Inflation and the Fed
Kroszner said the U.S. Federal Reserve appears finally ready to act after acknowledging that high inflation following pandemic spending is no longer a “transitory” issue. He said to expect interest rate increases to begin in March, followed by further rate hikes and a reduction of the size of its balance sheet throughout the year.
“Today they’re going to lay the foundation for an interest increase, and we’ve seen some central banks around the world already start to raise rates in Asia as well as in the West,” he said.
As interest rates rise, the United States may draw investment away from some emerging markets, triggering further rate hikes in Asia and elsewhere, he added. Both Kroszner and Hsieh said increasing interest rates will require some caution. If the Fed acts too quickly, it could lead to a sharp rise in market interest rates and trigger troubles for debt repayment. If it acts too slowly, however, it could lose credibility to fight inflation and allow the expectation of high inflation to become “baked-in.”
Structural problems in China’s economy
As the United States begins to raise interest rates, China’s central bank continues to move in a reverse pattern due to low inflation, said Wong. China’s “COVID-Zero” strategy has allowed its economy to keep functioning as it relies on internal circulation, but it is still burdened by its debt-laden property sector, Wong said. While investing in property has known risks in China, it is still extremely popular as one of the only vehicles for investment and savings available to ordinary people.
“The financial markets need to be reformed, and this has obviously to do with deleveraging in a still repressed financial market, so that people can get back into better quality and diversified forms of savings, and then they would be ready to increase consumption to achieve a better balance between consumption and investment,” said Wong, describing China’s main issue as “a repressed financial capital market reform challenge.”
Beyond the property market, China has also taken steps recently to rein in the power of its tech companies as it attempts to address areas of vulnerability to U.S. economic pressure, said Hsieh.
Supply chains will change irrevocably
Wong said the full impact of COVID-19 on supply-chain disruptions is still being assessed around the world, as different regions were affected in different ways—whether it was increased shipping costs and container rates or the constrained ability to source materials.
Kroszner said he expects to see a shift in how supply chains are managed from operating on a “just in time” delivery model to a “just in case” model that is more thoughtful about long-term risks. The next challenge, he said, will be how to make supply chains more resilient without drifting into protectionism.
“If you’re making supply chains more resilient, that’s totally sensible,” he said. “If you’re doing it just to protect some particular groups in the long run, that’s not going to be helpful to anyone.”
Hsieh also warned that adjusting interest rates alone will not solve the U.S. inflation problem, because the issue was also triggered by a pandemic-era shift toward the consumption of goods over services.
“At what point are we going to go back and shift our demand back toward services in the same way that we were doing back in 2019? The question is by the time we get there, what is going to be the change in terms of our expectations of inflation?” Hsieh said, describing this as a key challenge for policymakers.
Kroszner, however, said that the U.S. readjustment may not be as painful as some may fear. Part of the current inflation pressure was the result of unprecedented government spending through stimulus checks—but many consumers chose to save rather than spend. As the pandemic subsides, their savings will enable them to support consumption above pre-pandemic levels, including of services, even as new government fiscal spending fades.
—This story was first published by the Booth School of Business.