Thus, as most companies proved able to transfer rising costs to their sale prices, the higher financial bill they faced weighed less than expected. Only when real rates switched to plus sign, they have started denting margins and profits.
Monetary tightening is meant to work by putting a brake on demand, as Powell emphasised when triggering the rate hike process. Yet, the real problem lay on the supply side. Shortages and disruptions following the pandemic led to rapidly rising prices. A looming danger dismissed by central bankers claiming it amounted to a temporary mismatch.
Only when the Ukraine invasion fuelled a wild jump in commodities and inputs, did they realise the pressing need to act. Not all of them. Lagarde refused to follow the Fed’s path until the situation became out of control, arguing it would prove useless in curbing a supply-side inflation. As she bluntly put it, raising rates does not bring gas prices down.
Even if it may seem reckless to wait and be confronted with such a destabilising storm, Lagarde was basically right. As commodities plunged once speculation faded away, prices stepped down to reasonable levels, higher rates playing only a subdued role in this process.
Jerome Powell changed course once he acknowledged that fighting cost-led inflation proved quite evasive unless dumping demand as the Volcker shock did. Footing the bill of an outright slump seemed out of question. Thus, the Fed confined its goal to fighting inflationary expectations to avoid second-round effects.
Once more, its record stands as rather lacklustre. Salaries shot up until the labour market markedly softened. Inflation is fading away on its own while the economy drives towards a more stable outlook by decreasing its growth rate and cooling off the previous employment overheat.
Powell takes credit for the foreseeable soft-landing of the US economy. Yet, fiscal policy has also played a key role in preserving overall demand and growth. By indulging in huge public deficits, it has largely balanced monetary tightening. Unravelling the staggering debt pile will no doubt prove a most challenging task.
Should the US fail to harness its budget financial instability would increase even if the Fed acts, in practice, as the last resort lender to the Treasury. Europe fails to have such a safety net. For the time being, the sluggish performance of its core economies keeps divergence low.
But, confronted with any potential shock, the current doldrums could turn into a vicious turmoil. The prospect that the extreme-right might take over the presidency in France could, for instance, wreak havoc. Highly indebted countries should not waste time reverting to fiscal virtue to prevent any unpalatable backlash.