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Finance drives the world to inflation – Global issues

  • Idea by Jomo Kwame Sundaram, Anis Chowdhury (sydney and kuala Lumpur)
  • Joint press service

However, “The ratio between fervent belief and tangible evidence seems unusually high on this topic “. It’s no surprise that central banks are still trying to keep inflation below 2% – an arbitrary target.”spit out of the air“, by a”random comment‘ of the New Zealand Finance Minister then.

An increase in interest rates would undermine resilience and exacerbate disruptions and supply shortages caused by pandemics, wars, and sanctions. European Central Bank (ECB) Executive Board member Fabio Panetta has note The euro area is “de facto stalling” as economic growth comes to a near halt.

As policymakers grapple with inflation, growth and welfare are at great risk. As Panetta warns, “tightening monetary policy aimed at curbing inflation will hamper growth that is already waning.”

Interest rates rise globally
Among emerging markets and developing economies, South Africa’s central bank raised interest rates for for the first time in three years in November 2021.

On March 24, 2022, the Bank of Mexico raised interest rates seventh time in a row. On the same day, the central bank of Brazil raised interest rates highest level since 2017.

Without proof or argument, they claim higher interest rates keep inflation in check. Their admittedly adverse effects on recovery and growth are dismissed as inevitable short-term costs to some unspecified long-term return.

But despite facing higher inflation expectations, tightening international monetary conditions and uncertainties over the Ukraine war, the ECB and the Bank of Japan have yet to join the bandwagon, refusing to raise interest rates. policy rate to date.

Interest – blunt tool
But the dogmatic views, knee-jerk reactions and ‘follow the leader’ behavior by central bankers aren’t helpful. Even if inflation reaches dangerous levels, raising interest rates may not be the right policy response for a number of reasons.

First, raising interest rates only addresses the symptoms – not the causes – of inflation. Inflation is often thought to be the result of an economy that ‘overheats’. But overheating can be caused by many factors.

Higher interest rates can reduce overheating, by slowing economic activity. But a good doctor should first investigate and diagnose the cause of the disease before prescribing the appropriate treatment – which may or may not be necessary.

It is widely accepted that the current spike in inflation is due to supply chain disruptions – exacerbated by war and sanctions – especially for essential commodities like food and fuel. If so, long-term solutions require an ever-increasing supply, including removing bottlenecks.

Higher interest rates reduce aggregate demand. But raising interest rates alone doesn’t even address the specific causes of inflation, let alone rising prices due to supply disruptions for essential commodities, such as food and fuel. .

Interest rate – regardless
Second, interest rates affect all sectors, everyone. It does not even distinguish between sectors or industries that need to be expanded or encouraged and those that should be phased out because of inefficiency or inefficiency.

In addition, raising interest rates too often, and at excessively high levels, can suffocate or even kill efficient businesses along with less efficient or less efficient businesses.

US bankruptcies have skyrocketed in the early 1980s after the President of the Fed of the United States of America raised Volcker’s legendary interest rate. “Thousands of businesses with bank loans may fail,” warning a leading UK tax consulting firm recently.

Third, interest rates do not discriminate between households and businesses. Higher interest rates may discourage household spending, but they also reduce spending of all kinds – for both consumption and investment.

As a result, overall demand may fall – discouraging investment in new technology, plants, equipment and skills. Therefore, higher interest rates adversely affect the long-term productive capacity and technological progress of economies.

Debt, recession and financial crisis
Fourth, higher interest rates increase debt servicing costs for governments, businesses, and households. With exceptionally low interest rates formerly available after the 2008-09 global financial crisis (GFC), debt burdens have increased in most countries.

These are for sure mobilize risky behavior, speculation as well as inefficient share buybacks, dividend increases, and mergers & acquisitions. Interest rates increase activated many recessions and financial crises. As a result, the current rate hike is likely to trigger a new, albeit different, era of stagnant inflation.

The pandemic has pushed public debt to a new historic high. Forty-four percent of low-income and least-developed countries are at high risk or are already outside piled up debt in 2020.

Before the COVID-19 crisis, half The small island developing countries surveyed had solvency problems, that is, at high risk, or already in dire straits. As a result, an increase in interest rates could trigger a global debt crisis.

Fifth, paradoxically, higher interest rates increase the cost of debt repayment, especially mortgage payments, for indebted households. The cost of living also increases if businesses pass higher interest costs on to consumers by raising prices.

Thus, the main beneficiaries of low inflation and higher interest rates are holders of financial assets that fear their relative decline.

Vulnerable developing countries
Developing countries are particularly vulnerable. Higher interest rates in developed countries – especially the US – trigger capital outflows from developing countries – causing exchange rate depreciation and inflationary pressures.

Higher interest rates and weaker exchange rates will exacerbate an already high debt service burden – as happened in Latin America in the early 1980s after US Fed Chairman Volcker raised US interest rates. up a lot.

To prevent sudden capital outflows and prevent massive currency devaluations, developing countries sharply raise interest rates. This can lead to economic collapse – as in Indonesia during the 1997-98 Asian financial crisis.

While pandemic response measures – such as debt relief – have helped ease some costs, the business failure increase by nearly 60% in 2020 from 2019. Low and middle income countries see more business failures.

World Bank Pulse Business Survey – among 24 low- and middle-income countries – found that 40% of businesses surveyed in January 2021 expect to be in debt within six months.

This includes more than 70% of businesses in Nepal and the Philippines, and more than 60% in Turkey and South Africa. Business failures on such a scale can trigger a banking crisis when bad loans suddenly spike.

Instead of examining contemporary inflation, a rate hike is likely to do great damage to the recovery and medium-term growth outlook. It is therefore imperative for developing countries to innovatively develop appropriate means to better deal with the economic dilemmas they face.

IPS UN Office


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© Inter Press Service (2022) – All rights reservedOrigin: Inter Press Service

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