It looks like the health of the United States economy and its future prospects will be the key issue in voters’ minds this time around. It appears that more people trust Kamala Harris over Donald Trump as someone who can better address economic issues. A poll conducted in August 2024 for the Financial Times and the University of Michigan Ross School of Business found that 42% of voters in the United States believe the presumptive Democratic candidate can handle the economy more effectively, compared to 41% who favoured the Republican candidate on this issue.

Was Biden’s withdrawal from the 2024 race surprising? One might say yes, considering that surveys conducted in April, May, and July showed only 35% of voters had confidence in incumbent President Joe Biden’s ability to handle the economy better than Trump. The former president was leading by a margin of 10% over the incumbent. In the poll conducted in June, 37% of people expressed confidence in the president.

Biden’s Reign: In Numbers

The power transition from Trump to Biden occurred during the 2020-21 period, when the global economy was at a standstill due to the COVID-19 pandemic. While the United States, under Trump’s leadership, recovered quickly compared to its Western peers, this trend continued under Biden’s administration, as the nation experienced the strongest pandemic recovery within the G7, as measured by GDP.

In Biden’s words, the US economy has been the “envy of the world” under his economic stewardship. To justify his stance, he pointed to data such as record job creation and historically low unemployment.

“Fifteen million new jobs in just three years – that’s a record! Unemployment is at 50-year lows. A record 16 million Americans are starting small businesses, and each one is an act of hope,” he remarked during his March 2024 State of the Union address.

During Trump’s four years in office (between January 2017 and January 2021), the average annual growth rate was 2.3%. Under the Biden administration so far, this figure has often exceeded the 3% mark since 2023.

When it comes to inflation, during the first two years under Biden, the price rise peaked at 9.1% in June 2022, followed by a downward trend. Trump claims that the US has experienced “the worst inflation we’ve ever had.” However, inflation was last above 9% in 1981. On the other hand, the rate has now fallen to around 3%, but it remains higher than when Trump left office.

To justify the above trend, it is worth noting that many other Western countries also faced extremely high inflation rates after 2021, as global supply chains experienced disruptions due to COVID and the Ukraine war. Economists also point out that Biden’s $1.9 trillion American Rescue Plan, which was enacted in 2021, contributed to the issue. The injection of cash into the economy led to further price increases.

The Biden administration has repeatedly highlighted strong job growth as a major achievement. Before the high unemployment in 2020 due to COVID, the first three years of Trump’s presidency saw the addition of nearly 6.7 million jobs, according to data on non-farm employment (which covers about 80% of workers in the labour force). Since the Biden administration took over in January 2021, there has been an increase of almost 16 million jobs.

Biden has claimed this as the “fastest job growth at any point of any president in all of American history,” and data from 1939 supports this assertion. However, analysts also point out that the current administration has benefited from a sharp rebound in economic activity as the country emerged from the pandemic.

“Many of the jobs would have come back if Trump had won in 2020 – but the American Rescue Plan played a major role in the speed and aggressiveness of the labour market recovery,” says Professor Mark Strain, an economist at Georgetown University, while interacting with the BBC.

Prior to the pandemic, Trump had delivered an unemployment rate of 3.5%. Lockdown measures led to soaring levels of unemployment in the United States, which then dropped to around 7% when Trump left office. Under the Biden administration, unemployment continued to fall to a low of 3.4% in January 2023, the lowest rate in over 50 years, but it has since ticked up to 4.3%.

In terms of wages, they did rise under Trump but at a similar rate to his predecessor, Barack Obama, until 2020. Wages increased rapidly at the start of that year, but the sudden uptick was linked to lower-paid workers being more likely to be laid off, which raised the average wage of those who were still employed. Under Biden, average weekly earnings have grown, but they have struggled to keep up with inflation.

US presidential elections are often won and lost on the economy. “It’s the economy, stupid,” coined by Bill Clinton during his 1992 election campaign, remains a popular slogan among American voters.

By the time Biden withdrew from the White House race, he was indeed fighting a battle of perception.

“The alarming fiscal trajectory of the nation has been made worse by a sharp increase in federal spending. Allies have been incensed by corporate investment subsidies in the United States, which may ultimately be ineffective. However, many of these policies are undoubtedly having an effect already. Just have a look at the construction boom in factories: even after taking inflation into account, investment in manufacturing facilities has more than doubled under Mr. Biden, reaching an all-time high,” The Economist noted.

Presenting Harris’ Vision

It revolves around the prosperity of middle-class and working Americans. Harris aims to facilitate 25 million new small business applications (including start-ups) during her first term, up from the record 19 million received under the Biden administration as of mid-August. This goal will be achieved through tax reliefs and simplification of bureaucratic red tape. She has already released a four-part package designed to make housing, groceries, child-rearing, and prescription drugs more affordable. Many of these proposals build upon efforts previously unveiled by the Biden administration.

However, these ideas come with significant price tags, and she has yet to detail how she will cover the costs. Her prior package would add $1.7 trillion to the deficit over the next decade, before interest, according to the Committee for a Responsible Federal Budget.

So far, her campaign has stated that she would increase the corporate tax rate to 28%, up from the 21% rate established by Trump’s 2017 tax cut law. This increase would raise about $1 trillion over the next decade, according to the committee.

Harris has also expressed support for the revenue-raising provisions in Biden’s fiscal year 2025 budget blueprint, which includes tax hikes on wealthy Americans and large companies. Overall, these measures would raise approximately $5 trillion.

Currently, small businesses are allowed to deduct up to $5,000 of eligible start-up expenses in the year they begin operations, according to the Congressional Research Service. Harris’ plan would expand the tax deduction to up to $50,000 and allow businesses to claim that deduction in the year they first turn a profit to ensure they receive the full benefit.

Additionally, Harris will advocate for increased investment in community development financial institutions (CDFIs), which are dedicated to serving low-income individuals and communities. While many small businesses struggled during the COVID-19 pandemic, those owned by people of color were hit hardest.

Harris’ affordable housing plan includes providing up to $25,000 in down-payment support and a $10,000 tax credit for first-time homebuyers. To spur construction, she would introduce a first-ever tax incentive for builders who construct starter homes sold to first-time buyers. She also plans to expand an existing tax incentive for building affordable rental housing and create a $40 billion fund for innovative housing construction.

Furthermore, the Democratic nominee will ban algorithm-driven price-setting tools for landlords and remove tax benefits for investors who purchase large numbers of single-family rental homes. While incentives to build more homes should increase inventory and help drive prices down, experts have warned that down-payment support could stimulate demand and lead to higher prices.

Harris’ $25,000 homebuyer credit and additional affordable housing policies are projected to cost $200 billion over a decade, according to the Committee for a Responsible Federal Budget, which assumed these provisions would be in effect for four years.

Among Harris’ other plans, she is advocating for a federal ban on price gouging to help lower grocery prices. Additionally, she supports restoring the American Rescue Plan Act’s popular expansion of the child tax credit to as much as $3,600 and extending the more generous Affordable Care Act premium subsidies that are set to expire at the end of 2025.

She also wants to expand the current $35 monthly cap on out-of-pocket costs for insulin and the upcoming $2,000 annual limit on out-of-pocket costs for prescription drugs to all Americans. These caps were initially established for those on Medicare under the Inflation Reduction Act. Harris is also backing the idea of accelerating Medicare’s drug price negotiations to reduce the costs of more medications more quickly.

Furthermore, she has expressed eagerness to work with states to cancel medical debt for millions of Americans. According to her campaign, states and municipalities have used American Rescue Plan funds to cancel $7 billion of medical debt for up to 3 million Americans.

Imagining US economy under Trump 2.0

Expect import tariffs, a hallmark of Trump’s first term, to return, along with more tax cuts and a sharp reduction in immigration.

Trump has been discussing the idea of targeted tariffs as well as an overall import duty of 10% on all goods entering the country. While the Republican repeatedly claims that China bore the costs of his earlier tariffs, economists view these moves as “a tax on Americans,” potentially leading to higher inflation.

“Such a tariff, and likely retaliatory tariffs from other countries, would increase the price of imported goods. It’s not clear how much this proposed tariff would affect the inflation rate. A bigger concern is that such a steep tariff and ensuing trade war would harm both American producers and consumers,” said Patrick Horan, research fellow at the Mercatus Centre at George Mason University,” while talking to the US News.

According to economist Kenneth Rogoff, Trump’s proposed tariffs on imports would have “recessionary effects on the US economy and could end up sending inflation higher again.”

The Harvard professor and former chief economist of the International Monetary Fund told Bloomberg that Trump’s proposed policies and Joe Biden’s current Inflation Reduction Act make them both the “most protectionist” presidential candidates the United States has seen in a while.

“10% tariffs, I think, would push up inflation. They’d push up interest rates. If you do it out of the blue, it’s very dislocating to the economy. I think it would tend to be very recessionary and inflationary,” he added, expressing concern that other countries might retaliate, potentially sparking trade wars and making Trump one of the biggest threats to the global economy.

Cutting taxes, especially on corporations and high-income individuals, has been a staple policy for Republicans. In 2017, Trump secured a $1.7 trillion tax cut from Congress. Economists widely agree that this move will further add to the nation’s debt if not offset by other cuts or revenue enhancements.

The Trump tax cuts are set to expire in 2025, and if the Republican returns to power, he will likely pursue an approach opposite to Biden’s: raising taxes on the wealthy.

The corporate tax rate, which was lowered to 21% from 35% as part of the 2017 tax cut package, may be maintained at the current level if Trump returns to office.

According to Allianz Research, “A Trump 2.0 presidency would inherit very large fiscal deficits from the Biden administration, rising interest expenses, and an economy probably more prone to bouts of inflation. Another round of large, deficit-financed tax cuts (or increased spending) could thus reignite inflation and heighten concerns about the sustainability of US public finances in the bond markets.”

Maxime Darmet, senior economist at Allianz Trade, even predicts that Trump might reverse some of Biden’s policies supporting green energy and high-tech manufacturing to finance his own industrial policy, which would be broader and less targeted than Biden’s.

Darmet noted that the current economic environment is significantly different from the one seen during Trump 1.0. Interest rates are now higher, which makes most of Trump’s industrial subsidies inflationary in nature.

While Trump’s accusation that the current Democratic administration has ruined the “greatest economy in the history of the United States,” which he created, may sound like empty rhetoric, the nation experienced a rapid and sharp recovery post-COVID under the Biden-Harris administration compared to its Western and G7 peers. Additionally, the current government has done a far better job of adding new jobs in record time.

If we take a close look at Kamala Harris’ roadmap for the US economy, it appears to be geared toward benefiting the middle class and working Americans by making housing, groceries, child-rearing, and prescription drugs more affordable. Additionally, she aims to support the growth of small businesses and start-ups. On the other hand, Trump, if elected for a second term, plans to implement targeted import tariffs, industrial subsidies, and more tax cuts, while reversing some of Biden’s policies in support of green energy and high-tech manufacturing. This approach would
finance a broader and less targeted industrial policy compared to Biden’s.

However, regardless of who becomes the next President, they will inherit an American economy with large fiscal deficits, rising interest expenses, and a potential for increased inflation. How the new leader addresses these challenges will be crucial in determining the nation’s future economic stability.

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The Labour Department recently said that initial claims for state unemployment benefits decreased by 6,000 to a seasonally adjusted 233,000 for the week ending June 22. This Juneteenth National Independence Day was one of the new holidays included in the claims data. Public holidays tend to be a tumultuous time for claims.

They had reached the peak of 2024’s 194,000–243,000 range. There is disagreement among economists over whether the current spike in claims is indicative of an increase in layoffs or of the same volatility seen at this time last year.

Claims are still at historically low levels, and the Federal Reserve has raised interest rates by 525 basis points since 2022 to contain inflation. However, there are concerns that employers may be increasing layoffs as the economy contracts.

The economy grew less quickly in the first quarter, as the Joe Biden government affirmed in a different report.

In its third estimate of GDP for the January–March 2024 quarter, the Commerce Department’s Bureau of Economic Analysis said that the overall GDP grew at a slightly upwardly revised 1.4% annualised pace last quarter.

Prior estimates of the growth pace were 1.3%. The fourth quarter saw a 3.4% growth in the GDP. Since July 2023, the US central bank has kept its benchmark overnight interest rate within the current range of 5.25% to 5.50%.

According to the claims report, during the week ending June 15, the number of people getting benefits after an initial week of aid, a proxy for hiring, increased by 18,000 to a seasonally adjusted 1.839 million. The government conducted a household survey in June 2024 to determine the unemployment rate, and this data, known as the continuing claims data, covered that month.

In May, the unemployment rate increased to 4.0% for the first time since January 2022. However, most economists argued that the growth was concentrated in the 35–44 age bracket, recent immigrants, and specific industries and that the rate at its current level did not pose a threat to the labour market.

Oxford Economics senior economist Ryan Sweet said, “Even though job growth will decelerate, it will remain sufficient to preclude a major and broad-based increase in the unemployment rate.”

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Price stability and full employment, the United States’ Federal Reserve’s two legally mandated goals, are necessary to ensure a healthy and expanding economy in the global powerhouse. The Fed has done this in the past by changing reserve requirements, doing open market operations (OMO), and changing short-term interest rates. The Fed has also developed new ways to fix the economy since the subprime crisis started in 2007. What are these instruments, and how do they lessen the effects of a recession? First, let’s examine the Fed’s toolbox.

Talking about Fed’s policy stance for 2023, it has already released the hypothetical scenarios for its annual stress test, which will help it to ensure that large banks are able to lend to households and businesses during a severe recession.

“This year, 23 banks will be tested against a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets,” the Fed communication remarked.

The Federal Reserve Board’s stress test generally evaluates the resilience of large banks by estimating losses, net revenue, and capital levels, which provide a cushion against losses, under hypothetical recession scenarios, that may extend two years into the future.

Critical Points

The Federal Reserve is the central bank of the United States. Its job is to set monetary policy and control the amount of money in circulation. The Fed’s two main instruments (OMO) are interest rate setting and open market operations.

Among other less common ways to help failing banks, the Fed can change the legal reserve requirements for commercial banks or act as a lender of last resort.

These measures allow the Fed to implement an expansionary monetary policy when the economy is struggling. It can resort to unconventional measures like quantitative easing if that doesn’t work.

Interfering with Interest Rates

The Fed and other central banks worldwide employ short-term interest rate manipulation as their primary instrument. Simply put, this strategy is increasing/decreasing interest rates to slow/boost economic growth and manage inflation.

The mechanics are pretty straightforward. By lowering interest rates, borrowing money becomes more affordable and saving money becomes less profitable, encouraging people and businesses to spend. As a result, savings drop as interest rates fall, more money is borrowed, and more money is spent. Also, the overall amount of money in the economy rises as borrowing levels do. So, lowering interest rates has the excellent side effect of making people save less and spend more, which is good for the economy as a whole.

Conversely, decreasing interest rates also tend to raise inflation. This has a negative side effect since, in the near term, the total supply of commodities and services is fundamentally finite. When more money competes for a limited number of items, prices rise. The economy experiences various undesirable side effects if inflation becomes too high. The key to manipulating interest rates is not to go too far and start inflation by accident. Although this approach to monetary policy is flawed, it is still preferable to taking no action.

System of Federal Reserve (FRS)

Public Market Transactions

Open market operations (OMO), in which the Fed purchases or sells Treasury bonds on the open market, are the Fed’s other primary weapon. Because OMO can change interest rates and the overall money supply, it is comparable to directly influencing interest rates. This process’ rationale is relatively straightforward.

When the Fed purchases bonds on the open market, it expands the money available to the general public by exchanging the bonds for cash. In contrast, if the Fed sells bonds, it reduces the money supply because it takes money out of circulation in return for bonds. OMO thus has a direct impact on the money supply. OMO also affects interest rates because when the Fed purchases bonds, prices are pushed up, and swiftness is lowered; conversely, when the Fed sells bonds, prices are pushed down, and rates are raised.

Hence, OMO has the same effect as direct manipulation of interest rates in terms of lowering rates/increasing money supply or raising rates/decreasing money supply. The essential distinction, however, is that OMO can apply to bonds of any maturity to alter the money supply since the size of the U.S. Treasury bond market is so enormous.

Prerequisites for Reserves

The amount of reserves a bank must retain about specific deposit liabilities is determined by the reserve requirements, which are subject to adjustment by the Federal Reserve. Therefore, based on the required reserve ratio, the bank must hold a portion of the specified deposits in vault cash or warranties with the Fed-backed banks.

The Fed can also effectively raise or lower the amount these facilities lend by altering the reserve ratios imposed on depository institutions. For instance, if the bank gets a USD 500 deposit and the reserve requirement is 5%, it can lend out USD 475 because it only needs to keep USD 25, or 5%, of the deposit. The bank has less money to lend out on each dollar deposited if the reserve ratio is raised.

Changing Consumer Attitudes

The Fed’s final instrument for influencing markets was its influence over market perceptions. Given the transparency of our economy, this strategy is more challenging because it relies on influencing investors’ opinions. Practically speaking, this includes any economic announcement made public by the Fed.

The Fed could say that the economy is growing too fast and that inflation is a concern. If the Fed is telling the truth, an increase in interest rates is logically on the horizon to slow the economy. If the market agrees with what the Fed says, people who own bonds will sell them before interest rates increase and they lose money. Bond prices would decline as investors dumped their holdings, and interest rates would rise. This would allow the Fed to raise interest rates to slow the economy without taking action.

On paper, this looks fantastic, but it’s a little more challenging in practice. This method holds water in terms of impacting the economy because, if you observe the bond markets, they move in unison with the Fed’s instructions.

Term Securities Lending Facility and Term Auction Facility

The credit markets, which significantly impacted the economy, presented challenges to the Fed in 2007 and 2008. Investors have now received an unexpected and acute reminder of the possible risks associated with taking on credit risk due to the recent hikes in interest rates and the subsequent collapse in the value of subprime-backed collateralized debt obligations (CDOs).

Although the underlying cash flows of the majority of credit-based investments did not significantly erode, investors started to demand higher return premiums for holding these investments, which not only increased interest rates for borrowers but also restricted the total amount of money that financial institutions were willing to lend, which in turn put pressure on the credit markets.

Given how bad the crisis was, the Fed had to devise new ways to lessen its effects on the economy as a whole. The Fed supported credit markets, investors’ perceptions of them, and institutions’ willingness to lend despite deteriorating economic and credit market conditions. The Fed established the term “auction” and “securities lending facilities” to achieve this. Let’s examine these two things in detail.

Term Auction Center

The term auction facility was created to give financial organisations anonymous access to Federal Reserve funds to help with short-term liquidity needs and generate capital for lending.

Because businesses would bid on the interest rate they would pay to borrow money, it was given the name auction. This contrasts with the concession window, which makes an institution’s need for funds known to the public, causing depositors to worry about the institution’s viability, which only serves to heighten worries about the stability of the economy.

Lending Facility for Term Securities

The Fed established the term securities lending facility as an additional option to address balance sheet concerns, enabling banks to exchange mortgage-backed CDOs for U.S. Treasury securities. Because of the high exposure that the firms had to mortgage-backed CDOs, the value of their assets was declining. This had profound implications for their balance sheets. If uncontrolled, falling CDO prices might have caused financial institutions to go bankrupt and contributed to losing faith in the American financial system.

Balance sheet worries, however, may be lessened until liquidity and pricing circumstances for these securities improve by replacing falling CDOs with U.S. Treasuries. This recently developed technique allowed for the 2007 Fed-planned seizure of Bear Stearns.

Monetary Easing

The Fed’s arsenal of tools may occasionally need to be improved to boost economic activity during a severe crisis. For example, quantitative easing (QE) is an unconventional monetary policy where a central bank buys longer-term government securities or other kinds of protection on the open market to expand the money supply and promote lending and investment. By driving up the price of fixed-income assets, purchasing these securities boosts the economy’s money supply and lowers interest rates. As a result, the central bank’s balance sheet also significantly increased.

Normal open market operations, which target interest rates, are ineffective when short-term interest rates are at or near zero. Thus, a central bank can instead target specific asset purchases. In addition, quantitative easing expands the money supply by acquiring assets with freshly issued bank reserves to give banks more liquidity.

Some central banks have turned to even more severe measures like hostile interest rate policy if QE fails (NIRP). Although it was adjusted to 0%-0.25% after the 2008 financial crisis and once more in March 2020 in the wake of the COVID-19 pandemic, the Fed has never before placed target interest rates below zero.

Even though monetary policy is generally in flux, it relies on the fundamental idea of changing interest rates, which affects the money supply, the economy, and inflation—understanding the Fed’s motivations for implementing particular policies and how those policies might affect the economy. This is so that opportunities presented by the ups and downs of economic cycles can be taken advantage of to accept or shun investment risk. As a result, finding attractive chances in the markets requires a solid understanding of monetary policy.

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Bill Ackman, whose hedge fund Pershing Square Capital Management is responsible for managing assets worth about USD 16 billion, slammed the Joe Biden government’s response while predicting an “economic disaster” to occur.

The United States Federal Reserve has stressed that no government funds would be required to compensate for the losses because the body is funded by its financial operations when it announced that everyone who had money in Silicon Valley Bank would receive their money back.

According to the Daily Mail, Bill Ackman, who had urged the American government to intervene and protect all of the bank’s depositors, applauded the action but cautioned that it was unlikely to stop the collapse of more financial institutions.

He wrote on Twitter, “We would have had a 1930s bank run continuing first thing Monday, causing substantial economic damage and hardship to millions, had the @FDICgov @USTreasury and @federalreserve not interfered today.”

He also said, “We now have a clear plan for how the government will manage them”, adding that “more banks will probably fail despite the involvement.”

According to US regulators, customers of the defunct bank will have access to all of their deposits beginning on Monday morning, even those that are greater than the USD 250,000 federally guaranteed cap.

“Our government made the right choice. In no way was this a bailout. The blame will fall on those who made a mistake. The bondholders will have a similar fate as the investors who failed to supervise their banks properly,” Bill Ackman said.

Meanwhile, the Silicon Valley Bank’s collapse might increase trouble for other US lenders, and even bring SoftBank Group’s investments under heightened scrutiny from the regulators, reported Bloomberg.

Silicon Valley Bank’s failure has reportedly raised concerns among investors over the exposure to start-up firms in the SoftBank Vision Funds. SoftBank shares plunged by 13% in four sessions to below 5,000 yen. The whole crisis has been dubbed the worst one since the 2008-09 banking rout, and has brought the spotlight to private tech investments.

Image Credits: Pershing Square Foundation

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It came against the backdrop of the United States Federal Reserve aggressively tightening its monetary policy six times in 2022 alone. The domestic inflation crossed the 8% mark, before cooling down to 7.7% in November.

Not only the US, central banks from Argentina, India, the Philippines, Brazil, Indonesia, South Africa, UAE, Sweden, Switzerland, Saudi Arabia, Britain, and Norway too have been following similar steps recently.

While fed rate hikes have strengthened the dollar, the impact hasn’t been a kind one. Since 40% of global transactions are done in dollar, African, Latin American, and Southeast Asian countries are spending more on imports and debt payments.

Emerging markets are facing the heat as well, as investors are flocking back to the US markets, with expectations of getting better returns, amid a strong dollar. Euro is the only currency maintaining some parity with the dollar till now.

Understanding Rationale Of Fed Interest Rate Hikes
Monetary policy adjustments from the Federal Reserve cater to two conditions set by the United States Congress, keeping domestic consumer prices stable and bringing down the unemployment ratio.

So, they raise interest rates in case the inflation rate goes up too high. If it’s a high joblessness kind of scenario, they simply cut the policy rates. Other factors which the central bank keeps in mind, while forming policies, are GDP figures, consumer and industrial behaviors, financial crises, and extraordinary situations like pandemics, war, terrorist attacks, etc.

Since the United States possesses the world’s largest economy, its monetary policy changes affect global markets as well, especially the small, emerging, and developing ones.

Post-2008, while the fed rates were mostly eased to aid economic recovery, they were kept like that till 2014, in order to boost investments and consumer spending. After 2015, fed rate hikes became prominent again. And every time, policy rates were raised, the dollar got stronger, affecting credit markets, commodities, stocks, and bonds.

Another important factor to look at here is the US Treasury Bond values, which are directly connected with the monetary policy changes. As per the movement of bond rates/Treasury yield curves, interest rates within US and global markets get set. If the interest rates go up, investors put their money in the US market, putting pressure on emerging and developing economies to stay attractive. If they fail, unemployment rates go up in those parts of the world.

As per Investopedia, dollar-denominated global debt currently stands at USD 9 trillion, and emerging markets have some USD 3.3 trillion in that. For example, countries like Turkey, Brazil, and South Africa have trade deficits, and they finance their Current Account Deficits (CAD) by building up dollar-denominated debt. With a stronger dollar, the exchange rate between these nations and the US widens, leading to the ballooning of debts.

With global credit markets following US Treasury Bonds, an increasing interest rate means a hike in credit costs as well. From bank loans to mortgages, everything gets expensive, affecting consumer behavior adversely.

As mentioned in the article already, 40% of global trade happens through dollars. A stronger dollar means oil, gold, and cotton getting expensive, hurting the economies which have huge reserves of natural resources and rely on the commodity. With the value of their principal industry products declining, their available credits shrink.

However, growth in interest rates boosts the US demand for global products, aiding foreign trade and corporate profits.

Decoding 2022 Scenario
As the US economy was recovering from the aftershocks of the COVID pandemic, the Fed continued to hold the funds’ rate at around zero till the first quarter of 2022. It was also buying billions of dollars of bonds to boost the economy.

All these were happening despite the Consumer Price Index (CPI) steadily rising since 2021. It reached its record high of 8.2%, before cooling down too. So, yes, inflation has been there in the United States and it has been at its highest since 2021.

Also worth mentioning is Joe Biden’s USD 2.5 trillion stimulus program, which succeeded his predecessor Donald Trump’s USD 900 billion initiatives to deal with COVID fallouts. Both programmes have driven the upward growth of CPI indexes.

Now, as the Fed stepped in, they went for an aggressive series of rate hikes, coinciding with the global supply chain disruption due to the Russia-Ukraine war, thereby contributing more to the pre-recession build-up. Once the Fed decided it was time to do something about inflation, it moved forcefully and raised the fed funds rate by three percentage points in about six months.

The latest hike has been by 75 basis points, taking the interest rate to 3.75-4.0%. This is the highest one since the 2008 financial crisis, affecting sectors like mortgage, pension, and student loans, amid volatile job and manufacturing markets.

Can Rate Cut Be An Option?
Although the Fed officials have hinted about things possibly improving in 2023, the latest World Bank warning means the protectionist approach from the Joe Biden government needs a relook.

Professor Michael Parkin, member of the University of Western Ontario’s Economics Department, during an interaction with International Finance, said, “The US Federal Reserve interest rate increases of 2022 look too small compared with those of the 1970s that successfully lowered inflation. Over the six months from February to August 1973, the federal funds rate rose from 6% to 10.5%, and over the seven months from August 1979 to April 1980, it almost doubled from 11% to 19%.”

Talking about the Fed’s Monetary Policy stance, professor Michael Parkin remarked, “The tightening of 2022 looks small in two dimensions. First, the overall increase is smaller at 3.75 percentage points compared to 4.5 and 8 percentage points. Second, the level is a long way below those of the 1970s at 3.75% compared to 10.4 and 19.4%.”

Can Fed’s Latest Steps Be Enough To Conquer Ongoing Bout Of Inflation?
“No one knows the answer to this question. But we can get some clues to the answer by looking at the outcomes of the earlier monetary tightening in the 1970s. In February 1973, when Fed Chairman Arthur Burns started tightening, the inflation rate was 3.9% and the federal funds rate was 6.6%. Over the next six months, inflation climbed to 7.4% and the funds rate rose to 10.5%,” professor Michael Parkin added, while giving a case study of a similar situation in the 1970s.

“Despite the rising interest rate, inflation soared and by 1974 end, it had reached 12.2%. After raising the federal funds rate again to 13% in mid-1974, inflation fell to 5% but not until the end of 1976. On the road to lower inflation, the unemployment rate increased to peak at 9% in May 1975,” he said.

Drawing a parallel between the situation then and now, professor Michael Parkin remarked, “If the time lags in the 1970s repeat in the 2020s, we can expect it to take many months before inflation falls. And through the period of falling inflation, we can expect the unemployment rate to keep rising. While there are many differences between then and now, there is one striking difference that may turn out to be crucial. In the 1970s, when interest rate increases eventually lowered inflation, the interest rate exceeded the inflation rate. In 2022, the gap is reversed.”

Professor Michael Parkin also believes that if history repeats this time around, inflation will not fall until the interest rate is raised to a level that exceeds the inflation rate.

So given his prediction, the road ahead of the fed is a tough one. Not only the US, but the same situation also applies to other central banks across the world as well. Recession is looming large and despite multiple warnings from the World Bank, the phenomenon of rate hikes will continue.

However, with the latest US figures suggesting the cooling down of inflation, all the other central banks will be hoping for things to improve in the coming months so that monetary policy easing from the Fed lessens the pressure on the global economy.

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The report states that mortgage debt had grown to USD 11.39 trillion. The origination of purchase mortgages increased by 7% in the second quarter as a result of increased borrowing limits. The US central bank started raising interest rates in March as it ended the easy money policies it had maintained during the worst of the COVID-19 pandemic to safeguard an economy that had been severely harmed by lockdowns and other protective measures.

Since then, the Fed’s benchmark overnight lending rate has been increased by 225 basis points as a result of persistently high inflation that has reached four-decade highs. The goal range for that rate is now between 2.25% and 2.50%. The central bank is expected to continue raising interest rates for the rest of the year in an effort to stop the inflation that is draining Americans’ wallets. Over the past two and a half years, prices for expensive commodities like homes and cars have risen sharply as demand has outpaced supply. As a result, the average new purchase origination dollar amount for both of those goods has increased by 36% since 2019.

The invasion of Ukraine by Russia led to an increase in global food and energy prices. According to the New York Fed, total household debt in the United States has increased by more than USD 2 trillion since the fourth quarter of 2019, right before the pandemic started. In the second quarter, credit card balances rose by USD 46 billion, ranking among the highest the Fed has seen since 1999, while auto loan originations increased by USD 33 billion to USD 199 billion. According to the research, this was mostly due to higher origination rates per loan as opposed to a bigger number of loans.

“All debt types saw sizable increases, with the exception of student loans. In part, the growth in each debt type reflects increased borrowing due to higher prices,” the regional Fed bank’s researchers said. The average contract rate on a 30-year fixed-rate mortgage has shot up by more than 240 basis points since the turn of the year to levels not seen since 2008, according to the Mortgage Bankers Association. It now stands at 5.74%.

New York Fed researchers said on a call that delinquency rates were increasing to more typical pre-pandemic levels seen in 2019 that are still historically low. “But we have to keep an eye on that because if they rise above that we’ll be a little more concerned about the state of household balance sheets. The concern is where we are heading,” New York Fed researchers said.

Consumers’ credit soaring?

Americans have racked up record-high credit card debt. According to the doomsayers, this demonstrates unequivocally how difficult it is for households to make ends meet in the face of the highest inflation rates since the early 1980s. The truth is not quite so bad. Consumers have a long runway until mounting debt commitments become an issue because their finances are actually in some of the greatest shapes they have ever been in. It is simple to comprehend anxiety. According to data from the Federal Reserve, there have been four of the largest monthly increases in consumer credit on the record. Over the last six months, outstanding balances have increased by an average of USD 33.1 billion each month. To put that into perspective, the monthly average for all of 2019 was USD 15.4 billion, or slightly less than half that sum. Although the figures are indeed startling, there are signs that they are largely healthy and normal.

First, think about revolving credit, such as credit cards. Early in the COVID-19 pandemic, this type of financing rapidly declined as customers used extra savings and stimulus money to settle bills rather than spending since they had fewer options. As long as the quantity of revolving credit outstanding stays below the pre-pandemic trend line, consumers will primarily just be playing catch-up. The financial system as a whole isn’t even close to that degree now, but if it bursts past the trend that would suggest wider inflation-induced trouble. Of course, many households with lesser incomes are impacted by the sharp increase in costs and are being compelled to use their credit cards. But there are no indications that a widespread debt issue is developing that could harm the economy.

The situation with non-revolving credit is a little different. That includes financing for other expensive items like boats and trailers, which saw an increase in popularity during the pandemic. The majority of those loans are for education and cars. Automobiles, which make up 39% of non-revolving credit and 30% of consumer credit, appear to be the main culprit for the category’s pandemic-era expansion that outpaces the trend. Put that down to the startling rise in car prices in 2021 and, possibly to some extent, the increased interest in car ownership brought on by concerns about public health. Many people who earlier used public transportation now choose to drive because it offers better social isolation.

Although considerably smaller than the auto sector, the “other” category of non-revolving loans, which includes the aforementioned maritime toys, was the true driving force behind the loan increase. Early in the COVID-19 pandemic, boating interest skyrocketed in coastal areas as a result of social distance rules. However, that category is too small to have a significant effect. Additionally, boat owners often don’t live paycheck to paycheck, so exclude that possibility from the list of potential causes of a structural leverage crisis. The non-revolving credit segment would contain any cause for concern in the consumer credit data. However, that segment’s growth reached its apex earlier in the year and began to moderate in the most recent report.

Finally, the household debt service ratio, which measures how much of a household’s income is used to pay off debt, is at or near historic lows. That’s because there will be opportunities to refinance debt at cheap rates in 2020 and 2021, as well as because the government poured in trillions of dollars during the COVID-19 outbreak. Even if inflation is terrible, homeowners with fixed-rate mortgages—which make up the vast majority of home loans—might have benefited from pay raises while their greatest liabilities stayed the same or were renegotiated at lower rates. Even when you combine credit card debt with mortgage debt, the overall load is still incredibly low.

Household debt history

Historical data might shed light on the current condition. Since the middle of the 1980s, the ratio of household debt to total disposable income has increased significantly. By the turn of the century, the percentage had risen from 60% to 130%. This excessive family debt was a major cause of the financial catastrophe in 2008.

After fast declining from its 2008 peak, household debt stood at around 92% by the time of the pandemic. In a report for Barons, economist J.W. Mason makes the case that this growth in debt was actually caused by high-interest rates set by Fed Chairman Paul Volker in the 1980s rather than an increase in borrowing. Mason claims, “With higher rates, a level of spending on houses, cars, education and other debt-financed assets that would previously have been consistent with a constant debt-income ratio, now led to a rising one.”

After the 2008 financial crisis, interest rates were low. Household debts decreased as a result of this, along with decreased borrowing and defaults. Contrary to common assumption, higher interest rates combined with excessive borrowing appear to be the main contributors to today’s rising debt burden rather than excessive borrowing alone. Mason comes to the conclusion that a decrease in borrowing and low-interest rates is both necessary for a decrease in household debt. The Fed’s evident commitment to continuing rate hikes suggests that household debt will increase in the near- to medium-term.

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Employers have struggled for more than a year to fill its ranks, since there are more than 11 million job opportunities but just 6 million unemployed people.

Employee frustration and burnout as a result of this inequality are generating fresh struggles for power at work.

Although the railway conflict has received the greatest attention, several other strikes are sweeping the United States.

In addition to the 15,000 nurses who left their jobs recently in Minnesota, recent authorizations for strikes by healthcare workers in Michigan and Oregon.

A week-long strike by Seattle teachers was called off, postponing the start of the academic year.

Widespread labour shortages that have led to poor working conditions are at the core of each of these issues.

Staffing shortages in vital sectors like healthcare, hospitality, and education have put millions of workers under immense pressure, sparking a wave of labour disputes as well as fresh efforts to organise across the United States.

Too many industries continue to have difficulty filling positions.

Data from the Labor Department show that 62.4% of people in the United States who are of working age either have a job or are looking for one, which is a full percentage point less than it was in February 2020.

The causes are dense and complicated. The number of available workers has been reduced by early retirements, a significant slowdown in immigration that started under the Donald Trump administration, persistent issues with child care and elder care, as well as COVID-19 illnesses and fatalities.

Wendy Edelberg, director of the Hamilton Project at the Brookings Institution, said, “We have approximately 2.5 million fewer people in the labor force than we were on track to have with pre-pandemic trends. That’s a big number, and it means that people who are still there, who are still working these jobs, are having to do even more.”

The stress of working at an understaffed business is a major factor in worker demands, which frequently centre on staffing, or the lack of it.

Teachers in Seattle desired greater teacher-to-student ratios in special education.

Engineers and conductors on trains were requesting sick leave.

Additionally, the Minnesota nurses who stopped working claimed they wanted more flexible schedules and protections against being fired for reporting understaffing incidents.

Lisa Lynch, an economics professor at Brandeis University and former Labor Department chief economist, said, “If you look at sectors like nursing homes, local schools, railroads – employment has fallen like a stone. And with that, you see a marked increase in labor action and strike activity. People are tired and overworked.”

The improvements have been unequal, despite the fact that the United States economy has formally recovered the 20 million jobs it lost at the start of the COVID-19 pandemic.

Major gaps still exist, especially in low-wage sectors where workers have left for more lucrative jobs in warehousing, construction, and professional and business services.

From February 2020 to the present, the hospitality and leisure sector has lost 1.2 million jobs.

Nearly 360,000 personnel are missing from public schools, and 37,000 jobs in the health care sector have not yet been filled. The employment in rail transportation has decreased by 12,500.

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Till recently, economists across the globe believed that by the end of the decade, China’s gross domestic product, expressed in US dollars, would surpass that of the United States, capping what many people believe to be the most spectacular economic rise ever.

But this year, Beijing’s policies—such as its zero-tolerance for COVID-19 and attempts to control real estate speculation—have stifled development, dimming the outlook for China’s economy.

Economists are becoming more concerned about China’s longer-term prospects as they reduce their projections for 2022, with unfavourable demographics and high debt levels likely hampering any recovery.

In one of the most recent modifications, the United Kingdom think tank Centre for Economics and Business Research predicts that China will surpass the United States as the largest economy in the world two years later than it predicted when it made its last prediction in 2020. It now anticipates that it will occur in 2030.

The Japan Center for Economic Research in Tokyo has indicated it expects the passing of the baton won’t happen until 2033, four years later than its prior projection.

Some economists doubt that China will ever overtake the United States.

Former United States Treasury Secretary Lawrence Summers said China’s aging population and Beijing’s rising tendency to engage in corporate matters, combined with other problems, had prompted him to drastically decrease his forecasts for Chinese growth.

Lawrence Summers draws comparisons between projections of China’s development and prior claims that Japan or Russia would surpass the United States, predictions that now seem absurd.

“I think there is a real possibility that something similar would happen with respect to China,” Lawrence Summers said.

Researchers argue the significance of GDP rankings and wonder if anything will change even if China overtakes the United States.

The United States will continue to have a significant impact because of the strength and openness of its economy. For many years to come, it is anticipated that the dollar will remain the global reserve currency.

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In mid-September, the average interest rate for a 30-year mortgage reached 6.02%, which is significantly higher than it was a year ago.

The relocations make housing affordability issues worse for families wanting to purchase a home.

The increase coincides with the aggressive rate hikes made by the US central bank in an effort to ease the pressures that are driving up inflation throughout the economy.

The Labor Department reported in mid-September that United States consumer prices increased by 8.3% in the year ending in August, the quickest rate in almost 40 years.

Since the result was greater than anticipated, more people now anticipate that the Federal Reserve will keep aggressively hiking interest rates. Mortgage rates have increased as a result of the changes.

Freddie Mac chief economist Sam Khater, “Rates continued to rise alongside hotter-than-expected inflation numbers this week, exceeding 6% for the first time since late 2008.”

By increasing borrowing costs, officials hope to reduce demand from consumers and businesses, easing pressure on prices.

However, even though increased interest rates have slowed sales in the housing market, home values are still rising.

In July, the average United States home cost over USD 400,000, an increase of almost 10% from the previous year.

Sam Khater said, “Although the increase in rates will continue to dampen demand and put downward pressure on home prices, inventory remains inadequate.”

For the United States housing market, which has benefited from relatively cheap borrowing costs since 2008 when the US central bank reduced rates during the financial crisis to support the economy, the rise in mortgage rates represents a striking change.

When the COVID pandemic struck in 2020, the Federal Reserve again lowered interest rates, which helped to spark a wave of irrational property buying that saw unprecedented price hikes.

When the bank began to quickly hike rates in March in response to indications that rapid price increases were becoming entrenched throughout the economy, that era came to an end.

In reaction to the slowdown, some mortgage brokers and realtors have already announced job cuts.

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Both the headline (8.3%) and core inflation rates of the US CPI release were clearly higher than expected compared to expectations (6.3%). The Nasdaq fell 5% and Fed Fund Futures now discount at least a 75 bps hike at the next FOMC on September 20-21 and a non-negligible likelihood of a 100 bps boost, the Morgan Stanley report stated.

This unexpected development swiftly revealed recent shifts away from the US dollar and toward risky assets.

Morgan Stanley said, “For our coverage markets we think the chances of a sudden downside dislocation are also rising, We recommend continuing with a broad UW Tech, Semi and Internet stance and expect near term further declines away from our June 2023 base case targets and towards our bear case targets, particularly for MSCI EM (890 or 9% downside), Hang Seng (17,000 or 12% downside) and MSCI China (55 or 15% downside).”

According to Ritika Chhabra, an economist and quantitative analyst at Prabhudas Lilladher, US inflation increased in August, rising to 8.3% y-o-y from the expected 8.1%. Due to a significant reversal in energy costs, the CPI index climbed 0.1% month over month while economists had predicted a 0.1% decrease.

The high cost of food, housing, transportation, and other services is further evidence of the high consumer demand and price pressures in the service sector.

Ritika Chhabra predicted that the Fed will likely raise interest rates by 75 basis points at its upcoming FOMC meeting on September 21 due to inflation being ‘stickier’ than predicted.

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