Will the RBI have the gumption to follow the Fed?

If that was not a clear enough signal of the Fed’s intentions, Powell elaborated, "Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone." Further, "Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth… While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain."

Powell then went on to quantify exactly what this "pain" is likely to mean in terms of rate action, "July's increase in the target range was the second 75 basis point increase in as many meetings, and I said then that another unusually large increase could be appropriate at our next meeting. We are now about halfway through the intermeeting period. Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook. At some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases."

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To those still hoping for an early Fed pivot (a softening of the pace of rate hikes), his warning that "the historical record cautions strongly against prematurely loosening policy," should leave no one in any doubt that the Fed means business. To his thinking, "central banks can and should take responsibility for delivering low and stable inflation". The Fed would be focused on "rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored". More importantly it will "keep at it" until it "is confident the job is done".

As an exercise in clarity and transparency, Chairman Powell’s speech could not have been better. Other central banks, including our own Reserve Bank of India (RBI) and its rate-setting committee, the Monetary Policy Committee (MPC), could well take a leaf out of Powell’s book!

So, what does all this mean for markets and, more importantly, for global economy? If the reaction of US markets–the Dow Jones fell three per cent after Powell’s speech–is any indication, it means we are in for tough times. Higher interest rates could well tip the US economy into recession (US GDP has already contracted two consecutive quarters, even as a booming jobs market gives the lie to the technical definition of recession) and result in a growth slowdown, worldwide.

In the interim, higher US interest rates could see the flight to safety from emerging markets, including India. And with renewed vigour. Concomitantly, a strengthening US dollar (and weakening Indian rupee) will aggravate our pain as imports, especially oil imports, become more expensive in rupee terms. For a country already battling inflation–wholesale price inflation in double digits for 16 consecutive months while retail inflation has been above the upper end of the RBI’s target range of six per cent for seven consecutive months–higher imported inflation leading to higher generalised inflation should normally evoke only one response: higher interest rates. Even if it hurts growth, as it is bound to.

Will the RBI have the gumption to follow the Fed? For, as Powell admits, "The burdens of high inflation fall heaviest on those who are least able to bear them." Will the BJP government, known to favour right-of-centre policies, allow it? The reality is, as Diane Coyle, Professor of Public Policy, Cambridge University, writing for Project Syndicate, says, "The redistributive effect of inflation makes the policy response to inflation unavoidably political."

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