US Fed Transformed into a 'Deflation Fighter'... Reactions from Bank of Korea and ECB

"Maintaining Base Interest Rate at Zero for 3 Years"
Inflation Overshooting Accepted but No Mention of Negative Interest Rates

Korea, Europe, etc. Say "Let's Observe Market Reactions for Now"
Massive Liquidity May Only Inflate Bubble Risks

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), is explaining monetary policy at a press conference immediately after the Federal Open Market Committee (FOMC) meeting on the 16th (local time).
[Image source=Reuters Yonhap News]

[Asia Economy Reporter Kim Eun-byeol, New York = Correspondent Baek Jong-min] The U.S. Federal Reserve (Fed) announcing that it will not raise interest rates for the next three years signifies a transformation into a 'deflation fighter' and 'employment fighter.' While the central bank had previously focused on curbing rapid inflation, it now expresses its intention to prevent excessive price drops and revive the economy. The prolonged COVID-19 pandemic has slowed the pace of growth recovery, prompting the Fed's shift. Major countries including Europe and South Korea have also unintentionally become 'deflation fighters' by continuing accommodative monetary policies after COVID-19. The problem remains whether the money injected into the market can actually boost inflation and growth rates, as market skepticism persists. The moment central banks lose market trust, funds concentrated in asset markets could turn into a 'bubble,' which cannot be ignored.

"Accommodative stance until inflation overshoots"

Jerome Powell, Fed Chair, stated at a press conference following the Federal Open Market Committee (FOMC) meeting on the 16th (local time), "It will take a long time for the economy to expand, and sectors such as airlines and hotels will face even greater difficulties," adding, "We will maintain an accommodative policy stance to support employment recovery, even if inflation temporarily overshoots."

This statement came as the Fed revised upward its U.S. growth forecast for this year, seeing a faster-than-expected improvement, but still assessed overall economic activity as sluggish. The Fed raised its 2020 U.S. economic growth forecast to -3.7% from the June projection of -6.5%, but lowered growth forecasts for the following years. The unemployment rate forecast for this year was revised down from 9.3% in June to 7.6%.

Recent U.S. economic indicators show a clear slowdown in employment and consumption recovery. August retail sales, announced by the U.S. Department of Commerce on the day, increased by only 0.6% month-over-month, significantly below the 1.1% expected by experts surveyed by Dow Jones. Although the unemployment rate is improving, about 11 million of the approximately 22 million jobs lost due to COVID-19 remain vacant.

Deflation fighter in words only?

The problem is that the Fed's expression of intent remains just that?an expression. While FOMC members expect no rate hikes for three years according to the dot plot, they did not mention any additional measures beyond holding rates steady. They announced maintaining asset purchases at current levels, and no participant advocated introducing 'negative interest rates' to raise inflation. The Fed only stated it would pursue accommodative policies "until full employment and 2% inflation targets are achieved over the long term," but specifics on what constitutes full employment or the averaging period for the 2% inflation target remain unknown. Wells Fargo predicted, "The likelihood of the Fed introducing negative policy rates is low," but "if inflation fails to rise, the Fed may accelerate asset purchases." BNP Paribas also noted, "There are no concrete figures linked to employment and inflation targets, so monetary policy discretion remains, and asset purchases remain unchanged," evaluating that "the accommodative policy stance is consistent with the July FOMC."

Major central banks such as the European Central Bank (ECB) and the Bank of Korea have also become deflation fighters after COVID-19 but have refrained from specific reactions to the Fed's recent move, instead watching cautiously. Recently, within the government, there has even been talk that the Bank of Korea should raise inflation to escape the economic recession caused by COVID-19. Since it is difficult to increase tax revenue, rising prices would naturally lead to additional tax collection. Bank of Korea Governor Lee Ju-yeol also stated, "In a situation where deflation is a concern, we face the issue of whether the current inflation targeting system is appropriate or needs to be changed." However, internally, the stance is that it is not too late to respond after confirming the Fed's specific measures and market reactions.

Unprecedented money supply may only inflate bubbles

There is also concern that the Fed's policy could ultimately only inflate bubbles. Since injecting funds after COVID-19, stock markets worldwide, including the U.S., have surged. Experts point out that despite the Fed sending 'dovish' messages to the market, the moment the market loses trust will be when financial markets become volatile again. Emerging markets, including South Korea, are particularly vulnerable to shocks as funds may exit first.

Another issue is that the Fed keeping benchmark rates steady while purchasing large amounts of corporate bonds could create zombie companies. Recently, the U.S. corporate bond market has seen a surge in junk bond issuance, increasing corporate debt. Over time, moral hazard among companies and inefficiencies in support allocation may become apparent.

Some interpret Chair Powell's message on the day not as the Fed announcing additional accommodative policies but as a warning to the political sphere. The Wall Street Journal (WSJ) explained the effects of the Fed's existing accommodative policies and interpreted the message as directed at politicians. WSJ stated, "The Fed has already provided significant loan-type financial support through the financial sector and is seeing effects," adding, "It was a reminder of the importance of reaching an agreement on the 'COVID-19' fiscal support bill, which remains unresolved."