December 4, 2023

One analyst said raising interest rates to tame demand – and thus inflation – is not the right solution, because higher prices have been driven primarily by supply chain shocks.

Global manufacturers and suppliers have not been able to efficiently produce and deliver goods to consumers during the Covid lockdowns. More recently, sanctions against Russia have also reduced the supply, especially of basic commodities.

“Supply management is very difficult, we find that across a whole range of industries, a whole range of companies, they face very different challenges, you just have to turn the taps back on,” Paul Gambles, managing partner at MBMG Group, a consultancy, told CNBC. Street signs on Monday.

Referring to the energy crisis Europe is facing as Russia threatens to cut off gas supplies, he said that “on American Independence Day, this is kind of a co-dependence day where Europe is totally shooting itself, because a lot of this is the result of sanctions.”

“And the Fed is the first to raise their hand and say monetary policy can’t do anything about the supply shock. And then they go and raise interest rates.”

The US Federal Reserve raised its benchmark interest rate by 75 basis points to a range of 1.5%-1.75% in June – the largest increase since 1994. Federal Reserve Chairman Jerome Powell (above) has indicated that there may be another rate hike in July.

Mary F Calvert | Reuters

However, governments around the world have focused on reducing demand as a way to curb inflation. Raising interest rates aims to increase demand for equal keel with tight supply.

For example, the US Federal Reserve raised its benchmark interest rate by 75 basis points to the 1.5%-1.75% range in June – the largest increase since 1994 – with President Jerome Powell on hold, there may be another rate hike in July.

The Reserve Bank of Australia is set to raise interest rates again on Tuesday, and other Asia-Pacific economies such as the Philippines, Singapore and Malaysia have jumped on the same rate hike bandwagon.

The Federal Reserve said in a statement It chose to raise interest rates as “general economic activity” appears to have rebounded in the first quarter of the year, with higher inflation reflecting “pandemic-related supply and demand imbalances, higher energy prices, and broader price pressures”.

Monetary policy is the wrong solution

Gambles said demand is still below the level it was before the pandemic began, but that it would have fallen even without the Covid barriers.

“If we look at where employment in the United States would have been, if we didn’t have Covid, and we didn’t have closings, we’d still be about 10 million fewer jobs than where we would be. So there, there, actually, there’s a lot more. of potential stagnation in the labor market. In a way that does not translate into actual stagnation.”

“And again, I don’t think this is a monetary policy issue. I don’t think monetary policy is going to make much difference to that.”

With ugly supply shocks appearing from time to time, Gambles added, it will be difficult for central banks to maintain their continued control over inflation.

Gambles argued that the United States should instead look to a fiscal push to fix inflation.

“The US federal budget for fiscal year 2022 is $3 trillion lighter on a total basis than it was in 2021. So we have, you know, we have big deficits in the US economy. And you know there probably isn’t much that monetary policy can do about that.” .

Adjusting monetary policies, says Gambles, is “the wrong solution to the problem”.

Other “unconventional economists” – cited by Gambles in the interview – such as HSBC’s chief economic adviser Stephen King, have also offered analyzes, saying it’s not just the demand or supply shock that is responsible for inflation, but the actions of both sides of the equation.

Economists like King have said pandemic shutdowns, supply chain disruptions and the Russo-Ukrainian war, as well as stimulating governments pumping into their economies and loose monetary policies, have contributed to rising inflation.

“In economic terms, the COVID-19 crisis was seen by many as a challenge to demand in the first place. Central banks responded by offering very low interest rates and continuing quantitative easing, even as governments offered massive fiscal stimulus,” In a note earlier this year, King said in a key reference to the epidemic.

“In truth, COVID-19 has only had demand-related side effects associated with limited shutdowns in advanced economies.”

“The supply side effects have proven to be significant and much more persistent: markets now operate less well, countries are economically disconnected, workers are less able to cross borders and, in some cases, are not readily available within borders. To ease policy conditions when supply performance deteriorates, This is likely to lead to inflation.”

He added that since supply is unable to fully respond to the increased money passing through economies like the United States, prices must rise.

Still a popular antidote

However, higher interest rates are still the common antidote to inflation.

But Economists We are now concerned that using higher interest rates as a tool to solve the problem of inflation could lead to a recession.

Higher interest rates make business expansion more expensive. This, in turn, can lead to cutbacks in investments, which ultimately hurt employment and jobs.

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