The monetary policies of the U.S. Federal Reserve and of the European Central Bank are data driven. Those two central banks are, therefore, part of a huge community of short-term economic forecasters.

Hence the derisive comment that interest rate forecasts are “a dime a dozen.”

The corollary is that reading stories about the timing of interest rate changes is a waste of time.

The best one can do is to watch data about inflation, employment and consumer spending. That’s enough to form a good view on the likely direction of interest rates and asset values.

What we know now is that the U.S. and E.U. economies are struggling with serious problems of inflation, public finances, labor markets and geopolitical tensions affecting trade, investments and global supply chains.

To make things worse, those problems are not of a short-term cyclical nature. For the most part, they are structural issues requiring fundamental policy changes and a long time to heal.

Energy and food prices driving inflation

The U.S. core consumer price inflation (the general consumer price index less food and energy prices) of 4.8% last June -- significantly exceeding the total CPI reading of 3% -- is showing that the soaring energy prices for most of the last year had been built into price increases of important service sectors, such as shelter (7.8%) and transportation (8.2%). And those “second round” price effects continue to spread through the rest of the economy.

Rising food prices are having the same effect on the general consumer price inflation. The U.S. is self-sufficient in basic food production, but the destruction of Ukrainian grain stocks and port facilities will increase the global demand for American food supplies. That is bound to drive food prices up to new highs. Sanctions on Russia’s exports of its huge wheat and grain production will only make matters worse.

Still, with the world’s largest energy resources and self-sufficient food supplies, the U.S. might be able to prevent a new inflationary flare-up. But it will be very difficult, if not impossible, to keep inflation on a steady downward path to 2% -- without running a risk of deep recession.

By contrast, food and energy shortages will continue to fuel inflation in the European trading bloc. Last year, the E.U.’s food and energy imports increased 32% and 131% respectively. With that sort of food and energy dependence, the inflation rate of 5.5% (June 2023) will remain a big policy problem -- and a powerful drag on an already sinking European economy.

This discussion shows that monetary policies in open economies crucially depend on external developments beyond their control. The ECB talked about that last week, allowing for further interest rate increases in response to the (high) probability of rising energy prices.

There is also a problem of unsound fiscal policies in the U.S. and the E.U. In an inflationary environment, a loose fiscal stance must be offset by monetary restraint.

Trade sanctions will raise the cost of inflation control

That’s the case we have here with budget deficits ranging from 3.6% of GDP (E.U.) to 5% of GDP (U.S.), and public debt from 97% of GDP (E.U.) to 121% of GDP (U.S.). It’s obvious that this configuration of public finances does not offer any room for accommodative credit policies.

All that means that the U.S. and the E.U. must maintain tight monetary policies until there are clear signs of a steadily receding inflation. That must also be a period of structural reforms to go back to sound public finance accounts and to obtain a more flexible operation of demand and supply in labor and product markets.

And now comes the hardest part. Open economies are supposed to work in a rules-based multilateral system of free commerce and finance overseen by the World Trade Organization.

That’s the trading system where the U.S. economy, whose external sector accounts for 27% of GDP, and the E.U.’s customs union, with an external sector of 38% of GDP, are supposed to thrive – while supporting economic growth in the struggling developing world.

Sadly, the U.S. and the E.U. are the world’s leaders with thousands of trade sanctions and millions of dollars exacted in their enforcement penalties.

Such sweeping impediments to global trade, investments and financial flows are creating huge problems for restoration of price stability in the trans-Atlantic community.

Instead of relying on unfettered competition and “the law of one price,” American and European monetary policies have to depress their economic growth, incomes and employment in a long and uncertain process of trying to balance the forces of demand and supply in their labor and product markets.