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‘Central banks are intent on driving the world economy perilously close to a recession. Late to see the worst inflation in four decades coming, and then slow to crack down on it, the Federal Reserve and its peers around the globe now make no secret about their determination to win the fight against soaring prices – even at the cost of seeing their economies expand more slowly or even shrink.’ – An excerpt from a recent Bloomberg published article ‘The global race to hike rates tilt economies towards recession’

The above highlights that major central banks of the world such as the US Federal Reserve and the European Central Bank, on one hand, were well behind the curve in terms of raising interest rates to check rising inflation, mainly due to both global commodity supply shock last year, and early this year by the war in Ukraine. On the other hand, years of neoliberal dominance in many countries meant that the catch up in terms of interest rate hikes has been much too quick, and in much larger chunks than a better understanding of inflation determination.

In this regard, the same article highlighted widespread and fast-paced monetary tightening as follows: ‘About 90 central banks have raised interest rates this year, and half of them have hiked by at least 75 basis points in one shot. Many did so more than once, in what Bank of America Corp. chief economist Ethan Harris labels “a competition to see who can hike faster.” The result is the broadest tightening of monetary policy for 15 years… The current quarter will see the biggest rate hikes by major central banks since 1980, according to JPMorgan Chase & Co., and it won’t stop there.’

Hence, while inflation had, and continues to have, a significant basis in the shape of supply shock, and speculative/over-profiteering practices, and therefore required a more balanced, well tapered monetary policy tightening, along with supply-side-, and greater non-neoliberal governance/regulatory initiatives, including adopting ‘price controls’ where needed, yet heavy-loaded monetary tightening at a fast pace by central banks, on one hand, and lack of supply-sided stimulus by governments, on the other, have resulted in strong recessionary build-up.

Here, with regard to adopting price controls, in an eight-month-old Guardian published article ‘Could strategic price controls help fight inflation?’, noted economist Isabella Weber argued: ‘…a critical factor that is driving up prices remains largely overlooked: an explosion in profits. …The Federal Reserve has taken a hawkish turn this month. But cutting monetary stimulus will not fix supply chains. What we need instead is a serious conversation about strategic price controls – just like after the war. …the government could target the specific prices that drive inflation instead of moving to austerity which risks a recession. … Price controls would buy time to deal with bottlenecks that will continue as long as the pandemic prevails. Strategic price controls could also contribute to the monetary stability needed to mobilize public investments towards economic resilience, climate change mitigation and carbon-neutrality.’

Moreover, developing countries like Pakistan, which are under International Monetary Fund (IMF) programmes, have to suffer aggressive austerity/demand management-, pro-cyclical policy prescription, even when they were not able to provide any significant stimulus during the pandemic or make needed health-related expenditures – especially when there is a strong possibility of more pandemics happening in the not too distant future due to fast unravelling of climate change crisis.

In addition, climate change caused catastrophic flooding in the country, which has displaced around 33 million people, has all the more created the need to adopt counter-cyclical policy to tackle rising inflation, reduce inequality, and make the much-need infrastructural investments.

Yet lack of international support, insignificant debt relief, and the strong comeback of the IMF in terms of its usual pro-cyclical policy stance after some respite during the hey-days of the pandemic, has all meant that even after a tight monetary policy stance since September last year, a supply-shock, and pro-cyclical policy-driven inflation saw a sharp and significant rise.

Moreover, economic growth is expected to take a nose dive for the current fiscal year, which reportedly will likely to be close to zero, as was pointed out in a recent ‘Fitch Solutions’ published article ‘Floods to exacerbate Pakistan’s economic and political challenges’ as follows: ‘On the economic front, we have lowered our real GDP growth forecast for Pakistan to 0.2% for FY2022/23 (July – June), from 0.6% previously, as adverse weather conditions will not only reduce agricultural production which accounts for 19% of GDP, but also weigh on exports and exacerbate Pakistan’s external imbalances.’

There is also the problem of drastic capital flight from not just developing countries like Pakistan but even from Europe to the US, as US Federal Reserve has continued to raise interest rates both at a high speed and in big chunks. Yet more heavy monetary tightening is likely to come in high frequency and big chunks sooner than later.

The same article pointed out: ‘This week alone, the Fed is set to lift its key rate by 75 basis points for a third time, with some calling for a full percentage point… Anna Wong, chief US economist at Bloomberg Economics, estimates that the Fed will eventually have to take its benchmark rate to 5%, double today’s level – a dose of further tightening that could cost the economy 3.5 million jobs and deal further blows to already-battered markets.’

This has been particularly damaging for foreign exchange of developing countries, and has contributed to a significant domestic currency devaluation and, in turn, has contributed immensely to inflation through the channel of imported inflation.

Rising cost-push inflation, in turn, has meant alarmingly high cost of living, especially for the middle- and lower-income groups, and in particular for developing countries like Pakistan, in addition to the rising cost of imports, and the negative impact of all of this on exports. So, in developing countries like Pakistan, there is not just high risk of recession, there is also strong stagflationary current being felt.

Hence, to rein in inflationary and stagflationary consequences for the economy, while there is a strong case for pulling back on the pro-cyclical policy stance at home, internationally the US Federal Reserve, for instance will need to adopt a more cautious monetary policy stance, so that there is relatively much less capital flight from developing countries in particular, including Pakistan, than has taken place up till now, putting in turn lesser pressure on exchange rate, and helping lower the high level of imported inflation component.

A recent article ‘The Fed is overreacting’ published by Project Syndicate (PS) highlighted this aspect as ‘The Fed’s mistake reflects a misreading of the US labor market, which Powell noted “is particularly strong”. And it is indeed true that US wages have been rising sharply. … The economy has simply shifted to a higher-wage equilibrium, thanks to the big pandemic-induced jolt to the labor market.

Part of the rise in US wages reflects this adjustment. To overlook this and regard current wage increases solely as the result of inflation can lead to an excessive policy reaction. That is the mistake the Fed will make if it persists in raising interest rates sharply.’

Copyright Business Recorder, 2022

Dr Omer Javed

The writer holds a PhD in Economics from the University of Barcelona. He previously worked at the International Monetary Fund. He tweets @omerjaved7


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