What has happened?
- The US economy shrank for a second straight quarter, raising chances of a recession,
- As decades-high inflation undercut consumer spending and Federal Reserve interest-rate hikes stymied business investment and housing demand.
- Gross domestic product fell at a 0.9% annualized rate after a 1.6% decline in the first three months of the year.
- The median projection in a Bloomberg survey of economists called for a 0.4% advance in GDP and a 1.2% rise in consumer spending.
- The report is likely to add to political headaches for President Joe Biden and complicate the Federal Reserve’s calculus over how aggressively to raise interest rates.
- In addition to the slowdown in household spending, the report also showed declines in business investment, government outlays and housing.
- In its continuing bid to cool down raging inflation in the United States — at 9.1% in June, the inflation rate is at a four-decade high —
- The Federal Reserve or Fed (US’ central bank) decided to raise the Federal Funds Rate target by another 75 basis points on Wednesday.
- Since March, the Fed has steadily pushed up the targeted FFR from zero to almost 2.5% now.
What is federal fund rate?
- The FFR is the interest rate at which commercial banks in the US borrow from each other overnight.
- The US Fed can’t directly specify the FFR but it tries to “target” the rate by controlling the money supply.
- As such, when the Fed wants to raise the prevailing interest rates in the US economy, it reduces the money supply, thus forcing every lender in the economy to charge higher interest rates.
- The process starts with commercial banks charging higher to lend to each other for overnight loans.
Why is fed tightening money supply?
- This is called monetary tightening, and the Fed resorts to it when it wants to rein in inflation in the economy.
- By decreasing the amount of money, as well as raising its price (the interest rate), the Fed hopes to dent the overall demand in the economy.
- Reduced demand for goods and services is expected to bring down inflation.
But what Is the risk of monetary tightening?
- Aggressive monetary tightening — like the one currently underway in the US — involves large increases in the interest rates in a relatively short period of time, and it runs the risk of creating a recession.
- This is called a hard-landing of the economy as against a soft landing (which essentially refers to monetary tightening not leading to a recession).
- The chances of a soft-landing for the US exist but are extremely low.
So is the US in recession?
- The most common definition of recession requires the GDP of a country to contract in two successive quarters.
- Contracting GDP typically results in job losses, reduced incomes, and reduced consumption.
- Since the US GDP has already contracted by 1.6% during the first quarter (January, February and March) of 2022, a contraction in the second quarter imply the US is in recession.
Why some people are contesting this?
- A massive point of contradiction is the remarkable job creation in the first half of 2022.
- The labour market remains quite “tight” — that is, unemployment still remains at historic lows.
- In fact, despite a contraction in GDP in the first quarter and a likely contraction in the second quarter, the US economy created around 2.7 million new jobs in the first half of 2022.
- This is more than the number of jobs created in any full-year period in the recent past.
- This is the reason why Fed Chairman Jay Powell refused to characterise the US economy as one undergoing recession when asked during the media interaction on Wednesday.
- Janet Yellen, US Secretary of the Treasury, has also argued that the US economy is not in recession even if the GDP contracts for two successive quarters.
Outlook for US economy
- The US economy is facing a curious situation.
- One the one hand, it faces an inflation rate that is at a four-decade high and, on the other, its unemployment rate is at five-decade low.
- However, aggressive monetary tightening of the kind being witnessed will likely result in a recession sooner rather than later.
- The US inflation rate is at over 9% and the Fed’s target inflation rate is 2% — that’s a gap of 7 percentage points.
- Historically, every time the Fed has tried to bring down inflation by more than 2 percentage points, the US has witnessed a recession.
Impact on India?
- In the latest — July update of the — World Economic Outlook, the IMF has downgraded the growth projections for the US, China and India.
- “Downgrades for China and the United States, as well as for India, are driving the downward revisions to global growth during 2022–23, which reflect the materialization of downside risks highlighted in the April 2022 World Economic Outlook,” it states.
- A global slowdown is unlikely to have any positives for India apart from some relief in crude oil prices.
- The IMF has knocked off almost a full percentage point each (0.8%, to be precise) off India’s GDP projections for the current year and the next.
- “For India, the revision reflects mainly less favorable external conditions and more rapid policy tightening,” explains the IMF.
- The impact of a US recession on India will depend on the magnitude of the recession; how big the recession is, Crisil Chief Economist D K Joshi told.
- “As of now, the US recession is likely to be a shallow one. It can slow down India’s exports but will also lower commodity prices globally which is positive.
- So, for now, the recession is likely to be shallow and its impact will be moderate on India.”
Q) If a non profit organization is converted into a profit earning company, the process will be called as?