Caution from Basle

EDITORIAL: The Bank for International Settlements (BIS), the global umbrella body for central banks, sure poured cold water on hopes of the hawkish interest rate cycle subsiding in advanced economies the other day as it admitted, in very clear terms, that inflation in top economies remains stubbornly high despite a sharp rise in rates over the last 18 months, while the jump in borrowing costs triggered the most serious banking collapses since the banking crisis of 2007-08.

In America, the Federal Reserve took a breather earlier last month but market bears are not going on any long break because the FOMC (Federal Open Market Committee) clearly telegraphed at least to more hikes, all the way to 5.6 percent, by the end of the year.

Most analysts, especially those warning against excessively loose monetary policy all this time, are convinced that these are the fruits of relentless quantitative easing – the Fed’s knee-jerk reaction to all recessions since the great fall of 2007-08.

And, as Chairman Jerome Powell broke the Fed’s so-called dual mandate in the Covid crisis, letting inflation soar beyond the mandated 2 percent limit to keep the economy from going completely bust, there was always the risk of runaway inflation as he let the Fed’s printing presses run overtime.

And, with 40-year high inflation that is responding very slowly to the highest rate hike cycle in just as long, the Fed’s policy is not only putting a question mark on its own abilities, but also making things hard for President Biden as he gears up for his re-election. It is important to note that after a brief pause, Fed looks poised to raise interest rates again.

Europe is a different story. Their miscalculation was of another sort. Decision-makers in the European Union must now be feeling silly for taking Washington for its word about a quick Russian collapse in the face of unprecedented sanctions.

Instead, the Ukraine war is stalemated and record energy inflation, which is a result of unrealistic expectations not roaring aggregate demand, is just not responding to the stiffest interest rate hike in living memory by the ECB (European Central Bank) as well as other central banks across the continent.

Now ordinary Europeans have to brave very high prices just because decision-makers at the very top, under heavy influence from Washington hundreds of miles away, miscalculated and provoked a war that disrupted their energy lifeline.

There are lessons in this interest rate cycle for poor, struggling countries like Pakistan. We, too, face the highest recorded inflation amid highest-ever interest rates, yet there’s very little sign of prices rationalising anytime soon.

We have far deeper problems, of course, because the threat of default mandates staying on the IMF (International Monetary Fund) programme even if its structural adjustment terms are too contractionary for an economy on life support. But the main issue is more or less the same. Employing conventional monetary tools like interest rate to arrest inflation not caused by demand is an abject policy failure.

This also has another potentially very disturbing side-effect. Contracting too hard for too long, waiting for prices to drop, can overdo the job and land the economy in proper depression; a double whammy that delivers a much harder punch than just a recession.

There are time lags between toggling the policy rate and seeing on-ground results, of course, and while raising rates doesn’t do much for cost-push inflation, it still depresses demand.

And we could soon be at that unenviable point where central bankers begin questioning if they were running so hard and fast, but in the wrong direction, all this time.

As SBP (State Bank of Pakistan) jacked up interest rates by another percentage point to 22 percent in the backdrop of last-minute talks with the IMF, pushing it yet higher into uncharted stretches of the stratosphere, perhaps we, too, are doing ourselves more harm than good in the long term.

Copyright Business Recorder, 2023