NEW YORK, NEW YORK – JUNE 15: People shop for food along a busy street in Brooklyn on June 15, 2022 in New York City. As the American economy continues to see a rise in inflation, the Federal Reserve announced on Wednesday that it is raising interest rates by 0.75%, the largest such move since 1994. The Fed is attempting to cool the economy and keep prices on everyday items such as food, gas, and rent under control. (Photo By Spencer Platt/Getty Images) == FOR NEWSPAPERS, INTERNET, TELCOS & TELEVISION USE ONLY == | Photo Credit: SPENCER PLATT
Global leaders need to find other means to combat inflation besides policy rate hikes
The US Federal Reserve’s aggressive stance against inflation is set to cause severe disruption to global financial markets and impact growth across countries. Supply disruptions caused by the Russia-Ukraine war and lockdown in China have combined with strong consumption demand in the US, taking consumer price inflation to a four-decade high. The Fed has vowed to use all the tools at its disposal to attain price stability and to make inflation move down towards the long-term target of two per cent. Therefore, besides hiking the Federal Funds Rate by 75 basis points, the largest increase in the last three decades, it is also continuing to reduce liquidity by not rolling over a fixed quantity of treasury securities, agency debt and agency mortgage-backed securities every month. Of greater concern to the financial market is the projections of the Federal Reserve Board members which indicate that the policy rate is likely to be 3.4 per cent by the end of 2022 and 3.8 per cent by the end of 2023. This implies that the Fed is trying to front-load its interest rate hikes, with another 165 basis points increase scheduled this calendar year.
Growth has clearly taken a back-seat in Fed’s monetary policy. Growth projection for 2022 has been revised sharply lower to 1.7 per cent from 2.8 per cent projected in the March policy. Growth for 2023 has also been pegged 50 basis points lower at 2.2 per cent. The Fed appears set to sacrifice some growth as it cools demand to push inflation lower. It’s however uncertain if the Fed’s gambit will deliver the desired result, given that a large part of the inflation is driven by the commodity price surge and supply disruption due to the ongoing war. The World Bank has revised global growth for 2022 lower to 2.9 per cent in its June forecast, down from 4.1 per cent in January, citing central banks’ withdrawal of accommodative policies as one of the reasons. Growth projections for India for the current fiscal are also being revised sharply lower as cost of external finance moves higher and services and merchandise exports get hit due to the Fed’s policies.
Financial markets are in a turmoil too with spike in US treasury yield leading to surge in sovereign bond yields of other countries as well. The dollar index has moved above 105 as money is expected to move back to dollar denominated treasury securities. This will accelerate foreign portfolio flows out of emerging market bonds. Indian 10-year government bond yield is at a 3-year high and there is yet another rout in equity markets. The Reserve Bank of India may not have any other option but to follow in the Fed’s footsteps and hike domestic policy rates in order to maintain the spread in the sovereign bond yields and to support the currency. Rising interest costs in the economy will constrict domestic consumption and hurt growth further. Instead of this fruitless pursuit to tame inflation through monetary tightening, it may be a better if global leaders try to arrive at a solution to address global supply issues, along with countries such as Russia and Iran, so that commodity prices cool down, easing inflation. There is an exigent need to rise above enmities and prejudices to prevent the global economy from slipping into a recession.
Published on June 16, 2022