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Monday, November 29, 2021

Inflation: Why it is temporary and raising interest rates will do more harm than good

The fear of inflation is increasing. Britain’s annual rate peaked at 4.2% in October, the highest in a decade, and it is a similar story in many other countries.

This has been the cause of much debate among central bankers about the best course of action. Some say that this burst of inflation is fleeting and will pass without the need for any intervention. Others worry that this is the start of a longer period of runaway prices, and argue that we should raise interest rates and cut back on “currency printing” – also known as quantitative easing (QE), Which most major economies, including the UK, have been doing in recent years.

So far, the US Federal Reserve has begun lowering its monthly QE quite leisurely and there has been talk of raising rates on both sides of the Atlantic, but central banks have generally refrained from being hawkish so far. . But as inflation numbers have risen and pressure mounts, there is good reason to fear that they will put their reputations first and die. As far as I’m concerned, that would be absolutely the wrong move.

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Inflation is like body temperature – it is not a cause but a symptom of underlying potential problems. Therefore, before prescribing any policy measure, you first need to make a proper clinical assessment of the cause of the condition. The recent rise in inflation is not simply due to central banks stimulating economies with QE and ultra-low interest rates. Had this been the case, inflation would have been going through the roof in the years following the global financial crisis of 2007-09, when these policies were introduced.

It was not until economies reopened after the COVID lockdown that inflation began to become an issue. There are two things to look for here. Firstly, the situation is not as bad as some inflation fearers are suggesting. In the years following the global financial crisis, it is not inflation but the risks of deflation that keep central bankers up at night in developed economies, especially in Europe and Japan.

There are several explanations for this deflationary period, including austerity, lack of public and private investment, low oil prices, and globalization, which helps keep wages and other costs as low as possible. The chart below shows that inflation in major economies has been consistently below 2% since 2015, the rate that central banks aim to achieve every year for stability.

Worldwide inflation since 2015

CPI = Consumer Price Index.
OECD/National Statistics Office

Even with the recent surge in inflation, prices in the Eurozone and Japan are 3.7% and 9.5% lower, respectively, than they would have been if they followed a consistent 2% inflation path. The UK is now slightly above the target path (0.7%), while the US is up 3.6% – the only significant deviation in the other direction, but hardly disastrous. One (good) reason for inflation is economic growth, and the US has enjoyed a particularly strong recovery after COVID, with 6% GDP growth expected for 2021. The fact that inflation is rising as a result of this increase is the cost of each one.

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Second, the recent surge in inflation is not caused by excessive monetary stimulus, but by a revival in global demand that outpaces the ability of suppliers to cope (so-called “disruptions and bottlenecks”) of the supply chain, which is fueled by rapidly growing energy. is in conjunction with. prices.

When supply and demand re-synchronize, price growth will stabilize again, as many of the deflationary factors of recent years are likely to still be corrected in the future. This is why the likes of the Bank of England and the European Central Bank predict inflation will ease over the next year. Even in the US, where inflation appears to be highest, the expectation is that recent growth will fade and prices may begin to slide below the 2% trajectory.


So there is no good reason for central banks to react. A knee-jerk reaction to inflation could also stifle growth that is already set to slow in 2022. This could cause a downturn in financial markets, and pile more debt on public sector balance sheets, making it more expensive for governments. Borrow.

Furthermore, the repercussions would not be limited to national borders – especially in the case of the US. By tightening monetary policy, it raises the value of a nation’s currency – and in fact the dollar is already rising against a basket of world currencies. Since the dollar is the reserve currency of the global economy, it is used to price everything from oil to the loans of most developing countries (and their major companies).

If the dollar rises, so does the price of oil, with huge ramifications for the world economy. Equally, a stronger dollar causes a rise in the value of developing countries’ debts, which can destabilize their economies. This can lead to capital flight, in which investors dump government bonds, reducing the value of the local currency and making their debt problems worse. In short, a strong dollar is too expensive for the global economy to afford.

To extend my temperature analogy a bit further, the rise in global inflation is in line with symptoms of COVID vaccines. The global economy is warming, but this heat is a small cost to the long-term health of the global economy. A little inflation is necessary to lubricate the wheels of the economy. As the forces of supply and demand find equilibrium post-pandemic, inflation will probably ease again, as central bankers have been saying. The best thing to do for them is to hold their ground in the face of temptations and not jump the gun.

This article is republished from – The Conversation – Read the – original article.

World Nation News Deskhttps://www.worldnationnews.com
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