The day after the Federal Reserve drastically raised interest rates and signaled the arrival of others, central banks in Asia and Europe followed suit on Thursday, leading their own campaigns to crack down on an inflation epidemic that is brewing. harassing consumers and worrying politicians around the world.
Central bankers generally move slowly. This is because their policy tools are blunt and work with a delay. The ongoing interest rate hikes from Washington to Jakarta will take months to seep through the global economy and take full effect. Jerome H. Powell, the Fed chairman, once likened decision making to walking into a furnished room with the lights off: Go slow to avoid a painful outcome.
Yet officials, learning from a story that illustrated the dangers of taking too long to eliminate price hikes, have decided they no longer have the luxury of patience.
Inflation has been relentlessly rapid for a year and a half. The longer the case remains, the greater the risk of it becoming a permanent feature of the economy. Employment contracts could start to take into account cost-of-living increases, companies could begin to raise prices regularly, and inflation could become part of the fabric of society. Many economists think it happened in the 1970s, when the Fed tolerated runaway price increases for years, allowing an “inflationary psychology” to take hold that later proved excruciating to crush.
But the aggressiveness of ongoing monetary policy action is also pushing central banks into new and risky territory. Quickly and simultaneously escalating as growth in China and Europe is already slowing and supply chain pressures are easing, global central banks risk exaggerating, some economists warn. They can plunge economies into deeper recessions than necessary to curb inflation, greatly increasing unemployment.
“The margin of error is now very slim,” said Robin Brooks, chief economist at the Institute of International Finance. “A lot of this hinges on judgment and how much emphasis to put on the 1970s scenario.”
In the 1970s, Fed politicians raised interest rates in an effort to control inflation, but backed off as the economy started to slow down. This allowed inflation to remain high for years and when oil prices rose in 1979, it reached unsustainable levels. The Fed, led by Paul A. Volcker, eventually raised rates to nearly 20% – and pushed unemployment to over 10% – in an effort to counter the rise in prices.
That example weighs heavily on the minds of politicians today.
“We think that failure to restore price stability would mean much greater pain later on,” Powell said in his press conference on Wednesday after the Fed hiked rates by three-quarters of a percentage point for the third consecutive time. The Fed expects to raise finance costs to 4.4% next year in the fastest tightening campaign since the 1980s.
The Bank of England raised interest rates by half a point to 2.25% on Thursday, although it said the UK may already be in a recession. Likewise, the European Central Bank is expected to continue raising rates at its October meeting to fight high inflation, even as Russia’s war in Ukraine throws the European economy into turmoil.
As major monetary authorities raise borrowing costs, their trading partners are following suit, in some cases to avoid large movements in their currencies that could drive up local import prices or cause financial instability. On Thursday, Indonesia, Taiwan, Philippines, South Africa and Norway hiked rates and a major move by the Swiss central bank ended the era of sub-zero interest rates in Europe. Japan has relatively low inflation and is keeping rates low, but on Thursday it stepped into the currency markets for the first time in 24 years to support the yen in light of all the action from its counterparts.
The wave of central bank action is expected to have consequences, acting in a design manner to dramatically slow down both interconnected trade and national economies. The Fed, for example, sees its moves push US unemployment to 4.4% in 2023, from the current 3.7%.
The moves are already starting to have an impact. Rising interest rates are making it more expensive to borrow money to buy a car or home in many countries. Mortgage rates in the US are back above 6% for the first time since 2008 and the housing market is cooling down. Markets collapsed this year in response to harsh talk from central banks about reducing the amount of capital available to large corporations and cutting household wealth.
Yet the full effect could take months or even years to feel.
Rates are rising from lows and the latest moves haven’t had time to play fully yet. In continental Europe and Britain, the war in Ukraine, rather than monetary tightening, is pushing economies into recession. And in the United States, where the fallout from the war is far less severe, hiring and the labor market remain strong, at least for now. Consumer spending, while slowing, is not collapsing.
That’s why the Fed believes it has more work to do to slow the economy, even if it increases the risk of a recession.
“We have always understood that restoring price stability by achieving a relatively modest rise in unemployment and a soft landing would be very challenging,” Powell said Wednesday. “Nobody knows if this process will lead to a recession or, if so, how significant that recession would be.”
Many global central bankers have painted today’s inflation explosion as a situation where their credibility is at stake.
“For the first time in four decades, central banks must demonstrate how determined they are to protect price stability,” said Isabel Schnabel, a board member of the European Central Bank, at a Fed conference in Wyoming last month. .
But that doesn’t mean the political path the Fed and its counterparts are plotting is unanimously agreed – or unequivocally the correct one. It’s not the 1970s, some economists have pointed out. Inflation has not been high for a long time, supply chains appear to heal and measures of inflation expectations remain under control.
Mr. Brooks of the Institute of International Finance considers the pace of tightening in Europe a mistake and thinks that even the Fed may be exaggerating at a time when supply shocks are waning and the full effects of recent political moves are yet to play.
Maurice Obstfeld, an economist at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund, wrote in a recent analysis that there is a risk that global central banks will not pay enough attention to each other.
“Central banks are clearly rushing to raise interest rates as inflation runs at levels not seen in nearly two generations,” he wrote. “But there can be too much good. Now is the time for monetary policymakers to raise their heads and look around. “
However, in many central banks around the world – and clearly at the Powell Fed – politicians see it as their duty to remain steadfast in the fight against rising prices. And that is translating into forceful action now, regardless of the impending and uncertain costs.
Mr. Powell may have warned once that moving quickly in a dark room could end painfully. But now it’s as if the room is on fire: the threat of a crooked finger still exists, but moving slowly and carefully risks even more.