of progress and the American people are also being vaccinated, I think the current state of the US economy is still struggling, with high unemployment, underemployment, inflation rate has been below the target of 2%, and the epidemic is still continuing. I think the epidemic may get better later this year, but we still need to maintain a high degree of vigilance until then. Therefore, the Fed must continue to “step on the gas pedal” to ensure that economic conditions continue to improve.
“21st Century”: The Federal Reserve stated that the probability of raising interest rates before 2023 is unlikely. In your opinion, when will the Fed start raising interest rates? why?
Mark Zandi: I think the Fed’s decision is very much in line with expectations. Assuming that all fiscal support measures work, all pent-up demand is released, American households must spend cash, and economic growth continues, I think the Fed may consider raising short-term interest rates in early 2023 two years later. Therefore, I think our short-term interest rates will be close to zero in the next two years.
“21st Century”: Will it be too late to adjust interest rates in 2023?
Mark Zandi: It might be. If the economy is really prosperous and inflation reaches a relatively high level, much higher than expected, then the Fed will face pressure to adjust short-term interest rates earlier than I expected. Therefore, I cannot rule out this situation, it is very possible. But I think that for now, considering the information we have and all the uncertainties, the most likely scenario is that the Fed will only start raising short-term interest rates in a few years.
U.S. stocks are likely to have a callback in the future
“21st Century”: The stock market reacted positively to the Fed’s decision. The Dow rose more than 200 points that day. The long-term U.S. Treasury yields remained positive. But in a recent interview, you said that economic recovery will increase inflationary pressure and warned Wall Street. What are your predictions for the current stock market?
Mark Zandi: I think investors, stock investors, and bond investors are only now gradually realizing the fact that the economy will recover strongly and inflation will rise. So I think they are starting to discount, which is a factor driving the rise in U.S. bond yields.
Of course, stock prices have been fluctuating up and down, but since the beginning of the year, the stock market has basically been sideways. I think this is because investors are gradually realizing that the fact that the economy is gradually improving is good for the stock market, and higher inflation and higher interest rates are bad for the stock market. The two offset basically the same, so there is a flat stock market.
“21st Century”: Are US stocks currently waiting for a correction?
Mark Zandi: This possibility is very high. I mean the current valuation is very high and the market is very tight, but I don’t think this is a bubble. We are in a scenario where people are buying stocks simply because they can sell them quickly and make a profit. This kind of hype was very popular during the millennium bubble 20 years ago. I don’t think we are repeating the same mistakes. But even in the case of low interest rates, the valuation is very, very high. If interest rates rise in the future, it will put pressure on the stock market, so I think a correction in the stock market is very likely to happen in the near future.
“21st Century”: Recently, US debt is a very hot topic. Is this because of rising inflation expectations?
Mark Zandi: Yes. The growth momentum of U.S. debt is indeed strong, which is related to the Fed’s long-term maintenance of low interest rates. This also raises expectations of inflation and actual growth for people and investors.
If the economy is really strong, the unemployment rate will fall and the inflation rate will rise. Then as a bond investor, you will pursue higher interest rates. I think this is the situation we are discussing. And considering that the future economic data is very strong and inflation expectations are rising, I don’t think there are any factors that can stop the current trend.
“21st Century”: Can you give investors some advice?
Mark Zandi: For investors, they have made quick money. Since bottoming out a year ago, the market has rebounded strongly, especially the stock market. I think the market will face more difficulties next and interest rates will rise. When interest rates rise, all asset prices will face downward pressure, so I think it will become more difficult for investors to obtain high returns. They must be more cautious and do their homework.
High inflation is only a short-term phenomenon
“21st Century”: In 2020, major central banks around the world will adopt loose monetary policies to support economic recovery. Inflation expectations are now rising. Will inflation be a big problem this year?
Mark Zandi: I think we are likely to see an explosion of inflation. The epidemic has disrupted global supply chains. As the US economy enters a stage of faster growth and demand begins to pick up, we may see different types of supply shortages, from wood and copper to oil and agricultural products, so we may see the prices of these products soar.
But I think this phenomenon is temporary, and we will turn it over soon. Inflation will remain below or close to the Fed’s 2% target. Therefore, in a very short short term, such as in the next three to six months, as the US economy grows, we may face high inflation, but this phenomenon will not last long.
“21st Century”: What kind of risks might inflation bring?
Mark Zandi: I think if the inflation level is too high, it will erode people’s actual purchasing power and ultimately affect the economy. High inflation rate will make it more difficult for companies to invest, and investment costs will become higher. Higher levels of inflation and higher interest rates make it worse for any borrower, because they have to pay more for their debts. So high inflation has many different ways of affecting it. If the inflation rate rises too high, then inflation will become a problem.
However, looking at it from a different perspective, we are in such a world. Many countries and regions in the world and the global economy as a whole are struggling with low inflation and deflation for a long time. This is our problem for the past 20 to 25 years. Therefore, high inflation is not unpopular.
I think that at this point, letting the inflation rate rise is a more desirable approach, even if it is an overcorrection, that is, for a period of time, it may be higher than anyone expects. This is just to get rid of the low inflation, deflation, and anti-inflation situation that has plagued us for many years.
Achieving full employment is the primary goal
“21st Century”: US President Biden has signed a $1.9 trillion fiscal stimulus plan. As the US economy recovers and the distribution of the new crown vaccine is faster than before, do you think it is necessary to introduce a new economic stimulus plan now?
Mark Zandi: It is necessary. As I said earlier, the US economy is still struggling under the new crown virus pandemic, the unemployment rate is still high, and the inflation rate is still below the Fed’s target, so I think it is wise for the government to continue to provide substantial financial support. As for the US$1.9 trillion fiscal stimulus plan, if it will help the US economy to fully recover in a few years. I think this is desirable.
Now if the Biden administration wants to propose another fiscal stimulus plan, in fact, we are already discussing this issue, then I do think that this plan has a price. This means that it must be deficit-neutral and cannot increase the country’s deficit. Because if we get to that point, our stimulation might be excessive. Inflation may reach unpopular heights, and the economy may overheat. Therefore, if the next fiscal stimulus plan that covers infrastructure spending and spending on more social projects needs to be introduced, then larger companies and high-income, high-net-worth households need to levy higher tax rates.
“21st Century”: In fact, we know that the $1.9 trillion stimulus plan will increase the government’s debt burden. Why do you think this plan is needed?
Mark Zandi: The unemployment rate in the United States is 6.2%. This does not include the millions of people who did not find a job and those who did not find a job again after losing their jobs. For example, many parents took care of their children at home because the school was closed, or they were unable to work because they needed to take care of family members who had been infected with the new crown virus. If you include these people in the calculation, the unemployment rate is close to 8%. In a well-functioning economy, the unemployment rate should be 4%.
In order to restore the economy to a state of full employment and let everyone resume work as soon as possible, I think deficit finance and financial support are very necessary.
“21st Century”: Will the fiscal deficit be a big problem in the long run?
Mark Zandi: Yes. In the long run, once the U.S. economy returns to full employment, the economy resumes normal operations, and inflation and interest rates return to normalization, the U.S. must solve its fiscal problems. For U.S. policymakers, resolving the long-term fiscal position of the United States will be crucial. This means that it is necessary to limit the growth of government expenditures and raise taxes, both of which can control long-term fiscal problems.
But, as I said, we cannot turn the cart before the horse. Let us first achieve full employment. After completing this goal, we can solve the financial problem.
“21st Century”: The Federal Reserve raised GDP growth and inflation expectations, and lowered the expected unemployment rate. How do you look forward to the outlook for the U.S. economy in 2021?
Mark Zandi: My point of view is similar to that of the Fed. I predict that the best-case scenario for GDP growth is a 6.5% year-on-year GDP growth in the fourth quarter of 2021. I think this is the growth rate we should expect to see. The unemployment rate is expected to drop to 4.5%, which is also a very reasonable forecast. Based on the information we know and the strong economic recovery, we may reach this goal in the next few months.
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