Surprisingly, central banks only possess limited toolboxes. Ailing economies don't always respond to same-old remedies, no matter how nuanced or tailored those remedies are purported to be. However, the banks have recently embarked on a very unusual route; a route which could lead to an almost deliberately stoked global recession.
This unusual pathway will likely compound any brewing recessionary pressures as, when (or if) the spectre of an economic downturn becomes a reality. Banks are openly fessing up about economic hardships that their policies are causing but have fallen short of sticking their hands up and admitting that it's the least well off who are most likely to experience the roughest trot. Naturally, a prolonged inflationary cycle isn't great for most people, so central banks portray themselves as being a proactive force honing an environment of economic stability.
I have questioned, in a previous article here in The Portugal News, whether rate-driven inflation reduction schemes generate noticeably different results compared with what might happen without such intervention? Right now, inflation appears to be showing some tentative signs of easing, albeit more gradually than many had hoped for a year ago (before Putin's war in Ukraine).
The problem we seem to have is that the current inflation story is, in itself, extraordinary. Usually, inflation is seeded amidst the melee of an overheating economy which compounds consumerism and leads to stress within supply chains. This scenario inevitably leads to incremental price hikes which gradually push up inflation. In such instances, tightening monetary policies has the desired effect of calming things down in a relatively controlled and organic manner.
This time, however, things have been markedly different. Many of our current woes have come about as a direct result of past central bank interventions, going back as far as 2008 (in the wake of the so-called 'credit crunch'). Central banks printed money like never before in an attempt to monetise economies. At the same time, interest rates plummeted for a prolonged period and the world became reliant on cheap money. This meant that base rates only had one direction to go. Up! It was simply a case of when, not if, because the status quo was clearly unsustainable.
Just when there were tentative signs of a post 2008 economic recovery – Covid-19 visited the world and yet more quantitative easing and emergency rate cuts were imposed on already shaky economies. As lockdowns took hold, it brought the entire global supply chain to a halt.
Once lockdowns eased and economic activity began to recover, commodities as well as manufactured goods became increasingly scarce at a time when economies were awash with an abundance of QE cash. Eminent economists warned that inflation was bound to make a return as an inevitable consequence of central bank interventions coupled with the unintended consequences of Covid-19 lockdowns. Inflationary signs soon became all too evident. For example, the price of new cars rocketed because there had been a drastic shortage of microchips causing dealership inventories to plummet. Even before the war in Ukraine, energy prices soared along with post-Covid-19 demand.
These days many Covid-19 bottlenecks have been addressed which has greatly increased new car inventories and helped reduce prices. At time of writing, oil prices are also in decline. The falling cost of renewables implies that the price of crude oil is likely to fall even further in the long term.
The one major takeaway we can gather from Putin's war in Ukraine is that individual territories need to do as much as they can to better insulate themselves from volatile food and fuel prices. Besides the environmental plusses this scenario might create, such action clearly means that we'd all be far less vulnerable to the whims of despots like Vladimir Putin who continue to use the fruits of their breadbaskets and petrochemical industries to hold western economies to ransom. Historical evidence demonstrates how oil-rich regimes have cynically contrived to use hiked fossil fuel prices as a lever to influence the direction of western elections. Of course, Putin isn't the only leader of an oil-rich country to have used such tried and tested tactics.
The current cost of living crisis has headlined nearly every recent news bulletin amidst threats of numerous strikes. Add to this, the talk of impending winter power outages and it suddenly begins to look frighteningly similar to a vintage 1970's "winter of discontent." When all is said and done, contentment appears to be in very short supply right now, particularly in the UK with its rapid-fire Prime Ministerial about-changes and its embarrassing back catalogue of embittered political rancour.
But the continued scope for hiking prices can only go so far before hitting the buffers. Most economists will declare that the best cure for high prices is high prices. There comes a point when the affordability factor ebbs away thus creating demand destruction. However, as the global economy emerges from the depths of pandemic downsides, prices should begin to moderate and inflation will calm by default.
In recent months wages have been rising faster than they did pre-pandemic. But this ought to be a positive because low wages obviously compound inequality and exacerbate ingrained social disquietude. However, there have been recent falls in workers’ salaries when inflation-adjusted take-home pay is calculated. This exaggerated sense of inequality sparked off the current spate of industrial action.
Let's revisit the central policy question. Will higher interest rates increase the supply of microchips for the automotive industry or compel petrostates like Russia to pump more oil? Somehow, I don't think so. Will interest rate hikes compel food producers to lower the price of their produce, other than by defaultly reducing global incomes so people might end up cutting their diets and perhaps cause a glut? Hardly likely.
Studies have in fact demonstrated that higher interest rates could make it more difficult for companies to invest in a way that helps alleviate supply shortages. There are many other ways that higher interest rates may exacerbate inflationary pressures because banks are making money more expensive. Who will ultimately pay? Yes, you've got it. We ALL will.
Quite frankly, interest rate hikes alone are a very blunt instrument and have morphed to be central banks' go-to quick-fix. But like all harsh medicine, it's only useful when administered swiftly, before any maladies take hold and become too firmly entrenched.
There's so much that's out of sync these days. Even well-directed fiscal and monetary policies face obstacles. Take high rents for example. The UK has seen immigration numbers soar but it's happened at a time when there's a chronic housing shortage. Such shortages have facilitated an environment of high rents which will surely only be compounded by presenting landlords with higher interest repayments.
After more than ten years of unprecedented low-interest rates, normalisation was eventually an inevitability. But raising interest rates beyond what's deemed normal in order to swiftly calm inflation will not just mean pain right now but, like all bad tasting medicine, could create some of those dreaded unintended consequences at a time when we don't need any further economic shocks.
Will insipid economic medicine work? The jury's still out.
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