On April 27, the official GDP reading for the United States was published. It turned out that economic growth in the first quarter of 2023 was less than expected. The last quarter of 2022 recorded GDP growth of 2.6%. While it is true that a lower growth rate was expected for this quarter, the result turned out to be lower than expected. It amounted to just 1.1% in the first quarter of this year, while experts' forecasts were estimated at 2%. The Federal Reserve may consider such a turn of events before their next week’s interest rate decision.
Relationship between production and money supply
GDP is simply the value of goods and services produced in an economy. The money supply is the number of units of legal tender that circulate in that economy. With a given money supply, the greater the number of goods and services produced, the greater the purchasing power of that money, because that money supply includes more things that are paid for with it. Similarly, a decrease in the value of goods and services produced means that there are fewer goods and services for every dollar, so this means inflation. However, it should be remembered that in practice the money supply is not constant, and this factor may not be so apparent at first glance.
While the GDP growth turned out to be weaker than expected, an official recession has not been registered yet in the US. Last month, inflation in the US as measured by the CPI was at an annual rate of 5%, with the inflation reading for April due on May 10, which is forecast at an annual rate of 5.2%.
Source: Tradingview
What is the Fed guided by?
The contemporary paradigm of monetary policy is based on the assumption that, on the one hand, in order to bring down inflation, a restrictive monetary policy is pursued consisting of increasing interest rates and reducing the money supply. On the other hand, lowering interest rates as part of an expansive policy may result in higher inflation. Expansionary monetary policy stimulates GDP growth in the short term, for which the price may be a long-term inflationary stimulus.
What decision the Fed would take, would probably depend on which goal is more of a priority. Will it be to maximize GDP or to further beat inflation? It should be noted that the standard inflation target worldwide is 2% per year. The United States hasn't reached it yet, and if the forecast for 5.2% comes true, it would even move away from that target. What further decisions the Federal Reserve will make may be determined by the CPI inflation readings published on May 10th. Current data reading has given central bankers reason to lean toward a dovish stance, but the inflation aspect, for the time being, gives reasons to maintain a hawkish stance.
Paweł Szarmach, MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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