A global backlash against the Fed is brewing

In March 2021, when the US Federal Reserve was still buying $120 billion worth of securities a month, Brazil’s central bankers raised their benchmark rate by 0.75 percentage point thanks to concerns that a rise in world commodity prices would trigger inflation.

It took another year for the US central bank to wake up to the fact that price pressures would not be transitory and would finally raise the federal funds target from almost zero. By then, Brazil had raised borrowing costs to 11.75 percent.

Time has proved Brazil’s monetary guardians right. However, the Fed’s tardiness in bringing inflation under control is unlikely to leave the South American country — or indeed anywhere — unscathed.

The Fed, which made its third straight 75 basis point hike on Wednesday, is playing catch-up. While that may be the best course of action for the US economy, its aggression is triggering what Maurice Obstfeld of the Peterson Institute for International Economics calls “beggar thy neighbor” policies. The consequences of the Fed’s mistakes are effectively exported from the US, placing a burden on US trading partners.

Higher US rates have buoyed the dollar, exacerbating inflation elsewhere by driving up the cost of commodities that are, in most cases, priced in dollars.

A “reverse currency war” is in full swing, with monetary authorities around the world now abandoning their standard quarter-point hikes in favor of moves of 50, 75 and, in the case of Sweden and Canada, 100 points. basics to stop the dollar. declines

Rate hikes, while necessary to stifle inflation, have become so aggressive that the World Bank warned last week they risked sending the world economy into a devastating recession that would leave the world’s poorest countries at risk of collapse.

The World Bank described the situation now as similar to the early 1980s, when rising global interest rates and falling world trade triggered the Latin American debt crisis and a wave of defaults in sub-Saharan Africa. .

That comparison rings true. Since the global financial crisis of 2008, the Fed and other major market central banks have rolled out wave after wave of stimulus. That left global interest rates at ultra-low levels for years. The result of that, plus the pandemic, is that international debt levels are close to all-time highs.

As financing costs rise, more and more of the world’s poorest countries are seeking support from the IMF and World Bank. China, for its part, is Provide tens of billions of dollars worth of emergency support for Sri Lanka, Pakistan and Argentina, raising concerns among Western creditors, who see the bailouts as opaque and argue they leave states beholden to Beijing.

Some economists want greater awareness of the spillover effects of their monetary policy and more international cooperation.

Bar chart of the cumulative change in policy rates since the US hike on March 17, 2022 (percentage points) showing that aggressive US monetary policy is forcing some other central banks to do the same

Raghuram Rajan, a professor at the University of Chicago Booth School of Business and a former head of India’s central bank, said: “If a poorer country overborrows in good times because global interest rates are low, would What responsibility does the US have? What? Don’t you have any? We have to find a middle ground.”

However, it is hard to see what the US central bank can do except raise rates. When asked about the global repercussions of the Fed’s actions on Wednesday, Chairman Jay Powell noted that he, while aware of what was happening elsewhere, had a mandate to reduce domestic inflation and protect jobs. nationals. It’s clear from its economic projections that the Fed believes the best way to fulfill that mandate is to impose another 75 basis point hike at its next meeting, followed by another 50 basis point hike before the year is out.

As Mohamed El-Erian, President of Queens’ College, Cambridge acknowledges, the consequence of the Fed’s reluctance to withdraw its aggressive support for monetary policy until it was too late has placed us “in the depths of the world of second and third best solutions”. .

As damaging as the repercussions may be, there are no courses of action that are not without pernicious side effects.

Daniela Gabor, a professor at the University of the West of England, has referred to an era of Zügzwang central banking The toxic mix of persistent inflation and slowing growth has left officials facing a situation common to unlucky chess players: stuck with nothing but bad moves to play. With inflation in the US still clearly looking stagnant, rising borrowing costs seem the least bit worse.

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