All this seems to suggest that the Fed will put off a rate hike for an indefinite period and wait for the global economy to repair before it tightens its monetary policy. However, things are, as always, not that simple. The data flow in the US economy suggests that it is actually recovering quite well and the Fed's decision will have to strike a fine balance between local trends and global factors. It will also have to gauge how much of the weakness in asset prices is indeed in anticipation of a tighter monetary regime in the US and how much of it reflects weak fundamentals.
Thus, it might be useful at this stage to quickly take stock of the US economy. There has been enough discussion on the growing traction in the US labour markets and the improving quality of employment (less part-time workers; higher earnings for newly employed workers) and we will not dwell much on it. Although recent retail spending figures have been a tad weak, consumption is strong, abetted by a healthy job market. Falling gasoline prices will give discretionary income and spending further boost. The consensus forecast for gross domestic product growth in the third quarter is being scaled down a little by forecasters from the earlier 3.5 per cent, but it is likely to be in the three-per cent ballpark. Those who look into the minutiae of inflation figures point out that both rents and medical costs (that were suppressed due to a set of one-off factors) will move up, pulling core inflation above the American central bank's two-per cent target. US exports have been strong and yet the non-petroleum current account deficit has widened. This again suggests that domestic economic activity is strong.
Two things need to be borne in mind. The Fed might actually be relieved that the dollar has gained against the euro. Europe is a major trading partner and was being weighed by a strong currency apart from its more structural woes (that are unlikely to go away in a hurry). A correction in the euro zone's exchange rate was thus warranted. Second, given its mandate of balancing domestic growth and inflation, it is resolutely focussed on domestic factors and has thus been somewhat insensitive to the collateral damage of its actions, much to the chagrin of other central bankers like Raghuram Rajan. Thus, if the US recovery continues and price pressures tend to build up, the Fed will move and I will argue that it is premature to take a mid-2015 US rate hike off the table. Instead of seeming to send a contradictory signal to the markets, the US central bank should continue to sensitise them to this possibility.
The implications for India and indeed other emerging markets are predictable. Despite the global financial markets' dismal showing in October, they cannot take a prolonged pause in the US Fed's rate decision for granted. The best defence is to get our domestic act together. That, mercifully, the government seems to be doing.
Abheek Barua is with ICRIER. Bidisha Ganguly is Principal Economist, CII