For the last year or two, the Fed's actions have been in the spotlight, sometimes confusing and sometimes controversial. From the new round of extraordinary monetary easing adopted by the Federal Reserve in response to the impact of the epidemic, to the implementation of the "average inflation target" and taking the initiative to set a short-term inflation target above 2%, to the fact that prices continue to rise but have been slow to tighten monetary policy, it reveals that the focus of the Fed's monetary policy goal has changed from "price stability" to "putting economic growth first". Will the US economy fall back into stagflation? Is the Fed, famous among global central banks for its policy independence, once again deeply bound to the national will of the United States with the changes of the times? How is this time different from the past?

Our research believes that the Fed's monetary policy choice of "giving priority to economic growth" may be successful. The US economy has begun to recover strongly and may be sustainable, and it cannot be ruled out that a virtuous circle of "demand-driven-supply-price stabilization-income increase" is being formed. Although the market is still worried about inflation and divergent on the economic outlook, the US labor market has obviously picked up and the supply chain has gradually recovered. At present, domestic inflation expectations in the United States are still under control, not only will not return to "stagflation", but is expected to usher in a longer period of economic prosperity. With the support of economic fundamentals, the process of normalizing US monetary policy is also likely to be more lasting in the future.

The Fed's current monetary policy choice is based on its judgment of inflation trends.

In March, US CPI growth exceeded 2 per cent year-on-year for the first time, reaching 2.6 per cent, up 0.9 percentage points from February. Since then, inflation has risen rapidly. Us CPI grew 5.4 per cent in July from a year earlier, the highest since August 2008, while core CPI remained as high as 4.3 per cent. The Fed's current monetary policy choice is based on its judgment of the rising trend of prices, that is, whether this rapid rise in prices is a short-term shock.

The rise in prices reflects a large gap between supply and demand for a variety of reasons. In the case of strong demand, the disruption of the global supply chain caused by the superimposed epidemic has exacerbated inflation in the United States. We share the view that the current rapid rise in prices in the United States is a short-term shock, mainly because the gap between supply and demand is prompting the market to increase supply through various means, and the US economy has begun to recover strongly. Price increases will eventually fall smoothly as a result of increased supply.

First, the increase in supply is driven by sustainable demand.The US economy was in good shape before the outbreak, with GDP growing at more than 2 per cent, and demand was already strong. During the epidemic, the United States issued a large number of subsidies to residents, which increased the purchasing power of society, and the unemployment rate in the United States was even difficult to fall because of generous government subsidies. When expectations for the economic outlook improved, demand was further released. The US consumer confidence index rose to a 17-month high of 129.1 in July from 128.9 in June.

Second, the current price system in the United States has not failed, but is still playing a role in regulating supply and demand.According to reports, Amazon.Com Inc plans to spend more than $120 billion on supplies and services to American companies. This is an example of an enterprise adjusting to the disruption of the supply chain caused by the epidemic. According to a survey by the Federal Reserve Bank of New York, 59% of respondents have found new suppliers in response to supply chain disruptions, and 58% have begun to add additional inventory. The impact of the epidemic has brought market clearance, which is a rare opportunity for the United States to restart its economy, upgrade its industries, and improve its labor productivity, which many countries do not have.

Third, there is a strong recovery in the labour market, which also helps to increase supply and curb inflation.Labor force participation rate is a sensitive index to economic fluctuation. By the end of July, the US labour force participation rate had rebounded to 62.3 per cent from 60 per cent in April 2020, equivalent to the pre-epidemic average (62.3 per cent in 2015-2019, 62.6 per cent in 2010-2019). Non-farm payrolls in the United States increased by 943000 in July and are expected to increase by 858000, compared with an increase of 850000 in June. Meanwhile, the unemployment rate fell to 5.4 per cent, better than expected at 5.7 per cent and 5.9 per cent in June.

Fourth, the impact of the epidemic will tend to weaken.With the large-scale promotion of the vaccine, the US economy is restarting in an orderly manner. COVID-19 's case fatality rate has also decreased significantly, so the disturbance of the epidemic to the economy is also weakening. Air occupancy in North America is now about 80 per cent of 2019, significantly higher than the global average (slightly more than 60 per cent in August due to repeated declines in outbreaks), according to OAG (Official Airline Guide). The passenger throughput of TSA checkpoints in the United States is also getting closer and closer to that before the epidemic. In the future, as the growth of durable goods consumption slows down, residents' demand will mainly be released in the service industry. The increase in service consumption in the future will further promote the economic growth of the United States.

Will the United States get stuck in stagnant inflation again?

There is a view that the US could slip back into stagflation, as it did in the 1970s. From June 1972 to December 1974, US CPI growth climbed from 2.7 per cent to 12.3 per cent, while from November 1976 to March 1980, US CPI growth climbed from 4.9 per cent to 14.8 per cent. But the current situation in the United States is different in many ways from the stagflation of the 1970s.

First of all, demand pull is the main reason for the recent price rise in the United States, but it also continues to promote the increase of supply, which may form a virtuous circle.The Fed chose to let the price system play the role of market regulation, rather than resorting to price controls, as it did in the 1970s. The latter not only fails to solve, but even aggravates the shortage on the supply side, laying a "curse" for high inflation.

The wage-price freeze imposed during the Nixon administration only ostensibly "controlled" inflation, while both the administration and Congress wanted expansionary monetary policy because of fears of economic stall. The combination of price control and expansionary monetary policy has brought temporary high economic growth and low inflation. In early 1973, CPI inflation was just over 3 per cent. But by mid-1973, inflation began to get worse. In the fourth quarter of 1973 and the first quarter of the following year, inflation in the United States reached 10.5% and 12.5%, respectively.

Many people attribute the inflation of the 1970s to the rise in oil prices. But in fact, the sharp rise in oil prices caused by the oil crises of 1973-1974 and 1978-1979 only exacerbated the rise in prices. Before oil prices rose, the superposition of supply shortages and expansionary monetary policy had led to accelerated inflation. In order to prevent the appreciation of their currencies against the US dollar, the central banks of various countries bought a large number of US dollars in the foreign exchange market, and the expansionary monetary policy of the United States was then transmitted to the world, creating conditions for the Organization of Petroleum Exporting countries (POEC) to raise oil prices, thus forming a vicious circle.

Second, inflation expectations are an important factor. The credibility of the central bank's monetary policy is based on expected stable inflation.At present, inflation expectations in the United States are manageable. Although the US CPI still rose 5.4 per cent in July from a year earlier, the growth rate slowed significantly to the same level as in June, while the core CPI annualised rate fell for the first time in four months. According to PCE indicators, the year-on-year growth rate of US PCE in May and June was 3.96% and 3.99% respectively, which was more than one percentage point lower than that of CPI. The fall in inflation expectations occurred even earlier in May. The difference between the maturity yield of 10-year Treasuries and the yield of inflation-indexed Treasurys of the same period reflects inflation expectations. The data show that the gap between the two yields has narrowed from 2.5 percentage points to about 2.4 percentage points. During the stagflation of the 1970s, otherwise stable inflation expectations were disrupted. Under the consensus of cost-driven inflation at that time, Congress, the government and most economists were in favor of expansionary monetary policy, while the Fed raised its acceptable level of inflation. When inflation expectations are stable, stimulus monetary policy can still use this expectation to expand aggregate demand and increase aggregate supply. But by 1979, stable inflation expectations were completely disrupted. One of the important reasons why the later Federal Reserve Chairman Volcker was able to reverse the vicious circle of self-fulfilling inflation expectations was that he established a credible and restrained monetary policy, which finally stabilized public expectations.

Moreover, the economic environment faced by the Fed has changed a lot.At present, the world is at the breakthrough of a new round of scientific and technological revolution and its application, with the accelerated development of advanced technologies such as artificial intelligence, biomedicine and new energy, and integrated into more and more advanced industries. As a world power in science and technology, the United States will undoubtedly benefit from this historic scientific and technological change. Labor productivity is also expected to continue to improve. All these will be an important force in curbing inflation. In the 1970s, the development of science and technology in the United States was at a low ebb-after nearly 20 years of the best part of science and technology, by the early 1970s, the driving force of the third technological revolution had significantly weakened.

The $1 trillion infrastructure bill proposed by the Biden administration has been passed by the Senate. This infrastructure package includes further increasing the broadband penetration of American households and investing money in the development of technology industries, including pure trams. The popularity of broadband in American homes will greatly boost the economic impetus of technology, because the various applications of modern communication technology in people's lives depend on this infrastructure.

In fact, there has been a marked increase in labor productivity in the United States. Us labor productivity growth jumped from less than 1 per cent to about 3-4 per cent in 2020. The growth rate remained at a high rate of 3-4% in the first two quarters of this year. Something similar happened during Greenspan's tenure. Although the unemployment rate fell steadily in 1997, from 5.2 per cent in March 1997 to 4 per cent at the end of 1999, FOMC did not continue to raise the federal funds rate until February 2000. This departure from the Fed's previous policy model stems from Greenspan's judgment that inflation is no longer a threat. At that time, the increase in labor productivity also effectively curbed inflation.

The revision of the Fed's policy framework is nothing new.

The policy objectives and systematic framework of the Federal Reserve are found in the process of sublation and wandering, and they will change with the changes of the situation, and their economic consequences will be good and bad. however, the overall evolution is in the direction of increased policy credibility, stable inflation expectations and conducive to the development of the real economy.

Martin (the third chairman of the Federal Reserve, 1951-1970) was the chairman of the Federal Reserve who laid the foundation for the operation of modern central banks. Before that, monetary policy was largely excluded from economic regulation, and at one point the Fed had no right to adjust interest rates. Martin believes that the monetization of government debt caused by fixed interest rates, artificially suppressed inflation, and direct controls that undermine the price system are the real reasons for the difficulty of full employment. In March 1951, the Federal Reserve reached an agreement with the Treasury to regain the power to raise interest rates. Since the US recession in 1953, the Federal Reserve began to try to implement counter-cyclical monetary policy. At this stage, proactive monetary policy operations begin to overwhelm changes in inflation expectations and become the dominant factor in determining real interest rates. Since then, the era of "going against the wind" in which monetary policy is applied to economic stability has officially begun. Some ideas in Martin's policy were shown again in the later Volcker era, one is to give priority to price stability in order to restore and develop the economy, and the other is to maintain price stability with pre-emptive policies.

But between Mr Martin and Mr Volcker, Mr Burns, Mr Martin's successor, resorted to price controls in the fight against inflation and inflation expectations. During this period, due to the pressure of some periods of government, Congress and the severe economic situation, the independence of the Federal Reserve was severely challenged, resulting in serious economic consequences. The "stagflation" that plagued the United States in the 1980s was largely the result of the Fed's excessive pandering to the government and its repeated increase in inflation tolerance.

In the Volcker-Greenspan period, the Federal Reserve formed a "quasi-rule" policy model, which restricted the adjustment of interest rates against the wind, so that the macro shock did not change the actual and expected level of inflation. Of course, while the Fed emphasizes price stability, it does not institutionalize the inflation target in accordance with fixed rules. In Greenspan's view, expectation is the center of all problems, and because it is not bound by the rules of monetary policy, policy can only make discretionary choices according to changes.

There are three main considerations for Greenspan's opposition to policy rules:First, the evolving economy will change the desirability of monetary policy in unpredictable ways; second, politically acceptable inflation depends on factors beyond the Fed's control; and finally, inflation targets will force policy adjustments at some point, which will greatly undermine the effectiveness of monetary policy in curbing investor herding. These factors are now more or less taken into account in the Fed's monetary policy decisions.

How is this time different from the past?

As mentioned earlier, the Fed's monetary policy choice of focusing more on full employment rather than price stability is different from the historical period of "stagflation". It needs to be emphasized that although the current shift in the focus of the Fed's monetary policy objectives is still closely related to the economic and political environment at home and abroad, it is evolving in the direction of resolving the principal contradictions in the US economy. The main contradiction in the US economy at present does not lie in price stability, but in economic growth, and the current price stability in the United States also depends on economic growth.

The first is that the accelerating gap between rich and poor and populism in the United States needs to be appeased by economic growth.Especially under the impact of the epidemic, the unemployment problem of low-income groups has intensified, and populism and social discontent have been further fermented. Only by increasing employment and promoting economic growth can the rift of social differentiation be bridged.

Second, the "normalization" of US fiscal and monetary policy is highly dependent on the improvement of US economic growth.The loose fiscal and monetary policies of the United States have been deeply bound. The service of principal and interest on US debt depends on the US fiscal revenue, which is mainly composed of tax revenue, which is closely related to the level of employment and economic growth.

The third is to deal with the pressure brought by the international environment, especially China's economic development.It is widely believed that China's GDP will overtake the United States to become the world's largest economy in 10 years' time. And with the improvement of economic strength, China continues to catch up in the political, military, scientific and technological fields, and plays a more prominent role on the world stage.

These factors have made both the Biden administration and the Federal Reserve "give priority to economic growth", reaching a high degree of agreement and reflecting the national will of the United States. The consistency and stability of the macro policy direction will enhance the ability of national organization mobilization, resource allocation and allocation, improve the role of the government in the economy, enhance its management ability and executive ability, and open up more space for the future economic development of the United States.