Indiana Trust Wealth Management
Investment Advisory Services
by Stephen J. Nilles, CFP®, AFIM™
Vice President, Director of Client Services, Investment Advisor

  • The US equity market, represented by the S&P 500 index, fell .2% for the week ending September 15.
  • It has been thought that monetary and fiscal policy work best when they are complementary, but so far that has not been the case during this period of increasing interest rates.  

As the father of a teenager who is learning how to drive, I have spent some time the past few months in the passenger seat attempting to teach my daughter the ins-and-outs of driving a car. One of the early lessons in this journey was pointing out the significance of using the right foot to both accelerate and brake. The reason for this strategy is to keep drivers from braking and accelerating at the same time, which can prove to be problematic. As I also pointed out to her, this strategy keeps the left foot free to engage the clutch if the car has a manual transmission, although I could tell from the look on my daughter’s face that was clearly an advanced topic for future discussion.

Much like automobiles, the US economy has different levers that can be pushed to accelerate or slow down activity. However, unlike autos, there are two separate drivers that determine the path and speed of economic growth.

The Federal Reserve (Fed) impacts economic activity through its monetary policy, which consists of adjusting interest rates and the size of its balance sheet. When the Fed wants to stimulate economic activity, it lowers interest rates and/or increases the size of its balance sheet. When the Fed wants to slow economic activity, it increases interest rates and/or decreases the size of its balance sheet. 

Just like the Fed can impact economic activity via monetary policy, the federal government (Legislative and Executive branches) can impact economic activity through fiscal policy. When the federal government wants to stimulate economic activity, it lowers taxes and increases spending. When the federal government wants to slow economic activity, it raises taxes and decreases spending.     

Over the course of the past year-and-a-half, the Fed has hit the brakes hard as it has aggressively tried to lower inflation by slowing economic activity. To accomplish this, it has raised the Federal Funds Rate by over 5% and shrank its balance sheet by roughly $1 trillion. Meanwhile, the federal government has continued full speed ahead. Its federal deficit in fiscal year 2022 was $1.4 trillion, and in fiscal year 2023, which ends on September 30th, it is projected to run a deficit of $1.8 trillion (which is approximately 6.5% of US GDP). 

On the surface, it seems illogical that one driver would be slamming on the brakes while the other driver has the accelerator firmly engaged, but the strategy has worked so far. Inflation in the US has meaningfully cooled while economic growth continues to surprise to the upside and unemployment remains extremely low.

In other parts of the world where monetary and fiscal policy seem to be a bit more in sync, the results are more mixed. In 2023 the Eurozone is projected to run a deficit of approximately 4% of GDP, and the European Central Bank has raised its benchmark rate to 4.25%. However, inflation is still running in excess of 5%, and anticipated economic growth in 2023 and 2024 is below 1%. In China, the world’s second-largest economy, falling prices recently led China’s central bank to cut its one-year loan prime rate 10 basis points to 3.45%, in an attempt to stimulate its economic activity and prices.

Thus far during the Fed’s current rate-increasing cycle, diametrically opposed monetary and fiscal policies have succeeded in producing a runway for an economic soft landing. Whether this paves the way for a soft economic landing or merely extends the time before an economic contraction is yet to be determined. In either event, my advice for my teenage driver does not change as automobile brake repairs are quite pricey.  

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