tag:theconversation.com,2011:/us/topics/central-banks-18144/articlesCentral banks – The Conversation2024-02-25T14:20:26Ztag:theconversation.com,2011:article/2242202024-02-25T14:20:26Z2024-02-25T14:20:26ZHere’s what we can learn from Canada’s response to inflation in the 1980s and 1990s<p>For the last two years, inflation has been at top of mind for Canadians. It is a tax on households. When prices rise, <a href="https://www.bankofcanada.ca/2020/08/understanding-inflation">the purchasing power of each dollar earned falls</a>.</p>
<p>This generates huge losses for the economy, as well as households on fixed incomes, and increases uncertainty, making it more difficult to plan for the future.</p>
<p>The real question in the minds of many economists is what the trend in inflation will be going forward, and when interest rates will begin to fall and bring relief to Canadians.</p>
<p>While this episode of inflation has created challenges for many, this is not the first time Canada has gone through such an experience; we have been here before.</p>
<h2>Inflation in the 1980s and 1990s</h2>
<p>Canada faced a serious inflation problem in the 1980s and 1990s when the consumer price inflation (CPI) index hit <a href="https://economics.td.com/ca-inflation-new-vintage">13 per cent in 1980 and was still at seven per cent in 1991</a>. </p>
<p>To solve this issue, in 1991, the Bank of Canada and the Minister of Finance agreed on a plan <a href="https://www.bankofcanada.ca/core-functions/monetary-policy/agreement-inflation-control-target/">to bring inflation down to a target level</a>. Initially, this was six per cent, but this was lowered to two per cent (within a one to three per cent range).</p>
<p>The Bank of Canada <a href="https://www.bankofcanada.ca/2022/04/understanding-policy-interest-rate">uses the overnight rate to control inflation</a>. This rate determines the rates of government treasury bills, the bank rate and variable rate mortgages. </p>
<p>In August 1981, <a href="https://www.huffpost.com/archive/ca/entry/high-interest-rates-canada-economy_ca_5fe4d080c5b66809cb30a445">the Bank of Canada pushed this rate to well over 20 per cent</a> — equivalent to a variable rate mortgage cost today of almost 23 per cent. In May 1990, the central bank increased the rate to almost 14 per cent. In both cases, the central bank brought inflation down, <a href="https://www.thecanadianencyclopedia.ca/en/article/recession">but at the cost of a serious economic slowdown</a>. </p>
<h2>The pandemic fuelled inflation</h2>
<p>The <a href="https://www.reuters.com/markets/us/canada-expected-renew-policy-framework-amid-concerns-about-rising-inflation-2021-12-13">inflation target was most recently renewed in December 2021</a>. It was remarkably effective until summer 2021, when inflation exceeded the three per cent range and <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/220720/dq220720a-eng.htm">peaked at over eight per cent in June 2022</a>.</p>
<p>The root cause of this inflation was not domestic like it had been in the 1990s. Rather, it was in response to the COVID-19 pandemic, which affected <a href="https://www.weforum.org/agenda/2022/06/inflation-stats-usa-and-world">all major Western economies</a>. </p>
<p>Canada was not alone in increasing its debt so citizens could stay home and limit the spread of infection. The Bank of Canada <a href="https://www.bankofcanada.ca/2020/05/our-policy-actions-in-the-time-of-covid-19/">lowered the overnight rate to 0.25 per cent</a> and intervened massively to <a href="https://www.bankofcanada.ca/2020/08/our-covid-19-response-large-scale-asset-purchases/">buy the government’s debt</a>.</p>
<p>Initially, <a href="https://thoughtleadership.rbc.com/proof-point-fewer-supply-chain-snarls-wont-be-enough-to-lower-inflation-to-2/">it was believed these inflation increases would reverse as supply chain challenges resolved</a>, so <a href="https://amp.cbc.ca/embed/index.html?preview=0&embed_type=customhtml&content_id=1.6807771&position=0&api=prod">central banks were slow to react</a>.</p>
<p>But this assumption proved false. As the pandemic receded, Canadians began spending <a href="https://www.theglobeandmail.com/business/article-canadians-savings-stockpile-is-a-300-billion-quandary-for-the">the money they had stored away during lockdowns</a>. With low interest rates, the prices of assets like houses and shares dramatically increased. The Russian invasion of Ukraine <a href="https://www.federalreserve.gov/econres/notes/feds-notes/the-effect-of-the-war-in-ukraine-on-global-activity-and-inflation-20220527.html">added another economic shock</a>. </p>
<p>By this point, high inflation had started to become entrenched in the expectations of businesses, unions and individuals. As history shows, once inflation becomes entrenched in the economy, <a href="https://www.imf.org/en/Blogs/Articles/2023/10/04/how-managing-inflation-expectations-can-help-economies-achieve-a-softer-landing">it is very difficult to reverse</a>.</p>
<h2>Taming inflation</h2>
<p>The Bank of Canada, although slow to react, successfully reversed the increasing inflation trend with <a href="https://www.theglobeandmail.com/topics/bank-of-canada">10 interest rate increases between March 2022 and July 2023</a> and by increasing the overnight rate to five per cent.</p>
<p>Inflation fell to 3.1 per cent in <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/231121/dq231121a-eng.htm">October</a> and <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/231219/dq231219a-eng.htm">November 2023</a>, creating optimism about returning to levels that would assure the Bank of Canada that inflation had been tamed.</p>
<p>Despite core inflation remaining stubbornly above three per cent, this relative success allowed the central bank to hold the overnight rate at five per cent, increasing the possibility of lower interest rates. </p>
<p>This confidence was confirmed with the <a href="https://www.cbc.ca/news/business/inflation-january-2024-1.7119796">January CPI coming in at 2.9 per cent</a>, just inside the Bank of Canada’s operating band.</p>
<p>It’s clear that central banks must act as soon as they can to prevent inflationary expectations from becoming entrenched in the economy. Once entrenched, the economy ends up bearing significant pain to reverse it — pain that is not spread evenly across the population.</p>
<h2>Food and shelter costs</h2>
<p>Interest rates and inflation are inextricably linked and they affect households in different ways. The CPI measures the rate of inflation on a basket of goods, but not all households consume every good in the basket, and not all prices increase at the same rate. Therefore, the impact of inflation varies across groups.</p>
<p>Younger, <a href="https://www150.statcan.gc.ca/n1/pub/75-006-x/2023001/article/00002-eng.htm">poorer households spend a disproportionately large portion of their income on food</a>, which has seen major price increases over the last two years. Similarly, those commuting from the outskirts of metropolitan areas faced higher commuting costs when gasoline prices spiked. </p>
<p>However, the biggest anomaly is in housing costs, where increasing interest rates designed to lower inflation automatically <a href="https://www.cpacanada.ca/news/pivot-magazine/2022-02-16-housing-market">translate into higher rental costs and imputed housing costs</a>.</p>
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<a href="https://theconversation.com/two-thirds-of-canadian-and-american-renters-are-in-unaffordable-housing-situations-221954">Two-thirds of Canadian and American renters are in unaffordable housing situations</a>
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<p>In its January 2024 CPI report, Statistics Canada reported that rental costs increased by 6.2 per cent year over year, while food price inflation was still up 3.9 per cent. </p>
<p>Together food and shelter costs amount to 45 per cent of the CPI, but younger, poorer households have disproportionately suffered because their price index is skewed more toward food and shelter. </p>
<h2>A waiting game</h2>
<p>The impact of higher interest rates in Canada’s mortgage market depends critically on the maturity of someone’s mortgage and rent controls.</p>
<p>Many households with variable rate mortgages, or those renewing mortgages during this period of high interest rates, <a href="https://theconversation.com/heres-how-the-bank-of-canadas-interest-rate-hike-to-5-will-impact-canadian-households-209369">are struggling with significantly higher mortgage payments</a>.</p>
<p>Additionally, those who know they will have to renew their mortgage in the coming year are taking steps to adjust to those increases. </p>
<p>In fact, approximately 20 per cent of mortgages held by some of Canada’s biggest banks are negatively amortized, meaning homeowner payments do not cover the monthly interest charges. So, each month, <a href="https://www.theglobeandmail.com/business/article-mortgage-borrowers-td-bmo-cibc-homeowners">the amount owed on the mortgage increases</a>. Needless to say, many are urgently hoping for interest rate reductions in 2024.</p>
<p>Right now, the Bank of Canada is waiting to see what happens to inflation in the coming months before deciding whether to hold the overnight rate where it is, decrease it or increase it. This decision hinges on whether it feels the underlying or core rate of inflation aligns with its target zone. </p>
<p>The central bank is well aware that signalling a reduction too early could feed into greater consumer spending and higher inflation. So interest rates could stay where they are for several more months. While shelter and food price inflation will moderate, don’t expect actual prices to revert back to pre-pandemic levels.</p><img src="https://counter.theconversation.com/content/224220/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The real question in the minds of many economists is what the trend in inflation will be going forward, and when interest rates will begin to fall and bring relief to Canadians.Walid Hejazi, Professor of International Business, Rotman School of Management, University of TorontoLaurence Booth, Professor, Rotman School of Management, University of TorontoLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2224602024-02-01T00:24:27Z2024-02-01T00:24:27ZWith the economy looking bright enough, the Federal Reserve seems content to play the waiting game<figure><img src="https://images.theconversation.com/files/572543/original/file-20240131-29-ugwtym.jpg?ixlib=rb-1.1.0&rect=43%2C410%2C5783%2C3468&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">When will Fed Chair Jerome Powell lower the curtains on the inflation battle?</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/FederalReservePowell/90516627fabd4f71b1122b964a78a211/photo?Query=jerome%20powell&mediaType=photo&sortBy=creationdatetime:desc&dateRange=Anytime&totalCount=2461&currentItemNo=1">AP Photo/Alex Brandon</a></span></figcaption></figure><p>If there’s one thing you can say about Fed policymakers, it’s that they don’t make decisions on a whim. When the Federal Open Market Committee met on Jan. 31, 2024, it <a href="https://www.nbcnews.com/business/economy/federal-reserve-interest-rate-decision-january-2024-increase-decrease-rcna136429">held interest rates steady</a> – <a href="https://finance.yahoo.com/news/federal-reserve-leaves-interest-rates-unchanged-tempers-expectations-on-rate-cuts-ahead-190255912.html">as most</a> observers expected. That marks six months since the Fed last changed the base rate.</p>
<p>And people should expect to wait a little while more: Fed Chair Jerome Powell <a href="https://www.cnbc.com/2024/01/31/fed-chief-jerome-powell-says-a-march-rate-cut-is-not-likely.html">said a rate cut was “not likely</a>” to come at the next meeting in March. But over the course of his news conference after the meeting, he emphasized that nothing is set in stone.</p>
<p>The Federal Reserve has what is called a <a href="https://www.stlouisfed.org/in-plain-english/the-fed-and-the-dual-mandate">dual mandate</a>: Its job is to achieve maximum employment and keep prices stable. Often there’s a trade-off between these goals: Cutting rates often helps with the former, while lowering them helps with the latter. </p>
<p>And in recent months, controlling inflation has been the focus of Fed policy. In his remarks on Jan. 31, Powell made it clear that Americans shouldn’t expect the Fed to do anything to rates until the U.S. gets <a href="https://sites.lsa.umich.edu/mje/2023/09/04/why-the-2-inflation-target/#:%7E:text=This%20meant%20that%20costs%20only,and%20an%20increase%20in%20prices.">closer to its target of 2% inflation</a>. And that could take some time.</p>
<p>There’s a reason Powell and his fellow policymakers are focused on the 2% inflation target. So long as <a href="https://www.bls.gov/cpi/">consumer price index inflation</a> is above 2%, the concern is that any lowering of interest rates could stimulate the economy too much and reignite inflation. </p>
<p>Still, the <a href="https://www.federalreserve.gov/monetarypolicy/fomc.htm">federal funds rate</a>, which helps determine mortgage and loan rates and quite a bit more, remains at 5.5%, higher than it’s been in 16 years. The Fed has raised rates 11 times since early 2022. </p>
<p>That aggressive rate-hiking has had the desired effect of putting the brakes on the economy. But it comes with some pain for borrowers – and some are now eager to bring rates back down. </p>
<p>Cutting rates usually makes sense when the economy is getting significantly worse, and there’s not much reason to think that’s happening now. Fourth-quarter gross domestic product grew <a href="https://www.bea.gov/news/2024/gross-domestic-product-fourth-quarter-and-year-2023-advance-estimate">3.3% on an annualized basis</a>, ending 2023 on a strong note. The economy added <a href="https://www.bls.gov/news.release/pdf/empsit.pdf">more than 2 million jobs</a> over the course of 2023. And consumer price index inflation is running at <a href="https://www.bls.gov/news.release/pdf/cpi.pdf">about 3.3% in December 2023</a>.</p>
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<figcaption><span class="caption">The chair of the Federal Reserve addresses reporters on Jan. 31, 2024.</span></figcaption>
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<p>“This is a good situation,” Powell said during his news conference. “Let’s be honest: This is a good economy.”</p>
<p>So what comes next? The Fed recently indicated that it expects to cut rates <a href="https://www.bloomberg.com/news/articles/2024-01-11/us-inflation-accelerates-tempering-case-for-fed-to-cut-rates?sref=Hjm5biAW">three times in 2024</a>. But as Powell was at pains to make clear, if the data changes, the Fed’s decision-making will, too.</p>
<p>The labor market data looks relatively sunny. There’s greater balance between the number of people who want jobs and the number of open positions than there was last year. Wage growth looks likely to continue at current rates. So unless there’s a sharp increase in unemployment, which <a href="https://apnews.com/article/retail-sales-december-economy-consumer-spending-800f78ae0a4428be3be7733238d16f40">doesn’t seem likely at the moment</a>, there seems to be little reason to cut interest rates.</p>
<p>There’s always a concern that keeping rates too high for too long may tip the economy into a recession. But recent history doesn’t suggest that will happen. </p>
<h2>Taking the long view</h2>
<p>Taking a historical perspective can be revealing. The 30-year fixed mortgage rate is about 6.6% – high by recent standards. However, back in 1998, the year I bought my first home, the rate was 6.9%. At that time, it was a real deal! </p>
<p>Mortgage rates have been as high as 18% if you go back to 1981. That’s not to say either I or the Fed believe there’s room to increase rates any time soon – just that rates are nowhere near record highs.</p>
<p>Powell did say there’s no reason for any rate increases, so the current Federal funds rate of 5.5% is likely the current cyclical peak. </p>
<p>The next meeting will start March 19. The odds are that the U.S. economy will continue to grow, and inflation will continue to moderate – however slowly. So I would expect the Fed to follow through on Powell’s noncommittal prediction and hold off on cutting rates until later in the year.</p>
<p>So there’s no soft landing yet – Powell said as much. But we look surprisingly close.</p><img src="https://counter.theconversation.com/content/222460/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christopher Decker does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The central bank is ‘really in risk management mode,’ its chairman said.Christopher Decker, Professor of Economics, University of Nebraska OmahaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2177442024-01-04T16:53:12Z2024-01-04T16:53:12ZCentral banks should be fighting the climate crisis – here’s why<p>Climate finance was a major focus at the recent <a href="https://theconversation.com/dont-applaud-the-climate-summits-loss-and-damage-fund-deal-just-yet-it-might-not-warrant-that-standing-ovation-218093">COP28 summit</a>, but one set of game-changing institutions remains largely missing in such conversations: central banks.</p>
<p>Central banks are public institutions, charged with maintaining economic stability through controlling the supply of money in an economy. These banks have enormous power to catalyse a more just, equitable and climate-stable future.</p>
<p>However, our <a href="https://www.tandfonline.com/doi/full/10.1080/17565529.2023.2268589">recent research</a> points out that their policies have been slowing down – rather than speeding up – transformative climate action. The problem is these banks focus on financial stability in the near term, which means propping up a status quo which promotes further climate instability. And that means they are making things more unstable in the long term.</p>
<p><a href="https://www.tandfonline.com/doi/full/10.1080/17565529.2023.2268589?src=#:%7E:text=Additional%20information-,ABSTRACT,climate%20crisis%20and%20climate%20injustices.">Our research</a> suggests that long-term stability cannot be achieved without first disrupting and transforming the existing financial system. One way to do this would be for central banks to use tools <a href="https://www.boeckler.de/pdf/v_2022_10_22_sokol.pdf">already available</a> to them to trigger a short-term intentional disruption in order to redirect financial flows and create greater stability in the long-term – we call this <a href="https://www.fingeo.net/central-banks-the-climate-crisis-and-the-need-for-a-creative-disruption-sokol-and-stephens-2023/">“creative disruption”</a>. </p>
<h2>Short-term v long-term stability</h2>
<p>Central banks generally try to keep the economy stable by controlling <a href="https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what_is_inflation.en.html">inflation</a> through interest rates. With climate disruptions causing more and more instability every year, <a href="https://www.ngfs.net/en">many central banks</a> are starting to take the climate more seriously. Yet, when price stability is threatened by increasing inflation or when the overall financial stability is questioned by a looming financial crisis, central banks quickly forget about the climate.</p>
<p>For example, recent <a href="https://theconversation.com/are-interest-rates-really-going-to-keep-rising-sharply-201577">aggressive increases</a> in interest rates have <a href="https://www.reuters.com/sustainability/climate-energy/renewables-funds-see-record-outflows-rising-rates-costs-hit-shares-2023-10-09/">disproportionately hit the renewable energy sector</a> and made it harder for people and governments to raise money for other measures that would help cut emissions or adapt to climate change. From a long-term perspective and from a climate justice lens, this is counterproductive. </p>
<p>To maintain short-term economic stability when COVID hit, central banks around the world quickly lent money to commercial banks in a variety of ways – even at <a href="https://www.reuters.com/world/europe/how-do-negative-interest-rates-work-2021-02-04/">negative interest rates</a>. But no strings were attached, so banks lent this money to the <a href="https://www.bankingonclimatechaos.org">fossil fuel industry</a> and other wealthy corporate interests, among others.</p>
<p>During the pandemic many central banks also increased the money supply, in a process called <a href="https://www.ecb.europa.eu/ecb/educational/explainers/show-me/html/app_infographic.en.html">quantitative easing</a>, to stimulate the economy, and some of this money ended up in the <a href="https://neweconomics.org/uploads/files/NEF-Decarbonise-BoE-report.pdf">pockets of carbon intensive industries</a>. These efforts to stabilise financial markets reinforced and exacerbated huge inequities in wealth and power, and were a missed opportunity to increase support for a green economy. </p>
<h2>Central banking, climate-justice style</h2>
<p>That’s why in our <a href="https://www.tandfonline.com/doi/full/10.1080/17565529.2023.2268589">latest research</a> we analysed central banks from the lens of <a href="https://link.springer.com/article/10.1007/s40641-022-00186-6">climate justice</a>. <a href="https://www.taylorfrancis.com/chapters/oa-edit/10.4324/9781003199816-17/feminist-antiracist-values-climate-justice-jennie-stephens">Climate justice</a> is an approach to climate action that goes beyond a narrow focus on decarbonisation and emissions and focuses on social change and economic equity as a way to make people less vulnerable to climate change. This means restructuring the financial system to work for the benefit of all people rather than just the top 1%.</p>
<p>So instead of stabilising markets by supporting corporate interests and the financial sector in the short-term, we suggest that central banks need to start prioritising long-term stability. An intentional short-term “creative disruption” would reverse established financial flows and would start funnelling investments towards the most vulnerable.</p>
<p>For example, central banks could use their power to create money to help local governments finance ambitious climate infrastructure projects or directly support community-oriented public investment programmes. </p>
<p>Rather than continuing to focus narrowly on inflation to determine economy-wide interest rates, central banks could create <a href="https://greencentralbanking.com/2023/08/01/dual-interest-rates-green-investment-inflation/">different interest rates</a> for different kinds of investments – establishing high interest rates for carbon-intensive activities and low or zero-interest rates for renewable energy. The <a href="https://greencentralbanking.com/2022/08/02/japan-green-lending-scheme-sayuri-shirai/">Bank of Japan</a> is one of a few central banks that have already started experimenting with such schemes.</p>
<p>Central banks can also create zero or negative-interest rates for climate justice investments. Imagine households could insulate homes, install heat pumps and solar panels – and get paid for it. And the most vulnerable communities should be served first, not last. If central banks can use negative interest rates to save banks during the COVID crisis, they surely can use such tools to save people and the planet in the climate crisis. Innovations like this could transform the financial landscape, and reshape the financial injustices that dominate today. And there is <a href="https://www.tandfonline.com/doi/full/10.1080/17565529.2023.2268589">much more</a> central banks can do. </p>
<p>Central banks have the power and the tools to trigger a rapid transformation towards a more just, fossil-fuel free future at a global scale. Instead of continuing to use their power to accelerate climate chaos, central banks could catalyse a shift toward a more equitable financial system. Going forward, the transformative role of central banks needs to be at the top of the climate policy agenda.</p>
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<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A focus on economic stability in the near-term makes the climate crisis worse in the long-term.Martin Sokol, Associate Professor of Economic Geography, Trinity College DublinJennie C. Stephens, Dean’s Professor of Sustainability Science & Policy, Northeastern UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2191922023-12-11T19:46:36Z2023-12-11T19:46:36ZCanadians have serious trust issues when it comes to a central bank digital currency<iframe style="width: 100%; height: 100px; border: none; position: relative; z-index: 1;" allowtransparency="" allow="clipboard-read; clipboard-write" src="https://narrations.ad-auris.com/widget/the-conversation-canada/canadians-have-serious-trust-issues-when-it-comes-to-a-central-bank-digital-currency" width="100%" height="400"></iframe>
<p>The Bank of Canada <a href="https://www.bankofcanada.ca/digitaldollar/a-digital-canadian-dollar-what-we-heard-2020-23-and-what-comes-next/">recently published</a> findings from its public consultation report on a central bank digital currency, known as CBDCs. </p>
<p>The findings reveal that financial privacy is top of mind for Canadians, yet those same Canadians do not trust the very institutions that would be responsible for handling data privacy and protection. </p>
<p>Put simply, CBDCs can be thought of as a digital banknote.</p>
<p>However, the key distinction between physical cash and a digital currency is that using cash allows for anonymous and untraceable transactions because it’s not recorded anywhere. CBDCs, on the other hand, would record all transaction details in a <a href="https://www.bis.org/publ/othp42_system_design.pdf">centralized ledger</a>. </p>
<h2>Design features</h2>
<p>One of the most important CBDC design features identified in the consultation was the ability to make private transactions. <a href="https://www.bankofengland.co.uk/speech/2023/october/jon-cunliffe-speech-at-the-economics-of-payments-xii-conference">Privacy is consistently ranked</a> as one of the <a href="https://www.ecb.europa.eu/pub/pdf/other/Eurosystem_report_on_the_public_consultation_on_a_digital_euro%7E539fa8cd8d.en.pdf">top concerns</a> among public consultation reports in other countries.</p>
<p>To address some privacy concerns, the innovation hub of the <a href="https://www.bis.org/about/bisih/about.htm">Bank for International Settlements</a>, a global financial institution owned by member central banks, is actively working on projects with those banks around the world, including exploring the possibility of <a href="https://www.bis.org/about/bisih/topics/cbdc/tourbillon.htm">cash-like anonymity</a> for CBDCs. Ultimately, the level of privacy employed will be up to individual nations to determine.</p>
<p>CBDCs are often described as the safer alternative to cryptocurrencies <a href="https://bitcoin.org/bitcoin.pdf">like Bitcoin</a>, because they are backed by a reliable and trusted institution — in this case, the central bank. </p>
<p>However, during a period of <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/230628/dq230628b-eng.htm">record-high inflation</a> and a cost of living crisis, the <a href="https://financialpost.com/news/economy/bank-of-canadas-carolyn-rogers-seeks-to-shore-up-central-banks-credibility-amid-political-attacks">Bank of Canada’s reputation</a> has faced increased scrutiny from politicians and the general public. Conservative Party leader Pierre Poilievre, for example, has attacked the credibility, <a href="https://twitter.com/PierrePoilievre/status/1517523993301078020">financial literacy</a> <a href="https://twitter.com/PierrePoilievre/status/1522224091423457282">and independence</a> of the central bank.</p>
<h2>Is Parliament up to the task?</h2>
<p>The decision to issue a digital Canadian dollar rests with the federal government. Yet there continues to be a lack of comprehensive discourse on the topic among Canadian politicians. </p>
<p>During his leadership campaign, Poilievre promised he <a href="https://web.archive.org/web/20220928161631/https://www.pierre4pm.ca/ban_central_bank_digital_currency_audit_bank_of_canada_says_poilievre_as_inflation_is_triple_the_target">would ban</a> a Canadian central bank digital currency if elected prime minister. That’s a pledge the Conservative party <a href="https://www.conservative.ca/cpc/reject-a-central-bank-digital-currency/">continues to support</a>.</p>
<p>In the <a href="https://www.ourcommons.ca/documentviewer/en/44-1/house/sitting-208/hansard#Int-12273491">House of Commons</a>, Poilievre has claimed that a CBDC would lead to government control of personal bank accounts, likening it to the situation faced by the so-called <a href="https://www.ctvnews.ca/politics/feds-crack-down-on-trucker-protest-financing-from-crowdfund-rules-to-freezing-bank-accounts-1.5781376">Freedom Convoy protesters</a>. </p>
<p>That line of thinking seems to have resonated with some Canadians; one survey participant stated “<a href="https://www.bankofcanada.ca/wp-content/uploads/2023/11/Forum-Research-Digital-Canadian-Dollar-Consultation-Report.pdf">a digital dollar sounded great until we saw the federal government freeze private bank accounts of its own citizens for supporting a political movement it disagreed with</a>.” </p>
<p>The 2022 federal budget <a href="https://www.canada.ca/en/department-finance/news/2022/11/government-consults-canadians-to-advance-key-priorities.html">included an announcement</a> of the government’s intention to launch a financial sector legislative review, focusing on the digitalization of money. </p>
<p>However, no additional statements or updates have been put forward and there has been virtually no discussion on the topic from Prime Minister Justin Trudeau or Finance Minister Chrystia Freeland. </p>
<h2>Building trust?</h2>
<p>In contrast to Bitcoin, <a href="https://www.investopedia.com/tech/return-nakamoto-white-paper-bitcoins-10th-birthday/">which operates in a trustless system</a> that is not issued or managed by a central authority, CBDCs <a href="https://www.bis.org/speeches/sp220118.htm">cannot succeed without trust</a>. </p>
<p>Historically, central banks have maintained high levels of public trust, but that reputation doesn’t necessarily extend to the digital sphere. A notable 87 per cent of respondents said they don’t trust the Bank of Canada to issue a secure digital Canadian dollar that is resistant to cyberattacks.</p>
<p>A majority of respondents — 74 per cent — also completely distrust the federal government’s ability to protect personal payments data. That’s understandable given the <a href="https://www.ctvnews.ca/canada/class-action-lawsuit-launched-against-federal-government-over-cra-cyberattack-1.6552315">class-action lawsuit</a> launched against Ottawa in the wake of Canada Revenue Agency cyberattacks in 2020. This skepticism extends to the central bank, with 58 per cent expressing complete distrust in their ability to safeguard that data. </p>
<p>Although participants self-selected into the survey, meaning the findings aren’t necessarily representative of the Canadian population, these findings should serve as a wake-up call for policymakers to do more to bridge the trust deficit that plagues public perceptions.</p>
<p>Currently, there is no appetite for a CBDC in Canada. If the central bank wants this to be a successful endeavour, it must continue to engage with Canadians through public consultations. </p>
<h2>Transparency required</h2>
<p>The decisions around CBDC design features must be transparent. The central bank must take the time to learn from <a href="https://www.bloomberg.com/news/articles/2023-02-21/nigeria-seeks-new-tech-partners-to-revamp-enaira-central-bank-digital-currency">lessons abroad</a>. It will also need to develop an extensive digital Canadian dollar literacy campaign to clearly articulate the value of a CBDC.</p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"1596117821263446016"}"></div></p>
<p>Canadian politicians must engage in comprehensive discussions about a CBDC that are open to the public. An outright ban could potentially stifle innovation, limit economic opportunities and the country’s ability to adapt to the rapidly evolving digital financial landscape.</p>
<p>The public consultation findings serve as a vital democratic tool offering Canadians and policymakers key data about public preferences and concerns. Understanding and addressing these concerns will be crucial in shaping responsible and inclusive policies for the future of digital currencies in Canada.</p><img src="https://counter.theconversation.com/content/219192/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anwar Sheluchin receives funding from the Social Sciences and Humanities Research Council of Canada.
</span></em></p>Recent Bank of Canada findings that showed Canadians have misgivings about a central bank digital currency should serve as a wake-up call that policymakers must do more to bridge the trust deficit.Anwar Sheluchin, PhD Student, Political Science, McMaster UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2179792023-11-29T13:40:14Z2023-11-29T13:40:14ZWhy the Fed should treat climate change’s $150B economic toll like other national crises it’s helped fight<p>Climate disasters are now costing the United States <a href="https://nca2023.globalchange.gov/">US$150 billion per year</a>, and the economic harm is rising.</p>
<p>The <a href="https://www.cnn.com/2023/11/07/homes/homeowners-insurance-climate-real-estate/index.html">real estate market</a> has been disrupted as home insurance rates skyrocket along with rising wildfire and flood risks in the warming climate. <a href="https://www.cbsnews.com/news/climate-change-food-prices-inflation-3-percent-study/">Food prices</a> have gone up with disruptions in agriculture. <a href="https://www.americanprogress.org/article/the-health-care-costs-of-extreme-heat/">Health care costs</a> have increased as heat takes a toll. Marginalized and already vulnerable communities that are least financially equipped to recover are <a href="https://nca2023.globalchange.gov/chapter/31/#key-message-1">being hit the hardest</a>.</p>
<p>Despite this growing source of economic volatility, the Federal Reserve – the U.S. central bank that is charged with maintaining economic stability – is <a href="https://www.brookings.edu/articles/why-the-fed-and-ecb-parted-ways-on-climate-change-the-politics-of-divergence-in-the-global-central-banking-community/">not considering the instability of climate change</a> in its monetary policy. </p>
<p>Earlier this year, Fed <a href="https://www.federalreserve.gov/newsevents/speech/powell20230110a.htm">Chair Jerome Powell declared</a> unequivocally: “We are not, and we will not become, a climate policymaker.”</p>
<p>Powell’s rationale is that to maintain the Fed’s independence from politics and political cycles, it should use <a href="https://www.federalreserve.gov/aboutthefed/the-fed-explained.htm">its tools</a> narrowly to focus on its core <a href="https://www.federalreserve.gov/boarddocs/rptcongress/98frgpra.pdf">mission of economic stability</a>. That includes price stability, meaning keeping inflation low and maximizing employment. In Powell’s view, the Fed should stay away from social and environmental concerns that are not tightly linked to its statutory goals. </p>
<figure class="align-center ">
<img alt="Powell, in a suit and tie, sits at a large desk in hearing room with papers in front of him and a name tag. He's looking up over the top of his glasses at the camera." src="https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=392&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=392&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=392&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=492&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=492&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561174/original/file-20231122-23-cihbmu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=492&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Federal Reserve Chairman Jerome Powell testifies before the House Committee on Financial Services on June 21, 2023.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/federal-reserve-chairman-jerome-powell-testifies-before-the-news-photo/1500340373">Win McNamee/Getty Images</a></span>
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</figure>
<p>However, it is getting <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230110%7E21c89bef1b.en.html">increasingly difficult for central banks</a> to ensure stability if they do not integrate climate instability into their monetary policies.</p>
<p>As researchers with expertise in <a href="https://cssh.northeastern.edu/faculty/jennie-stephens/">climate justice</a> and <a href="https://www.tcd.ie/research/profiles/?profile=sokolm">central banks</a>, we recently <a href="https://doi.org/10.1080/17565529.2023.2268589">published a paper</a> reviewing the monetary policy tools available to central banks around the world that could help slow climate change and reduce climate vulnerabilities.</p>
<p>With the new U.S. <a href="https://nca2023.globalchange.gov/">National Climate Assessment</a> and <a href="https://doi.org/10.1007/s10584-022-03319-w">other research</a> making clear that U.S. policies and actions are <a href="https://climateactiontracker.org/countries/usa/#">insufficient to minimize climate instability</a> and manage the growing economic costs, we believe it’s time to <a href="https://www.climate-transparency.org/wp-content/uploads/2021/08/ODI_role-of-central-banks-in-tackling-climate-change.pdf">reconsider the role of central banks</a> in <a href="https://unfccc.int/news/new-analysis-of-national-climate-plans-insufficient-progress-made-cop28-must-set-stage-for-immediate">responding to the climate crisis</a>.</p>
<h2>Rethinking interest rates</h2>
<p>One thing central banks could do is set lower interest rates for renewable energy development. The <a href="https://www.bloomberg.com/news/articles/2021-07-16/boj-takes-careful-first-step-on-green-loans-stands-pat-on-rates?sref=Hjm5biAW">Bank of Japan has used this strategy</a>. </p>
<p>The Fed’s aggressive increases in interest rates in response to rising inflation have <a href="https://doi.org/10.1038/s41893-019-0375-2">slowed the transformation</a> toward a more sustainable society by <a href="https://www.wsj.com/articles/fed-programs-have-kept-finance-flowing-to-fossil-fuels-11637317801">supporting fossil fuels</a> and making <a href="https://time.com/6281021/renewable-energy-interest-rates/">investments in renewable energy</a> infrastructure more expensive. <a href="https://www.reuters.com/sustainability/why-us-offshore-wind-industry-is-doldrums-2023-10-31/">Offshore wind</a> power has been particularly hard hit, with multiple multibillion-dollar projects canceled as higher interest rates raised the projects’ costs.</p>
<figure class="align-center ">
<img alt="The foundation of an offshore wind turbine tower without the top yet, and a construction crane and another tower in the background." src="https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561173/original/file-20231122-19-krtne0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Offshore wind turbines are under construction off Massachusetts, but high interest rates raised the cost of projects so much that some companies have put plans on hold.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/OffshoreWindsJobs/582b66f7df9a43488d3bf7a71e84b914/photo">AP Photo/Charles Krupa</a></span>
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<p>One way to introduce differentiated rates would be to create a special <a href="https://www.federalreserve.gov/funding-credit-liquidity-and-loan-facilities.htm">lending facility</a> under which commercial banks could borrow money from the central bank at preferential interest rates if used for renewable energy deployment or other climate-friendly investments. Whether the Fed already has authorization to do that depends on interpretation of its current mandate. </p>
<p>While the U.S. Federal Reserve has not done it before, <a href="https://www.bloomberg.com/news/articles/2023-01-29/china-central-bank-extends-use-of-tools-to-promote-green-lending">China’s central bank</a> has <a href="https://greencentralbanking.com/central-banks/peoples-bank-of-china/">used similar tools</a> to incentivize renewable energy, and the Bank of Japan’s lending facility offers <a href="https://greencentralbanking.com/2022/08/02/japan-green-lending-scheme-sayuri-shirai/">zero-interest loans</a> for green investments. </p>
<h2>Nudging banks to rethink investments</h2>
<p>Despite the Fed’s proclaimed efforts not to pick winners and losers, its monetary policies have taken steps that <a href="https://www.nytimes.com/2023/02/25/business/economy/federal-reserve-powe.html">favor established industries and companies</a>, including the fossil fuel industry.</p>
<p>For example, the Fed <a href="https://www.brookings.edu/articles/fed-response-to-covid19/">supported the financial sector unconditionally</a> during the COVID-19 pandemic to keep credit available to limit economic harm. Its massive <a href="https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200409a2.pdf">purchases of corporate bonds</a> resulted in <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/federal-reserve-takes-flak-for-buying-fossil-fuel-company-bonds-59677632">subsidies to the fossil fuel sector</a>.</p>
<p>Our analysis suggests two ways to help manage climate change now: The Fed can reinterpret its current statutory duties and start viewing climate action as a critical part of its role in maintaining economic stability within its existing mandate, <a href="https://www.ecb.europa.eu/ecb/climate/our_approach/html/index.en.html">as the European Central Bank has done</a>, or the mandate of the Fed can be changed by Congress to explicitly include “green” transformation objectives, similar to the <a href="https://www.manchester.ac.uk/discover/news/facilitating-the-transition-to-net-zero-and-institutional-change-in-the-bank-of-england-perceptions-of-the-environmental-mandate-and-its-policy-implications-within-the-british-state/">U.K.’s mandate for the Bank of England</a>.</p>
<p>Either of these options could empower the Fed <a href="https://neweconomics.org/2022/09/green-credit-guidance">to address climate change</a> and support the government, businesses, banks, households and communities in financing climate mitigation and adaptation efforts.</p>
<figure class="align-center ">
<img alt="Two maps showing extreme heat days rising almost everywhere and extreme precipitation increasingly common, particularly in the Eastern U.S." src="https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=368&fit=crop&dpr=1 600w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=368&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=368&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=462&fit=crop&dpr=1 754w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=462&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/561093/original/file-20231122-27-9qvpx0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=462&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Rising temperatures exacerbate climate risks, including droughts, wildfires and extreme storms. Global temperatures have already warmed by more than 1 degree Celsius (1.8 Fahrenheit) compared to preindustrial times. The projected changes with 2 C (3.6 F) of warming, which the world is on pace to exceed this century, are relative to the 1991-2020 average.</span>
<span class="attribution"><a class="source" href="https://nca2023.globalchange.gov/">Fifth National Climate Assessment</a></span>
</figcaption>
</figure>
<p>The Fed could also discourage banks and investors from investing in assets that ultimately harm the economy – for instance, by <a href="https://www.americanprogress.org/article/addressing-climate-related-financial-risk-bank-capital-requirements/">setting collateral requirements</a> for banks that would reduce the <a href="https://www.lse.ac.uk/granthaminstitute/publication/greening-collateral-frameworks/">attractiveness of holding carbon-intensive assets</a>. The European Central Bank recently announced that it would tilt purchases of <a href="https://www.allianz.com/en/economic_research/publications/specials_fmo/2023_06_27_Green-monetary-policy.html">corporate bonds toward “green” assets</a>. </p>
<p>The Fed has recently taken steps to push <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231024b.htm">large financial institutions to monitor climate-related risks</a> in their portfolios, <a href="https://bankingjournal.aba.com/2023/05/senators-criticize-fed-for-engaging-in-climate-activism/">drawing the ire of Republicans</a>, who claimed the bank had no authority to consider climate change. Whether this risk management approach will pressure banks to change their lending patterns is not yet clear.</p>
<p>The Fed and other central banks could go further and <a href="https://rooseveltinstitute.org/publications/supervising-the-transition/">mandate energy transition planning</a> with an eye toward economic stability. The European Union developed a <a href="https://www.ecb.europa.eu/ecb/climate/green_transition/html/index.en.html">whole new sustainable finance framework</a> designed to <a href="https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en">discourage investment</a> in economic activities that do not support an energy transition along the lines of the <a href="https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en">European Green Deal</a>, which aims to turn Europe into a climate-neutral continent with no one left behind. The European Central Bank is obligated to support EU economic policies, including the green transition. </p>
<h2>The Fed has used creative tools before</h2>
<p>Many times in its 110-year history, the Fed has <a href="http://doi.org/10.2139/ssrn.4516824">provided financial support to the U.S. government</a> during major crises, such as wars and recessions, by offering direct lines of credit or by directly purchasing Treasury bonds. During the pandemic, it took extraordinary steps to keep U.S. businesses running.</p>
<p>Now that the U.S. is facing rising costs from the climate crisis, we believe the Fed should treat climate change with the same urgency and importance. </p>
<p>In our analysis of the tools available to central banks, we took a <a href="https://doi.org/10.1007/s40641-022-00186-6">climate justice</a> perspective, looking beyond greenhouse gas emission reductions to incorporate social justice and economic equity. Instead of focusing on supporting corporate interests and the financial sector in the short term to stabilize markets, we believe central banks could <a href="https://www.boeckler.de/pdf/v_2022_10_22_sokol.pdf">prioritize longer-term stability</a> by funneling investments toward vulnerable communities and people.</p>
<p>The <a href="https://eprints.soas.ac.uk/36190/">Bank of England</a>, the <a href="https://www.brookings.edu/wp-content/uploads/2023/08/WP88-DiLeo-et-al.pdf">European Central Bank</a> and other central banks are already implementing some <a href="https://greencentralbanking.com/scorecard/">pro-climate measures</a>. At the Fed, Powell seems more concerned with political backlash than the economic damage to the U.S. economy outlined in the latest climate assessment.</p>
<p>We believe it is past time that the Fed consider climate destabilization as a major economic crisis and use more of the tools in the central bank toolbox to tackle it.</p><img src="https://counter.theconversation.com/content/217979/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jennie C. Stephens is affiliated with the Climate Social Science Network and is a Radcliffe-Salata Climate Justice Fellow at Harvard University for the 2023-2024 academic year. </span></em></p><p class="fine-print"><em><span>Martin Sokol received funding from the European Research Council (ERC) Consolidator Grant No. 683197.</span></em></p>Fed Chair Jerome Powell bristles at talk of managing climate change, but the damage it is doing the US economy is hard to ignore, as the latest National Climate Assessment shows.Jennie C. Stephens, Dean’s Professor of Sustainability Science & Policy, Northeastern UniversityMartin Sokol, Associate Professor of Economic Geography, Trinity College DublinLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2166532023-10-31T12:56:38Z2023-10-31T12:56:38ZInterest rates: if central banks don’t start cutting them soon, it could actually increase inflation<figure><img src="https://images.theconversation.com/files/556622/original/file-20231030-15-ssa8rd.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Another reason to be fearful. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/businessman-walking-on-abstract-growing-interest-2126771846">Golden Dayz</a></span></figcaption></figure><p>What next for interest rates? The Bank of England’s Monetary Policy Committee (MPC) is <a href="https://www.ft.com/content/2b0dcf95-b4ee-4eee-ad39-a7f5f3fbed3e">widely expected</a> to leave them unchanged when it meets on November 2, despite the fact that UK headline inflation is still at 6.7%. If so, it will mark the second monthly freeze in a row, following 14 consecutive hikes dating back to late 2021. </p>
<p>The main argument for pausing when inflation is still high is that each rise takes time to have full effect. It’s possible that the brakes have already been pressed far enough, and that any <a href="https://www.schroders.com/en-gb/uk/institutional/insights/uk-should-brace-for-6-5-interest-rates-here-s-why-we-ve-raised-our-forecast/">further rate rise</a> could push the economy into recession. The MPC <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023">said as much</a> in its rationale for the September hold. </p>
<p>While higher interest rates subdue inflationary pressure by reducing the amounts that people borrow and spend, households and businesses don’t feel the effect immediately. This is because they have either not borrowed or fixed their interest rates at a lower level. When those fixed-rate periods end, these borrowers will join the many who must already channel more of their income into interest payments, leaving less to buy other things.</p>
<p>The <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">Bank of England (BoE) estimated</a> in January that more than 1.4 million out of the <a href="https://www.ukfinance.org.uk/news-and-insight/press-release/uk-finance-mortgage-data#:%7E:text=There%20are%20a%20total%20of,if%20the%20Bank%20Rate%20rises.&text=There%20are%20a%20total%20of%202%2C033%2C512%20buy%20to%20let%20mortgages,also%20being%20on%20fixed%20rates.">total of 8.5 million</a> mortgage borrowers in the UK would see interest rates jump during 2023, as they move off fixed rates that were mostly below 2%. Another 1.6 million <a href="https://www.theguardian.com/money/2023/jun/17/uk-homeowners-face-huge-rise-in-payments-when-fixed-rate-mortgages-expire#:%7E:text=In%20total%2C%20up%20to%204.4,and%20the%20end%20of%202024.">are also expected</a> to have to remortgage in 2024. Meanwhile, even debt-free businesses will find their income reduced as customers who need credit find it’s costing them more.</p>
<h2>Alternative arguments</h2>
<p>Additional pressures to avoid any further interest rate rises are now evident. <a href="https://www.levyinstitute.org/publications/in-defense-of-low-interest-rates">Some economists doubt</a> that raising rates has had much effect against <a href="https://theconversation.com/inflation-raising-interest-rates-was-never-the-right-medicine-heres-why-central-bankers-did-it-anyway-216087">today’s inflation</a> because it has largely been caused, not by an overheating economy, but by scarcity of goods and commodities due to the Ukraine war and opening up after the pandemic. </p>
<p>Still others point to evidence that rises in interest rates are followed by <em>higher</em> inflation. This has been found in <a href="https://www.nber.org/system/files/working_papers/w23977/w23977.pdf">recent studies</a> of the US and Japan, and some lower-income economies such as <a href="https://intapi.sciendo.com/pdf/10.2478/jcbtp-2018-0019">Brazil and Indonesia</a>. To understand this, you need to grasp a standard economic theory called the “<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3349096">Fisher effect</a>”, named after an early 20th century American economist called <a href="https://en.wikipedia.org/wiki/Irving_Fisher">Irvine Fisher</a>. It suggests that economies have an equilibrium “real” interest rate, measured by the interest rate minus inflation.</p>
<p>For example, if a high-street bank offers one-year loans at 5% and annual inflation jumps from 3% to 5%, the bank has less incentive to lend at the same rate because the amount it gets back at the end of the year will be worth less than before. For the same reason, households and firms are dissuaded from saving. They are reacting to the fact that “real” interest rates have fallen. To keep lending and saving on track – in other words, to keep the economy running as normal – the central bank must raise the headline interest rate. </p>
<p><strong>UK interest rate vs inflation</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing 25 years of inflation and interest rates in the UK" src="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=350&fit=crop&dpr=1 600w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=350&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=350&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=440&fit=crop&dpr=1 754w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=440&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/556624/original/file-20231030-17-iur9lv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=440&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation (orange) is consumer price inflation. Interest rates (blue) are the Bank of England benchmark rate.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/symbols/SPX/?exchange=SP">Trading View</a></span>
</figcaption>
</figure>
<p>Some of this <a href="https://www.stlouisfed.org/publications/regional-economist/july-2016/neo-fisherism-a-radical-idea-or-the-most-obvious-solution-to-the-low-inflation-problem#fig1">research also suggests</a> there is a two-way causation. Not only do interest rates need to rise in response to inflation, they can also pull inflation upwards – precisely the opposite of what the monetary policymakers intend. This becomes a risk when interest rates are expected to stay high. Businesses then push up their prices, and households raise their wage demands, to cover their increased borrowing costs, and the expectation is fulfilled as central banks are forced to keep rates high. </p>
<p>Rate rises can still be effective if they reduce inflation quickly, allowing them to fall back to previous levels before expectations change. The International Monetary Fund, which often represents the economic mainstream, has <a href="https://www.imf.org/en/Blogs/Articles/2023/04/10/interest-rates-likely-to-return-towards-pre-pandemic-levels-when-inflation-is-tamed">conveyed the view</a> that global interest rates will drop back to pre-pandemic levels once the present inflation wave has passed.</p>
<p>But other experts, including the Bank of England’s chief economist, <a href="https://www.reuters.com/world/uk/boe-will-see-job-through-inflation-pill-says-2023-08-31/">Huw Pill</a>, believe interest rates must stay elevated for a longer time to ensure inflation is crushed. Some even argue that they should now stabilise close to present levels, as a reset from the exceptional 13 years in which they stayed close to zero after the global financial crisis of 2007-09. </p>
<p><strong>UK real interest rates 2000-22</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing real interest rates since 2000" src="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/557268/original/file-20231102-23-fzu1md.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">BoE/ONS</a></span>
</figcaption>
</figure>
<p><a href="https://www.jrf.org.uk/press/interest-rate-hike-will-have-serious-consequences-low-income-families">The risks</a> of keeping interest rates at their present high level extend further than the possibility of causing recession, and worsening misery for the poorest borrowers, without taming inflation. A rise in interest rates means <a href="https://knowablemagazine.org/article/society/2022/the-obscure-calculation-transforming-climate-policy">investors become</a> more short-termist – increasing their focus on immediate costs and putting less value on potential gains further into the future. Especially when we need many billions of dollars of investment to build the green economy, a shortfall caused by high interest rates could have ramifications for the future of the planet.</p>
<p>Besides that concern, production capacity will only grow slowly across the board if investment is choked off. That is likely to be another source of inflationary pressure, if central banks don’t start to reverse the rise in interest rates early next year.</p><img src="https://counter.theconversation.com/content/216653/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>So you thought raising interest rates brought down inflation? The reality is a bit more debatable.Alan Shipman, Senior Lecturer in Economics, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2135372023-09-28T19:45:31Z2023-09-28T19:45:31ZInterest rates: Monetary policy is always political as central banks opt to back the financial sector<iframe style="width: 100%; height: 100px; border: none; position: relative; z-index: 1;" allowtransparency="" allow="clipboard-read; clipboard-write" src="https://narrations.ad-auris.com/widget/the-conversation-canada/interest-rates-monetary-policy-is-always-political-as-central-banks-opt-to-back-the-financial-sector" width="100%" height="400"></iframe>
<p>As the Bank of Canada prepared to announce its decision on interest rates in early September, Tiff Macklem, the bank’s governor, <a href="https://www.theglobeandmail.com/business/article-ontario-bc-premiers-urge-bank-of-canada-to-halt-rate-hikes-ahead-of/">received imploring letters</a> from premiers spanning both the country and the political spectrum. </p>
<p>New Democrat <a href="https://www.cbc.ca/news/canada/british-columbia/david-eby-open-letter-bank-of-canada-halt-interest-rate-1.6953609">David Eby</a> of British Columbia wrote to the Bank of Canada, followed by Ontario’s <a href="https://www.cbc.ca/news/canada/toronto/doug-ford-letter-bank-of-canada-1.6956538">Doug Ford</a>, a Conservative, and by Liberal <a href="https://www.cbc.ca/news/canada/newfoundland-labrador/furey-bank-of-canada-interest-rates-inflation-1.6957762">Andrew Furey</a> of Newfoundland and Labrador. </p>
<p>In their letters, the premiers urged the bank against raising rates again and to think of the “human impact of rate increases” on Canadians already burdened by rising mortgage payments and financial pain. </p>
<p>When Macklem announced he was holding the rate at five per cent, Finance Minister <a href="https://www.cbc.ca/news/politics/freeland-bank-of-canada-interest-inflation-1.6958163">Chrystia Freeland </a> called the decision “a welcome relief for Canadians.” </p>
<p>Facing subsequent accusations from economists and journalists that she was meddling, Freeland <a href="https://twitter.com/paulvieira/status/1699513857142607935">made clear</a> a few hours later that she respected the independence of the Bank of Canada.</p>
<h2>Social impact of monetary policy</h2>
<p>But the criticism raises important questions. Is monetary policy really outside the realm of politics? What are the social ramifications of our current monetary policy system? </p>
<p>The view that central banks should be independent of politics has <a href="https://www.clevelandfed.org/publications/economic-commentary/2007/ec-20071201-a-brief-history-of-central-banks">shifted many times</a> over the history of central banks. </p>
<p>While central bank decision-making is independent from government, the banks follow mandates set by governments. These mandates vary in different countries. </p>
<p>The United States Federal Reserve (the Fed), for example, has a dual mandate: to manage inflation and pursue maximum stable employment. The Bank of Canada’s mandate, by contrast, is focused entirely on managing inflation, with <a href="https://sites.lsa.umich.edu/mje/2023/09/04/why-the-2-inflation-target/">an arbitrary</a> target of two per cent. </p>
<p>In theory, central banks pursue these goals without interference from government. </p>
<p>But we don’t believe political debates over monetary policy should be off limits.</p>
<h2>Ties between politics and monetary policy</h2>
<p>In the 1970s, Fed chairman Paul Volcker famously used monetary policy — specifically a campaign of rapid interest rate increases — <a href="https://www.thebignewsletter.com/p/on-the-tragedy-of-paul-volcker">to erode the bargaining power of labour</a> as a means of taming inflation. </p>
<p>That decision had wide-ranging effects — including a reduction in union membership — that continue to have an impact on American society and placed the burden of fighting inflation onto <a href="https://www.thenation.com/article/economy/volcker-inflation-economy/">the working class</a>.</p>
<p>This logic continues, crudely captured in a recent viral video when Australian real estate developer <a href="https://www.bbc.com/news/business-66803279">Tim Gurner argued</a>:</p>
<blockquote>
<p>“We need to see unemployment rise, we need to see pain in the economy … to remind people that they work for the employer, not the other way around.” </p>
</blockquote>
<p>In more polite language, Phillip Lowe, outgoing governor of Australia’s central bank, recently acknowledged that the effects of monetary policy are <a href="https://www.theguardian.com/australia-news/2023/sep/07/outgoing-rba-governor-philip-lowe-says-tough-decisions-made-him-very-unpopular">“felt unevenly across the community</a>.” </p>
<h2>The scene in Canada</h2>
<p>According to <a href="https://doi.org/10.1093/cjres/rsac040">our research</a>, monetary policy likewise has an impact on wealth inequality in Canada by supporting the financial sector over other parts of the economy. </p>
<p>Indeed, the overt goal of monetary policy is to stabilize the financial system, a priority that disproportionately benefits those in the financial sector.</p>
<p>This has become clear in recent decades, beginning with the <a href="https://www.britannica.com/money/topic/financial-crisis-of-2007-2008">2008 global financial crisis</a> and continuing to the COVID-19 pandemic, when <a href="https://www.bankofcanada.ca/2022/06/understanding-quantitative-easing/">central banks around the world began to use “quantitative easing”</a> to stimulate the economy. </p>
<p>While monetary policy had previously centred on setting the rates at which regulated banks could borrow, central banks expanded their role by undertaking massive asset purchasing campaigns via quantitative easing.</p>
<p>Central banks began supporting not just regulated banks but investment funds, hedge funds and other “<a href="https://www.bankofcanada.ca/2023/03/staff-discussion-paper-2023-6/">non-bank financial intermediaries</a>” — also known as shadow banks — that are largely unregulated.</p>
<p>This involved tactics like <a href="https://www.bankofcanada.ca/markets/market-operations-liquidity-provision/market-operations-programs-and-facilities/corporate-bond-purchase-program/">purchasing corporate bonds</a> to stabilize the corporate debt market. </p>
<h2>Investors benefit</h2>
<p>These new Bank of Canada policies grant <a href="https://crashcourseeconomics.org/webinar/central-banking-finance-and-power">“infrastructural power”</a> over how monetary policy is implemented to the financial sector, buttressing the profits of investors with public dollars. This allows investors to determine how the capital provided by the bank will be invested — with little regulation or public oversight.</p>
<p>Acknowledging this shift, Bank of Canada deputy governor <a href="https://www.bankofcanada.ca/wp-content/uploads/2021/03/remarks-2021-03-23.pdf">Toni Gravelle</a> said the bank has moved from its traditional role as “lender of last resort” to “liquidity provider of last resort,” promising to “resolve market-wide stresses when the financial system cannot find its footing.”</p>
<p>When the working class cannot “find its footing,” however, the Bank of Canada doesn’t extend a helping hand. In 2022, for example, Macklem <a href="https://www.theglobeandmail.com/business/article-wage-negotiations-inflation-canada/">told employers not to increase wages</a> despite rampant inflation, and told unionized workers not to ask for a raise. </p>
<p>The central bank’s decision to support the financial sector is, in fact, political. It benefits some — financial sector executives and investors — at the expense of others, and tilts economic decision-making in their favour.</p>
<p>When a public institution buys hundreds of billions in assets as the Bank of Canada did in <a href="https://www.bankofcanada.ca/rates/banking-and-financial-statistics/bank-of-canada-assets-and-liabilities-month-end-formerly-b1/">March 2020</a>, Canadians are right to ask questions about its impact, and politicians should respond.</p>
<h2>Enriching the already rich</h2>
<p>The premiers’ letters to the Bank of Canada, <a href="https://globalnews.ca/news/9931842/bc-premier-david-eby-freeze-interest-rates/">while described as unprecedented</a>, expose how monetary policy involves fundamentally political questions about the distribution of wealth in our society. </p>
<p>As we demonstrated in <a href="https://doi.org/10.1093/cjres/rsac040">our research</a>, the Bank of Canada’s quantitative easing tactics during the pandemic had a vastly uneven impact, driving up house prices and enriching already wealthier homeowners, while lower-income households and renters faced higher rents and precarity. </p>
<p>It also helped investors <a href="https://www.theglobeandmail.com/business/article-investors-account-for-30-per-cent-of-home-buying-in-canada-data-show/">who took advantage of cheap capital and rising asset values</a> to scoop up multi-family apartments and houses in Canada. </p>
<p>The impact doesn’t stop at housing. As inflation rose, central banks hiked interest rates, assuming that would boost unemployment, reduce labour costs and slow the economy so that inflation would fall. </p>
<p>But at a time when the causes of inflation are highly contested (there are ongoing debates around <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2023/june/global-supply-chain-pressures-and-us-inflation/">supply chain disruptions</a> and “<a href="https://doi.org/10.4337/roke.2023.02.05">sellers inflation,”</a> for example) choosing to focus on wages is political. </p>
<h2>What should central banks do?</h2>
<p>Where does this leave us in terms of the politics of monetary policy and central bank independence? </p>
<p>While central bank decisions may need to be independent of government influence, the factors banks consider are determined by our political systems. </p>
<p>Central banks could consider factors that benefit workers and people who don’t own assets — from maximizing employment to promoting housing affordability and addressing climate change risks.</p>
<p>European Central Bank president <a href="https://greencentralbanking.com/2022/11/14/ecb-climate-price-stability-mandate-christine-lagarde/">Christine Lagarde</a>, for example, has said climate change should factor into central bank decision-making. </p>
<p>Others argue monetary policy can be used to <a href="https://greencentralbanking.com/research/targeting-a-sustainable-recovery-with-green-tltros/">fund the green transition</a>, building on the <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2364%7E12a4540091.en.pdf">European Central Bank’s practice of using targeted loans to influence the financial sector</a> rather than leaving decision-making in the hands of financial institutions.</p>
<p>Given the connection between monetary policy and inequality, it’s time for a serious debate on why central banks use public institutions to support private finance — and what they should be doing differently.</p>
<hr>
<p><em>The authors would like to acknowledge and thank research assistant Yun Liu for her work on this article.</em></p><img src="https://counter.theconversation.com/content/213537/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Dan Cohen receives funding from the Social Sciences and Humanities Research Council</span></em></p><p class="fine-print"><em><span>Martine August receives funding from the Social Sciences and Humanities Research Council of Canada (SSHRC), and the Government of Ontario. </span></em></p><p class="fine-print"><em><span>Emily Rosenman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Why is monetary policy outside the realm of politics? What are the social ramifications of our current monetary policy system? What alternatives exist?Dan Cohen, Assistant Professor, Queen's University, OntarioEmily Rosenman, Assistant Professor of Geography, Penn StateMartine August, Associate Professor, School of Planning, University of WaterlooLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2139162023-09-27T12:26:31Z2023-09-27T12:26:31ZWhy central banks should stop raising interest rates<p>Mortgage borrowers breathed a sign of relief following <a href="https://www.bbc.co.uk/news/business-57764601">a recent pause</a> in the Bank of England’s 14-month campaign of base rate hikes.</p>
<p>Led by the US Federal Reserve, many of the world’s <a href="https://www.bis.org/statistics/cbpol.htm">major central banks</a>, including the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">European Central Bank</a> (ECB) and the <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">Bank of England</a>, have been hiking their main rates of interest for more than a year in a bid to slow <a href="https://data.oecd.org/price/inflation-cpi.htm">rapid price inflation</a>.</p>
<p><strong>Rising rates</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing rates rising in steps for UK, US and Eurozone but staying level for Japan." src="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=332&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=332&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=332&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=417&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=417&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549577/original/file-20230921-17-mqzlhx.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=417&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Central bank interest rates.</span>
<span class="attribution"><a class="source" href="https://www.bis.org/statistics/cbpol.htm">Bank for International Settlements (BIS)</a></span>
</figcaption>
</figure>
<p>While the ECB increased rates at its September 2023 meeting, the Bank of England has again followed <a href="https://www.reuters.com/markets/rates-bonds/fed-projections-show-if-soft-landing-is-new-baseline-or-baseless-2023-09-20/">the Fed’s latest decision</a> to pause. </p>
<p>There are <a href="https://www.bankofengland.co.uk/monetary-policy/upcoming-mpc-dates">two more opportunities</a> for a UK rise before the end of the year and <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023#:%7E:text=September%20MPC%20decision.-,Market%20pricing,-in%20the%20immediate">financial markets are expecting</a> rates to go from 5.25% to 5.5%. But the outlook for inflation, recession and the labour market – not to mention how the Fed’s rate changes can affect other economies – indicates that, if rates aren’t cut, the current pause should at least last longer than a couple of months.</p>
<p>The <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp230914%7Eaab39f8c21.en.html">ECB’s latest decision</a> to increase its key interest rate by 0.25% was made despite its expectation that Eurozone inflation will continue to fall. The region faces a unique challenge, however. </p>
<p>Although overall inflation is 5.2%, there is a huge gap between its members – from Spain (2.4%) to Slovakia (9.6%). Differences in inflation and growth indicate <a href="https://link.springer.com/book/10.1007/978-3-030-88185-6">incomplete integration</a> of the region, which does not make the ECB’s job of balancing the economy simple.</p>
<p>In other parts of the world, particularly East Asia, inflation has come down very sharply and is expected to remain low. While UK inflation is higher than in the US, Eurozone and Japan, it is also <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">on a downward trajectory</a>. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-the-bank-of-englands-interest-rate-hikes-are-filtering-through-to-your-finances-210344">How the Bank of England's interest rate hikes are filtering through to your finances</a>
</strong>
</em>
</p>
<hr>
<p>Mortgage rates are already high <a href="https://theconversation.com/why-mortgage-rates-will-not-return-to-recent-lows-any-time-soon-201619">and could stay that way</a>, bankruptcies are <a href="https://theconversation.com/bankruptcy-is-spiking-among-uk-borrowers-but-there-are-debt-relief-options-if-you-are-struggling-financially-213413">spiking</a> and there is a <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">very weak</a> economic outlook. The Bank of England will need to tread carefully to ensure that attempts to lower inflation further do not <a href="https://www.theguardian.com/business/2023/sep/22/uk-recession-risk-mounts-as-higher-rates-weigh-on-firms#:%7E:text=Britain's%20economy%20is%20at%20growing,pandemic%2C%20since%20the%20financial%20crisis.">stall the economy</a>.</p>
<p>The Fed has the most space to relax monetary policy because the US has experienced a sharper decline in inflation. It is now almost level with Japan, which didn’t even rise interest rates. </p>
<p><strong>Inflation rates are slowing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing inflation rates rising and then falling for US, UK, Eurozone and Japan." src="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=285&fit=crop&dpr=1 600w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=285&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=285&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=359&fit=crop&dpr=1 754w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=359&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/549178/original/file-20230919-25-p5v4ew.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=359&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Inflation rates, January 2021 - August 2023.</span>
<span class="attribution"><a class="source" href="https://data.oecd.org/price/inflation-cpi.htm">OECD</a></span>
</figcaption>
</figure>
<p>After the Fed’s last decision in July, its chairman Jerome Powell indicated that US interest rates, which are currently at a 22-year high, would <a href="https://www.youtube.com/watch?v=oAq-XXpfn1c&cbrd=1">remain high for some time, explaining</a> that “we need to see that inflation is durably down” and that “core inflation is still pretty elevated”.</p>
<p>While “durably down” is a vague measure, <a href="https://www.investopedia.com/terms/c/coreinflation.asp">core inflation</a> (the change in the price of a basket of goods and services, excluding items prone to price spikes such as energy) <a href="https://www.whitehouse.gov/wp-content/uploads/2023/07/June-CPI-Blog_Figure1.png?resize=1822,1280">has come down significantly</a> in the US. It was well below headline inflation (the overall rate for everything measured by the consumer price index) for most of the last two years.</p>
<p>Core inflation usually moves slower than the more volatile headline rate. But an important point that’s been absent from recent rate discussions is the influence of headline inflation on core inflation. Core and headline inflation <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2011/august/headline-inflation-core-convergence/">tend to converge</a> over time, which implies that when the headline rate decreases it will eventually drag on core inflation, causing overall inflation to slow. </p>
<p>As last year’s <a href="https://fred.stlouisfed.org/series/PNRGINDEXM">high energy prices</a> drop out of yearly inflation calculations, headline and core rates should dip further in most countries, including the UK. And the good news for the UK is that its core inflation <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2023">is already coming down</a> – even faster, in fact, than the headline rate.</p>
<h2>Wage watch and recession outlook</h2>
<p>Another reason for central bank caution about further monetary tightening is the weakening labour market outlook. In the US, wage growth has <a href="https://www.atlantafed.org/chcs/wage-growth-tracker">slowed</a> significantly and job vacancies have <a href="https://fred.stlouisfed.org/series/JTSJOL">declined</a>. The latter means that companies will have less need to use high wages to attract candidates. Meanwhile, lower wage growth leaves people with less money to spend, helping to slow price inflation.</p>
<p>In the UK, real wages have <a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/averageweeklyearningsingreatbritain/september2023">barely left negative territory</a>. Since the beginning of last year, wages were contracting in real terms as inflation remained a lot higher than pay increases.</p>
<p>In both cases, this also implies that the much-feared <a href="https://www.bis.org/publ/bisbull53.pdf">wage-price</a> spiral hasn’t happened.</p>
<p>Of course, using rate rises to slow inflation is a difficult balancing act: hike too much and central banks choke the economy altogether. This is what the US Fed shall be worried about following the appearance of “yield curve <a href="https://www.bloomberg.com/news/articles/2023-09-14/the-bond-market-has-never-sounded-recession-alarms-for-this-long?leadSource=uverify%20wall">inversion</a>” in US bonds. </p>
<p>This is when there is a surge in demand for long-term government bonds versus short-term. An inversion is thought to <a href="https://www.reuters.com/breakingviews/new-economic-rules-shatter-us-bonds-crystal-ball-2023-09-19/#:%7E:text=But%20after%20substantial%20government%20intervention,ball%20is%20all%20but%20shattered.&text=The%20yield%20on%20two%2Dyear%20U.S.%20Treasury%20notes%20has%20been,yield%20curve%20inversion%20since%201980.">indicate</a> an upcoming recession because it shows investors are worried about the economy.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/fed-hopes-for-soft-landing-for-the-us-economy-but-history-suggests-it-wont-be-able-to-prevent-a-recession-182270">Fed hopes for ‘soft landing’ for the US economy, but history suggests it won’t be able to prevent a recession</a>
</strong>
</em>
</p>
<hr>
<p>This is probably why the Fed hasn’t pressed ahead with further tightening at this time. The UK is now seeing similar signs, with economic growth expressed as <a href="https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/july2023">monthly real GDP</a> estimated to have fallen by 0.5% in July 2023.</p>
<figure class="align-center ">
<img alt="Sign for Bank station and Threadneedle Street in front of the Bank of England building." src="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/550576/original/file-20230927-25-svvfgn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The Bank of England is on Threadneedle Street in London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-may-2023-bank-england-city-2312894195">William Barton/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Following the Fed’s lead</h2>
<p>Fed decisions have global consequences. Research shows its monetary policy decisions have <a href="https://www.federalreserve.gov/econres/notes/feds-notes/international-spillovers-of-tighter-monetary-policy-20221222.html">spillover effects</a> on the rest of the world in terms of the impact of a rate rise on exchange rates and the long-term cost of borrowing. </p>
<p>If the Bank of England, the ECB and other central banks overreact to these spillover effects on their own economies, they may over-tighten monetary policy (that is, raise rates too high) and trigger a recession. </p>
<p>Central banks seem to have been in a race to the top when it comes to rate rises. The US has been setting the pace so it might be time for Fed-led tightening cycle to stop because elevated interest rates are not helping the global economy.</p><img src="https://counter.theconversation.com/content/213916/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central banks balance different factors when raising rates – or not – including inflation and the labour market. But what other countries are doing also has an effect.Muhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2140222023-09-21T01:31:39Z2023-09-21T01:31:39ZThe Federal Reserve held off hiking interest rates − it may still be too early to start popping the corks<figure><img src="https://images.theconversation.com/files/549439/original/file-20230920-17-gxfnbp.jpg?ixlib=rb-1.1.0&rect=0%2C35%2C5883%2C3880&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Federal Reserve Board Chair Jerome Powell is watching the data.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/federal-reserve-board-chairman-jerome-powell-speaks-during-news-photo/1692581089">Chip Somodevilla/Getty Images</a></span></figcaption></figure><p>Federal Reserve officials <a href="https://www.google.com/search?q=fed+holds+rates">held interest rates steady</a> at their monthly policy meeting on Sept. 20, 2023 – only the second time they have done so since embarking on a rate-raising campaign a year and a half ago. But it is what they hinted at rather than what they did that caught many economists’ attention: Fed officials indicated that they don’t expect rates to end 2023 higher than they predicted in June – when they last issued their projections.</p>
<p><iframe id="QLOD5" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/QLOD5/2/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Since the hiking cycle began, observers have worried about whether increased rates could push the U.S. economy into a downturn. Some have even speculated that <a href="https://theconversation.com/is-the-us-in-a-recession-well-that-depends-on-whom-you-ask-and-what-measure-they-use-187894">a recession had already begun</a>. However, the economy has been more resilient than many expected, and now many economists are wondering whether the seemingly impossible <a href="https://www.brookings.edu/articles/what-is-a-soft-landing/">soft landing</a> – that is, a slowdown that avoids crashing the economy – has become a reality. </p>
<p><a href="https://scholar.google.ch/citations?user=VxWst50AAAAJ&hl=en">As a finance professor</a>, I think it’s premature to start celebrating. <a href="https://www.bls.gov/cpi/">Inflation</a> is still <a href="https://www.bea.gov/news/2023/personal-income-and-outlays-july-2023">almost double</a> the Federal Reserve’s <a href="https://www.federalreserve.gov/faqs/economy_14400.htm">target of 2%</a>, and it is expected to come in at <a href="https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting">around 4%</a> for September. What’s more, the economy is still growing quite fast, with consensus forecasts showing gross domestic product will rise by <a href="https://www.atlantafed.org/cqer/research/gdpnow">nearly 3% this quarter</a>. Some early data suggests that could be <a href="https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/realgdptrackingslides.pdf">a low estimate</a>.</p>
<h2>What’s next for interest rates?</h2>
<p>Fed watchers are parsing every word from the central bank to determine whether another hike is coming this year or next, or if the cycle is truly over. To understand that decision, it helps to consider the bigger picture.</p>
<p>While the U.S. economy has certainly avoided a downturn for longer than many expected, the inflation battle is a long way from finished. In fact, this <a href="https://www.wsj.com/economy/central-banking/why-a-soft-landing-could-prove-elusive-3d17e134">wouldn’t be the first time</a> the economy looked like it would avoid a soft landing. For the next several months, the economy is <a href="https://kalshi.com/markets/govshut/government-shutdown#govshut-23oct02">not likely to implode</a> without a <a href="https://theconversation.com/us-regulators-avoided-a-banking-crisis-by-swift-action-following-svbs-collapse-but-the-cracks-it-exposed-continue-to-weaken-the-global-financial-systems-foundation-201724">major</a> <a href="https://theconversation.com/fed-faces-twin-threats-of-recession-and-financial-crisis-as-its-inflation-fight-raises-risks-of-both-193704">spark</a>.</p>
<p>However, inflation may not continue to fall as quickly in the coming year, which means the Fed may still raise rates more than <a href="https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html">some expect</a>. If rising oil prices continue to <a href="https://www.axios.com/2023/09/13/cpi-report-inflation-august-2023">boost transportation costs</a>, other goods could also get more expensive, which may mean higher interest rates for longer.</p>
<h2>Is this really the end?</h2>
<p>Though Federal Reserve Chair Jerome Powell seemed to indicate that the committee is approaching the end of the hiking cycle, <a href="https://www.kentclarkcenter.org/wp-content/uploads/2023/09/RESULTS-2023-09-13-Survey-10.pdf">only 10%</a> of economists expect that it is over at this point – not that economists’ <a href="https://www.vox.com/2014/12/18/7414973/economists-predictions-treasury">track record of forecasting rates</a> is great either. This is largely because Powell has been clear that the Fed is <a href="https://www.pimco.com/en-us/insights/blog/fed-cycle-enters-data-dependence-phase/">basing its decisions on economic data</a>, which has been strong so far and hopefully will continue in that direction.</p>
<p>So while everyone is watching the Fed this week, they should also keep an eye on broader economic conditions. With luck, the reported data will continue to be strong enough to avoid a downturn, but not so strong that inflation picks back up.</p><img src="https://counter.theconversation.com/content/214022/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>D. Brian Blank does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>News of a soft landing may be premature.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2047072023-04-28T17:48:04Z2023-04-28T17:48:04ZThe Federal Reserve and the art of navigating a soft landing … when economic data sends mixed signals<figure><img src="https://images.theconversation.com/files/523457/original/file-20230428-16-6qiovj.jpg?ixlib=rb-1.1.0&rect=36%2C256%2C6062%2C3767&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">'Surely we can avoid an economic crash? We can, but don't call me Shirley!'</span> <span class="attribution"><a class="source" href="https://corporate.fathomevents.com/press/media/3893/airplane_still_ks_c-5344_ccde77f8e99d535abb14358ba6e9a325941369ac.jpg?anchor=center&mode=crop&rnd=132882314110000000">Paramount Pictures/Fathom Events</a></span></figcaption></figure><p>With inflation easing and the U.S. economy cooling, is the Federal Reserve done raising interest rates? After all, gently bringing down the trajectory of prices without crashing the economy was the central bank’s objective when it began jacking up rates over a year ago. </p>
<p>Gross domestic product, the broadest measure of an economy’s output, <a href="https://www.bea.gov/news/2023/gross-domestic-product-first-quarter-2023-advance-estimate">expanded at an annual pace</a> of a mere 1.1% in the first quarter, according to data released April 27, 2023 – down from 2.6% recorded in the final three months of 2022. And the latest consumer price data, from March, shows inflation slowing to 5% on an annualized basis, the <a href="https://fred.stlouisfed.org/series/CPIAUCSL#0">least in about a year</a>. </p>
<p>Unfortunately for consumers and businesses weary of soaring borrowing costs, the Fed’s not likely done hiking rates quite yet. <a href="https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html">Financial markets are predicting another quarter-point hike</a> when the Fed meets for a two-day meeting that ends May 3, 2023. And there could be several more increases to come.</p>
<p>But this does raise another important question: With all the recent, often conflicting, data and narratives regarding <a href="https://theconversation.com/jobs-report-hints-that-fed-policy-is-paying-off-and-that-a-growth-recession-awaits-203485">inflation</a>, <a href="https://theconversation.com/us/topics/2023-bank-crisis-135462">bank failures</a> and <a href="https://techcrunch.com/2023/04/27/tech-industry-layoffs/">layoffs in the tech sector</a>, is the Fed close to engineering the “soft landing” it’s been hoping for? </p>
<h2>The economy zigs then zags</h2>
<p>The GDP data is a mixed bag and provides some clues to the answer. </p>
<p>Overall, the recent GDP figures suggest a likely economic slowdown going forward, due largely to a drawdown in inventories – that is, rather than ordering new goods, companies are relying more on stuff currently in storage. Businesses seems more inclined to sell what is on hand rather than order up new products, likely in anticipation of a slowdown in consumption. And business investment declined 12.5% in the quarter. </p>
<p>At the same time, consumer spending, which represents about two-thirds of GDP, grew at a healthy 3.7% pace, and investment in equipment such as computers and robotics increased by 11.2% – though this category is quite volatile and could easily turn in subsequent quarters. </p>
<p>Other data also points to a slowdown, such as a <a href="https://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf">decline in new orders for manufactured goods</a>. This, combined with the drawdown in inventories in the GDP report, might suggest that businesses are anticipating a slowdown in demand for goods and services.</p>
<p>When we look at the labor market, while job <a href="https://www.bls.gov/news.release/empsit.nr0.htm">increases have been strong</a> – 334,000 over the past six months – job openings have been declining. After peaking at about 12 million in March 2022, openings dropped to <a href="https://www.bls.gov/jlt/">about 9.9 million</a> as of February, according to the Bureau of Labor Statistics.</p>
<h2>Inflation: Is it high or low?</h2>
<p>In terms of inflation, we can also see conflicting numbers.</p>
<p>The headline consumer price index <a href="https://www.bls.gov/news.release/cpi.nr0.htm">has indeed slowed steadily</a> since peaking in June 2022 at 9.1%. But the core preferred consumption index, the <a href="https://www.bloomberg.com/news/articles/2023-03-25/fed-s-preferred-inflation-gauge-seen-staying-elevated-eco-week?sref=Hjm5biAW">Fed’s favored measure of inflation</a>, <a href="https://fred.stlouisfed.org/series/PCEPILFE#0">has remained stubbornly elevated</a>. The latest data, released on April 28, 2023, showed the index, which excludes volatile food and energy prices, <a href="https://www.bea.gov/news/2023/personal-income-and-outlays-march-2023">was up 4.6% in March</a> from a year earlier and has barely budged in months.</p>
<p>Meanwhile, wages, which when rising can have a strong upward push on prices, <a href="https://www.nytimes.com/2023/04/28/business/wage-inflation-march.html">climbed at an annualized 5.1% in the first quarter</a>, also according to data released on April 28. That’s down from the peak of 5.7% in the second quarter of 2022 but is still about the fastest pace of wage gains in at least two decades. </p>
<h2>More hikes to come</h2>
<p>So what might all this suggest about Fed actions on interest rates?</p>
<p>The next meeting is scheduled to end on May 3, with the <a href="https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html">market odds greatly favoring</a> another 0.25 percentage point increase – which <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm">would be the 10th straight hike</a> since March 2022. </p>
<p>With the inflation rate still well above the Fed’s target of about 2%, combined with continued job growth and a low unemployment rate, the central bank is likely not done ratcheting up rates. I agree with the market odds pricing in a quarter-point hike for the May meeting. Future data will guide any future rate increases beyond that. </p>
<p>The good news is that, I believe, the larger rate increases are well in the past.</p>
<h2>Landing softly – or at least mildly</h2>
<p>That brings us back to the big question: How close is the Fed to sticking a soft landing, in which the U.S. economy manages to tame inflation without a recession? </p>
<p>Sadly, it’s too early to tell. Labor markets can be very volatile and political and international events – such as <a href="https://www.brookings.edu/2023/04/24/how-worried-should-we-be-if-the-debt-ceiling-isnt-lifted/">potential gridlock on debt ceiling talks</a> or <a href="https://www.bbc.com/news/world-europe-65421341">further escalations in the Ukraine War</a> – can turn things upside down. That said, we are either looking at a mild recession or a growth recession.</p>
<p>What’s the difference? A <a href="https://www.investopedia.com/terms/g/growth_recession.asp">growth recession</a> signals a weak economy but not enough to significantly drive up unemployment – and that’s preferable to even a mild recession of multiple quarterly drops in GDP and much higher unemployment. </p>
<p>We just don’t know which is more likely. What I think is true now, though, is that, barring any catastrophic and unpredictable events, a severe recession has been avoided.</p><img src="https://counter.theconversation.com/content/204707/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christopher Decker does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The numbers seem to be going in the ‘right’ direction for the Fed to pull off a soft landing – and avoid a recession – but the picture remains murky.Christopher Decker, Professor of Economics, University of Nebraska OmahaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2029882023-04-12T11:17:42Z2023-04-12T11:17:42ZFour reasons inflation will stay stubbornly high for some time<figure><img src="https://images.theconversation.com/files/519560/original/file-20230405-18-q27586.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C6079%2C3394&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Climbing inflation.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/development-attainment-motivation-career-growth-concept-1029299632">Sergey Tinyakov/Shutterstock</a></span></figcaption></figure><p>Price inflation is <a href="https://www.theguardian.com/business/live/2023/mar/30/green-shoots-hopes-uk-economy-core-inflation-us-gdp-energy-strategy-business-live#:%7E:text=Inflation%20in%20Spain%20has%20tumbled,Spanish%20inflation%20dropped%20to%203.1%25.">starting to fall</a> in many countries but it still remains way above the typical <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">2% target of most major economies</a>. In the UK, inflation has been <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-9428/#:%7E:text=The%20cost%20of%20living%20increased,2023%20to%2010.4%25%20in%20February.">above target</a> since August 2021 and in <a href="https://www.economist.com/graphic-detail/2022/08/17/british-inflation-hits-double-digits">double digits</a> since August 2022.</p>
<p>In 2021, I was <a href="https://theconversation.com/rising-inflation-unless-we-act-now-it-will-not-be-temporary-168106">one of the economists who warned</a> that high inflation might not be “transient”, as major central and various think tanks were <a href="https://www.afr.com/policy/economy/why-central-banks-got-inflation-so-wrong-20220907-p5bg4w">claiming at the time</a> when they said rapid price rises wouldn’t last long. I argued for action before high inflation became embedded in the economy and <a href="https://www.bbc.co.uk/news/business-your-money-65079792">made the UK a poorer country</a>. </p>
<p>Unfortunately, <a href="https://news.sky.com/story/uk-economy-to-fare-worse-than-any-other-country-in-developed-world-this-year-imf-forecasts-12799201">this has now happened</a>. And while I believe inflation will start falling from current highs soon, it’s going to be tough to bring it back to <a href="https://www.bankofengland.co.uk/monetary-policy/inflation">the government’s 2% target</a>.</p>
<p>Central banks <a href="https://www.theguardian.com/business/2023/jan/09/bank-of-england-high-inflation-could-last-longer-than-expected-chief-economic-energy-prices-uk-recession">often point to</a> the war in Ukraine and spiking energy prices when explaining recent rapid price rises. But US and UK inflation was already at <a href="https://news.sky.com/story/us-inflation-hits-fresh-four-decade-high-even-before-ukraine-war-added-to-price-pressures-12562618">a four-decade high</a> before the start of the war. The truth is that the global economy is now entering a period of permanently higher inflation fuelled by four deeper forces.</p>
<h2>1. ‘De-globalisation’</h2>
<p>One of the long-term drivers of inflation is an economic cold war. The Trump administration in the US led initial efforts to <a href="https://observer.com/2017/03/protectionism-could-it-benefit-us-economy-free-trade-wto-useconomy/">impose trade sanctions against China</a> and the current administration seems <a href="https://www.forbes.com/sites/miltonezrati/2022/12/25/biden-escalates-the-economic-war-with-china/?sh=3a2e5eec12f3">even more determined</a> to end US reliance on Chinese products. The economic relationship between the west and Russia –- a major global exporter of energy and commodities – has entered a similar period of decline. </p>
<p>And this reversal of globalisation is not limited to international relationships. Politicians often <a href="https://blogs.lse.ac.uk/europpblog/2021/09/01/what-economic-nationalism-is-and-what-it-is-not/">promise to protect</a> jobs, rejuvenate industries and reduce national trade deficits by weakening the local economy’s global ties. They do this with higher tariffs and bureaucratic costs, and by subsidising national industries. </p>
<p>This can fail to account for retaliation by the affected countries, however, which squeezes markets, making goods more expensive and boosting inflation. Politicians should be honest about the potential impact of these decisions <a href="https://observer.com/2017/03/protectionism-could-it-benefit-us-economy-free-trade-wto-useconomy/">on domestic prices</a>.</p>
<p>With Brexit, for example, <a href="https://www.bbc.co.uk/news/uk-politics-eu-referendum-36086987">UK politicians promised</a> all the benefits of a unified European market without any of the obligations. Unsurprisingly, the EU retaliated by reducing UK access to its market. The result was <a href="https://www.theguardian.com/business/2022/dec/03/brexit-has-fuelled-surge-in-uk-food-prices-says-bank-of-england-policymaker#:%7E:text=there%20were%20clear%20signs%20leaving%20the%20EU%20was%20adding%20to%20soaring%20prices">higher prices</a>, <a href="https://edition.cnn.com/2022/12/24/economy/brexit-uk-economy/index.html">reduced investment</a>, <a href="https://www.theguardian.com/politics/2023/jan/17/shortfall-of-330000-workers-in-uk-due-to-brexit-say-thinktanks">workforce cuts</a>, and ultimately <a href="https://www.independent.co.uk/news/uk/politics/brexit-cost-uk-gdp-economy-failure-b2246610.html">a lower GDP path</a> for all involved – but chiefly for the UK. </p>
<h2>2. Climate change</h2>
<p>The recent “<a href="https://www.reuters.com/business/retail-consumer/uk-government-calls-supermarket-bosses-salad-crisis-talks-2023-02-27/">salad crisis</a>” saw shortages cause food prices spikes. This will not be a one-off. Weather is increasingly <a href="https://www.carbonbrief.org/mapped-how-climate-change-affects-extreme-weather-around-the-world/">unstable</a>, hindering production and even making <a href="https://www.oxfam.org/en/5-natural-disasters-beg-climate-action">natural disasters</a> more likely.</p>
<p>Like <a href="https://www.webmd.com/covid/news/20220912/climate-change-pandemics-more-common#:%7E:text=Increase%20of%20Other%20Pandemics,due%20to%20temperature%20and%20rainfall">pandemics</a>, these events disrupt production and can be costly for businesses to manage and overcome. Increased costs are passed on to consumers, as are the costs of <a href="https://blogs.worldbank.org/allaboutfinance/inflation-and-ecological-transition-european-perspective">government initiatives</a> such as carbon taxes.</p>
<h2>3. Wage-price spiral</h2>
<p>Central banks have been widely criticised for failing to act on inflation earlier and allowing a wage-price spiral to fuel further price inflation. This is when high inflation pushes up wages, which then boosts demand and spending, leading to more inflation. It’s a vicious circle that affects service-based economies (like the UK) the worst.</p>
<p>Recent <a href="https://www.cnbc.com/2023/02/01/uk-strikes-half-a-million-brits-are-taking-part-in-the-biggest-walkout-for-12-years.html">worker strikes</a> in the UK and <a href="https://www.piie.com/blogs/realtime-economics/us-workers-wage-gains-2023-are-likely-exceed-inflation">the quick pace of US salary rises</a> are not just a predictable reaction to high inflation, they also strengthen it. The wage-price spiral could push inflation higher for a long time unless addressed. </p>
<figure class="align-center ">
<img alt="Close-up of a gauge marked with a shopping trolley and low, medium high; pointer at high." src="https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=371&fit=crop&dpr=1 600w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=371&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=371&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=466&fit=crop&dpr=1 754w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=466&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/519098/original/file-20230403-24-zn7jv1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=466&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">High-price inflation is affecting the cost of food.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-illustration-key-performance-indicator-needle-1893009988">Olivier Le Moal/Shutterstock</a></span>
</figcaption>
</figure>
<h2>4. Highly liquid global markets</h2>
<p>Liquidity is the amount of money that exists in an economy. Following the 2008 global financial crisis, central banks pumped more money into major economies through a convoluted process called quantitative easing (QE). </p>
<p>What started as a reasonable measure to shore up the banking sector and help households and businesses via low interest rates became an addictive habit in the 2010s. QE liquidity is now <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing#:%7E:text=In%20turn%2C%20that%20increases%20how,billion%20were%20UK%20corporate%20bonds">equal to 40% of GDP</a> in the US and UK.</p>
<p><a href="https://www.economicshelp.org/blog/797/economics/why-printing-money-causes-inflation/#:%7E:text=If%20the%20money%20supply%20increases,firms%20to%20put%20up%20prices.">Economic theory</a> suggests such extreme liquidity would cause inflation. While this <a href="https://www.investopedia.com/articles/investing/022615/why-didnt-quantitative-easing-lead-hyperinflation.asp">didn’t happen</a>, it has created problems for the global economy. </p>
<p>QE boosted the valuation of all assets. From real estate to shares, art and even Bitcoin, we are now in an “<a href="https://fortune.com/2023/01/07/forecasts-gone-wrong-wall-street-bitcoin-stock-market-everything-bubble/">everything bubble</a>”. This has not only <a href="https://www.theguardian.com/inequality/2017/nov/14/worlds-richest-wealth-credit-suisse">increased inequality</a>, but has also affected how central banks fight inflation. Sustained high interest rates could bankrupt households, businesses or even whole countries that borrowed when rates were low. <a href="https://www.theguardian.com/business/2023/mar/13/silicon-valley-bank-collapse-central-banks-interest-rate-rises">Recent bank collapses</a> are a stark warning that central banks are limited in how much they can use rate rises to fight inflation. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next</a>
</strong>
</em>
</p>
<hr>
<h2>Solutions to persistently high inflation</h2>
<p>The current situation makes it difficult for central banks and governments to fight inflation. If interest rates rise further to subdue inflation and then remain elevated for a long time, households, pension funds, banks, stock markets and possibly even governments could collapse as they struggle to afford rising rates on loans such as mortgages. This means that interest rate changes – one of the main tools used to fight inflation – has potentially lost its edge and credibility. </p>
<p>Unfortunately there are rarely any miracle solutions in economics, but working to address these deeper causes of inflation will help bring inflation back towards the government’s 2% target. </p>
<p>Environmental degradation and its impact on inflation relies on change by governments, businesses and consumers. A thoughtful migration policy could alleviate shortages of people and skills, boost production and keep inflation lower. The impact of trade wars on GDP could be addressed through investment in technology, people and infrastructure. Reversing acts of economic self-harm such as Brexit and other forms of economic nationalism could also play a role: our politicians also need to be honest about the impact of different choices on local businesses and people. </p>
<p>Overall, it’s important to prevent longer-term damage from this period of high inflation, rising interest rates and uncertainty. Vulnerable groups that tend to be more deeply affected by price rises should be protected. While this won’t bring inflation down in the short term, it will make the cost of living crisis easier for more people and businesses to navigate while these deeper causes are addressed.</p><img src="https://counter.theconversation.com/content/202988/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Tziamalis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The deeper causes of inflation will make it very difficult to bring price rises down to more manageable levels.Alexander Tziamalis, Senior Lecturer in Economics, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2023772023-03-28T13:52:21Z2023-03-28T13:52:21ZWhat central banks are doing to safeguard financial stability and why they must proceed with caution<figure><img src="https://images.theconversation.com/files/517781/original/file-20230327-24-8f7acl.jpg?ixlib=rb-1.1.0&rect=284%2C163%2C5458%2C3518&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Trying to maintain some stability.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/abstract-businesswomen-fail-danger-tower-block-1934517353">David Gyung/Shutterstock</a></span></figcaption></figure><p>Before a crucial <a href="https://theconversation.com/interest-rates-why-the-federal-reserve-and-bank-of-england-should-still-raise-them-a-bit-202156">week of interest rate decisions</a> for central banks, and on the eve of the emergency takeover of <a href="https://www.politico.eu/article/swiss-finance-minister-defends-rushed-takeover-of-credit-suisse/">banking giant Credit Suisse</a>, the Bank of England and five other major central banks announced a coordinated effort to <a href="https://www.bankofengland.co.uk/news/2023/march/coordinated-central-bank-action-to-enhance-the-provision-of-us-dollar-liquidity">boost the flow of US dollars</a> through the global financial system. </p>
<p>Their aim was to keep credit flowing to businesses and households during recent banking sector turmoil. This had to coincide with <a href="https://theconversation.com/interest-rates-why-the-federal-reserve-and-bank-of-england-should-still-raise-them-a-bit-202156">ongoing attempts to control inflation</a> amid market chaos. </p>
<p>The measure implemented by the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Swiss National Bank and the US Federal Reserve extended existing arrangements called <a href="https://www.newyorkfed.org/markets/international-market-operations/central-bank-swap-arrangements">“liquidity swaps”</a> by increasing the frequency with which these central banks can exchange US dollars, from weekly to daily, at least until the end of April 2023.</p>
<p>Liquidity swap agreements are an important channel through which US dollars are made readily available to all major countries. The change in frequency from weekly to daily is designed to shore up stability. But <a href="https://www.imf.org/en/News/Articles/2023/03/25/032623md-china-development-forum-remarks">uncertainty remains</a> about whether the financial system has recovered from recent turmoil, and such tools still carry risks.</p>
<h2>What are liquidity swaps?</h2>
<p>Liquidity swap agreements are commonly used to enable central banks to exchange currencies using an agreement based on collateralised loans. They allow a central bank (the recipient) to obtain foreign currency from another (the source) and distribute it to commercial banks in their own country. </p>
<p>Agreements are often reciprocal, in that there is a two-way liquidity line and either bank can take up the recipient or source role. Central banks have a multitude of these agreements in place at any one time with other key central banks.</p>
<p>The reason for the recent increase in the availability of US dollars through these agreements is that the dollar is the dominant global currency. It plays a large role in trade and comprises significant chunks of <a href="https://www.imf.org/en/Publications/WP/Issues/2020/06/19/The-Non-U-S-Bank-Demand-for-U-S-49514">investors’ portfolio holdings</a>. </p>
<p>Of course, commercial banks have assets and liabilities denominated in many different currencies. But it’s not unheard of for <a href="https://www.bis.org/publ/qtrpdf/r_qt2103c.pdf">non-US banks to have large – sometimes even roughly the same – amounts </a> of US dollar-denominated assets as US banks. </p>
<p>So, these liquidity lines provide a way for commercial banks to get a currency they need but that their central bank may not have in abundance. Without this tool, non-US banks would have to acquire US dollars through their own markets or by lending in non-US markets in exchange for US dollars.</p>
<p>But any stress in the market, such we have seen recently with Credit Suisse, can lead to increased demand for cash as investors try to safeguard their assets. Because of the dominance of the US dollar in the global financial system, this can cause a shortage of dollars available to non-US banks. These banks then have to turn to their own central banks for US dollars – and this is where swap lines come in.</p>
<figure class="align-center ">
<img alt="Lifebuoy and a golden dollar symbol on blue sea and sky background." src="https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&rect=0%2C431%2C4985%2C2389&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517778/original/file-20230327-1567-t9nqnd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Plain sailing ahead?</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/money-crisis-rescue-lifebuoy-golden-dollar-597807614">rawf8/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Lender of last resort</h2>
<p>In a world of interconnected markets, negative financial events can spread quickly. Coordinated movements by central banks remind everyone that they can and will act as a lender of last resort.</p>
<p>The chart below shows the weekly average amount of US dollars transacted through these liquidity lines. These trades tend to increase during adverse times, such as between 2008 and 2010 due to the global financial crisis, and in 2020 at the beginning of the COVID pandemic. </p>
<p><strong>Use of USD central bank liquidity swaps:</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing use of central bank USD swap facilities, with significant increases during the 2008 global financial crisis and the COVID pandemic." src="https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=541&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=541&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=541&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=680&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=680&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517859/original/file-20230328-3042-vnwa4n.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=680&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">USD central bank liquidity swaps (2005-2020).</span>
<span class="attribution"><a class="source" href="https://www.newyorkfed.org/markets/desk-operations/central-bank-liquidity-swap-operations">Author provided using data from the board of governors of the Federal Reserve System.</a></span>
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<p>So, when central banks boost accessibility to dollars through these liquidity lines – as they are now – it suggests they are concerned about whether weekly access to US dollars is enough. In other words, when they have growing concerns about financial stability, they want to remind markets that they will act as a lender of last resort.</p>
<p>For the recipient central banks, the active lines can help prevent costly bank failures and can dampen domestic concerns about bank runs. For the source (typically the Federal Reserve), the liquidity lines maintain demand for US-denominated assets and prevent spikes in interest rates, which in turn supports US interests. </p>
<p>But this gives rise to another problem: moral hazard. The increasing frequency of liquidity lines can act like a subsidy for US dollar-based activities. Excessive amounts of this behaviour can in turn cause more instability even as central banks are trying to calm markets with these tools. </p>
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<a href="https://theconversation.com/what-does-moral-hazard-mean-a-scholar-of-financial-regulation-explains-why-its-risky-for-the-government-to-rescue-banks-202091">What does 'moral hazard' mean? A scholar of financial regulation explains why it's risky for the government to rescue banks</a>
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<h2>Financial (in)stability</h2>
<p>And moral hazard is not the only kind of risk these tools carry – liquidity lines can act as a useful medicine, but they do have side effects. There are two key components to a liquidity line that determines the potential risk to, and broader effect on, the financial system. </p>
<p>The first comes from the way they are agreed between central banks, and the second comes from how the recipient central bank passes the US dollars from the swap on to commercial banks in its own country. A recipient central bank is solely responsible for paying the source central bank for the US dollars, so the source central bank does not know the identity of the beneficiary banks in the commercial markets. </p>
<p>This creates supervisory and regulatory problems because the source is not able to regulate the foreign commercial banks that access these swaps via recipient banks. All central banks have their own incentives and rules around how and why they operate. So, this exposes a central bank to any risks arising from the decisions made by banks in other jurisdictions, some of which will operate based on different incentives and oversight.</p>
<p>This is why central banks need to use such tools with caution, particularly when they are trying to encourage stability. Liquidity lines can actually cause fires started in one country to spread through others, which could destabilise the global financial markets.</p><img src="https://counter.theconversation.com/content/202377/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Drew Woodhouse does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central banks are reaching into their toolkits to shore up the global financial system.Drew Woodhouse, Senior Lecturer in Economics, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2022952023-03-24T11:05:40Z2023-03-24T11:05:40ZSoaring interest rates contributed to recent bank failures – and there could be more to come<figure><img src="https://images.theconversation.com/files/517158/original/file-20230323-14-y9u8dd.jpg?ixlib=rb-1.1.0&rect=60%2C0%2C6687%2C4404&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/abstract-view-skyline-london-modern-skyscrapers-1140269726">Sven Hansche/Shutterstock</a></span></figcaption></figure><p>US bank regulators closed Silicon Valley Bank (SVB) on March 10 2023, after it suffered <a href="https://www.ft.com/content/b556badb-8e98-42fa-b88e-6e7e0ca758b8">US$42 billion (£35 billion) of deposit withdrawals</a> in a 24-hour period. This was <a href="https://www.reuters.com/business/finance/global-markets-banks-wrapup-1-2023-03-10/">the largest bank failure</a> since the 2008 global financial crisis and was not supposed to happen again. </p>
<p>Since the 2008 crisis, international bank regulations have been <a href="https://www.bis.org/publ/work859.htm">greatly tightened</a> and, among other measures, banks now have more capital to absorb losses and protect themselves from insolvency. Yet, even though SVB’s capital was above the minimum level required by regulators, this was not enough to keep it alive.</p>
<p>The SVB debacle has caused new concern about the safety of banks across the developed world, raising the likelihood of a run on deposits in any bank that has been showing signs of weakness. This sense of alarm was heightened by the collapse of Credit Suisse and its subsequent takeover by UBS just ten days after SVB’s failure. <a href="https://www.spglobal.com/spdji/en/indices/equity/dow-jones-us-banks-index/#overview">The Dow Jones index of US bank shares</a> fell by 22% in the two weeks from March 6.</p>
<p>Even though central banks have been providing “<a href="https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what-is-a-lender-of-last-resort.en.html#:%7E:text=A%20lender%20of%20last%20resort%20is%20whoever%20you%20turn%20to,need%20for%20their%20daily%20business.">lender of last resort</a>” facilities <a href="https://www.reuters.com/markets/us/banks-sought-record-fed-liquidity-wake-svb-collapse-2023-03-16/">to assist banks with their cash flows</a>, the major worry is that vulnerable banks may need capital injections from government to avoid failure. </p>
<p>This is what happened in 2008, but post-crisis banking regulation was supposed to prevent the need for such assistance. And so SVB’s troubles are a reminder that the current rules on capital have been designed to cushion banks against losses on defaulting loans. While this was the predominant cause of bank failures after the 2008 financial crisis, default risk was not a major issue for SVB. Its troubles stemmed from falling asset values as interest rates rose. This is known as interest rate risk. </p>
<h2>SVB’s interest rate risk</h2>
<p>As a specialist bank to the technology industry, deposits at SVB grew <a href="https://ir.svb.com/financials/annual-reports-and-proxies/default.aspx">from US$62 billion to US$189 billion</a> during 2020 and 2021, but demand for loans from tech companies grew at a slower pace. In order to achieve a return on these funds, SVB invested in long-term bonds, mainly <a href="https://www.forbes.com/sites/shivaramrajgopal/2023/03/15/svb-is-one-more-example-of-a-governance-crisis-that-seems-to-be-only-foretold-by-short-sellers-despite-plenty-of-red-flags-hiding-in-plain-sight/?sh=7edcf3b01f63#:%7E:text=In%20SVB%E2%80%99s%20case%2C%20%2463%20billion%20of%20these%20were%20%E2%80%9Cagency%20MBS%E2%80%9D%20where%20agency%20refers%20to%20one%20of%20Freddie%20Mac%2C%20Fannie%20Mae%20or%20Ginnie%20Mae%20and%20MBS%20refers%20to%20mortgage%2Dbacked%20securities.">“agency” mortgage-backed securities (MBS)</a>, which are effectively government-guaranteed.</p>
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Read more:
<a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next</a>
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<p>At the end of 2022, 47% of SVB’s US$212 billion asset portfolio comprised this kind of long-term debt. But the value of all fixed interest debt such as MBS falls as interest rates rise. As the US Federal Reserve raised its official interest rate during 2022 to combat inflation, long-term rates also rose and the market value of SVB’s holdings fell by US$15 billion.</p>
<p>But this drop was not recorded as a loss by SVB because it had classified nearly all of this MBS debt as “held to maturity” (HTM). Under standard <a href="https://www.investopedia.com/terms/h/held-to-maturity-security.asp">accounting rules</a>, this means they are valued according to their purchase price not the price SVB would have received for selling at that time (the market value). If these assets had been placed in the alternative accounting category – “available for sale” (AFS) – they would have been recorded at their market value and the resulting US$15 billion loss would have wiped out most of SVB’s capital. Instead of being well-capitalised, it would have been nearly bankrupt.</p>
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Read more:
<a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">How bonds work and why everyone is talking about them right now: a finance expert explains</a>
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<p>Meanwhile, as the tech boom came to an end, the inflow of deposits turned into an outflow during 2022 as investment dried up and depositors needed their cash. By early 2023, SVB was running short of liquid assets to pay out to depositors that were making withdrawals. It <a href="https://s201.q4cdn.com/589201576/files/doc_downloads/2023/03/Q1-2023-Mid-Quarter-Update-vFINAL3-030823.pdf">attempted to borrow extra cash</a> for this purpose on March 9 but failed. This shone a light on the bank’s weakness and the outflow of deposits became a flood. The fact that most of SVB’s deposits were greater than US$250,000, and therefore <a href="https://www.fdic.gov/resources/deposit-insurance/faq/index.html#:%7E:text=Q%3A%20What%20is%20deposit%20insurance%3F">not insured by the US government</a>, no doubt made this flood worse.</p>
<p>SVB could have raised cash by selling some of its HTM assets at a loss but that would only have confirmed its poor condition. Instead, the <a href="https://www.cbsnews.com/news/silicon-valley-bank-deposits-guaranteed-signature-bank-federal-reserve-fdic/#:%7E:text=All%20deposit%20accounts%20at%20both,Deposit%20Insurance%20Corporation%20(FDIC)">Federal Reserve stepped in with a guarantee</a> for all of SVB’s accounts. </p>
<h2>Why not change the regulations?</h2>
<p>SVB <a href="https://www.theguardian.com/business/2023/mar/19/silicon-valley-banks-collapse-will-not-be-a-one-off-a-banking-crisis-was-long-overdue">is not alone</a> in this situation. Although other banks are generally not as exposed as SVB, holders of long-term US dollar debt were collectively sitting on some <a href="https://www.ft.com/content/03bd1f20-0577-43bd-a68a-24cd51367f9d">US$600 billion of unrealised losses</a> at the end of 2022.</p>
<p>Why have US banks not been required to carry enough capital to take account of interest rate risk? For a start, <a href="https://www.bis.org/basel_framework/chapter/SRP/31.htm">it would be hard to design</a> suitable rigid rules or to amend the accounting conventions. Another likely reason is that this would raise costs for all issuers of long-term debt, and the largest such issuer in all countries is the government. </p>
<p>Another likely reason is complacency. Interest rate risk was never such a serious problem during the four-decade general decline in rates before the rapid rise that began in mid-2020.</p>
<p><strong>Falling long-term US interest rates</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="A line graph showing falling yields on 10-year US treasury bonds, 1985-2020" src="https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=378&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=378&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=378&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=475&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=475&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517195/original/file-20230323-26-qqcs9a.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=475&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Long-term US dollar interest rates.</span>
<span class="attribution"><a class="source" href="https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart'">Macrotrends</a></span>
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<p>In the absence of a regulatory remedy for interest rate risk, the concern is that central banks will face greater pressure to reduce the chance of that risk materialising. This could cause them to soft-pedal on the interest rate rises needed to curb inflation.</p>
<p>This is dangerous. If central banks are perceived to be hesitating in their resolve to tackle inflation for fear of exacerbating financial instability, they risk their credibility. This could mean that even higher interest rates are necessary in the future to bring inflation under control.</p><img src="https://counter.theconversation.com/content/202295/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Whittaker does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The failure of Silicon Valley Bank has exposed gaps in financial regulation that could be tricky to fill.John Whittaker, Senior Teaching Fellow in Economics, Lancaster UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2021742023-03-22T10:52:16Z2023-03-22T10:52:16ZWhat is systemic risk and how does it lead to a banking crisis?<figure><img src="https://images.theconversation.com/files/516650/original/file-20230321-1318-civ0ma.jpg?ixlib=rb-1.1.0&rect=214%2C103%2C4304%2C2779&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/dead-piggy-bank-lies-upside-down-2142575907">Andrii Yalanskyi/Shutterstock</a></span></figcaption></figure><p>The recent collapse of Silicon Valley Bank (SVB), <a href="https://www.investmentweek.co.uk/news-analysis/4080434/us-regional-banks-challenging-future-aftermath-svb-blowup">a regional US bank</a> that funded start-up companies in the technology and innovation sector, has created a worldwide wave of financial instability.</p>
<p>Despite the efforts of US financial regulators to contain the potential damage by immediately providing full protection to the bank’s depositors, the collapse triggered <a href="https://news.sky.com/story/jitters-over-health-of-us-banks-spark-global-stock-market-sell-off-12830097">a global dip in banking share prices</a>. </p>
<p>The turmoil in financial markets led to <a href="https://www.ft.com/content/8be852c0-f735-4634-89bc-45238d753659">the collapse of Swiss banking giant Credit Suisse</a>, which was promptly taken over by UBS, an even larger bank. This was after an initial US$54 billion (£45 billion) lifeline from the Swiss central bank proved to be insufficient to rescue Credit Suisse.</p>
<p>How is it possible that the collapse of a relatively small financial institution like SVB could be so contagious as to end up having global consequences, including bringing down <a href="https://www.reuters.com/business/finance/how-credit-suisse-has-evolved-over-167-years-2023-03-16/">a 167-year-old financial institution like Credit Suisse</a>? </p>
<p>Answering this question requires an understanding of systemic risk, which refers to risks associated with the entire financial system. Broadly speaking, there are two distinct sources of systemic risk: balance sheet contagion and information runs.</p>
<h2>Balance sheet contagion</h2>
<p>The risk of balance sheet contagion arises from the vast number of financial agreements between companies in the international financial system. No bank operates in isolation – they are all tightly interconnected through agreements that might include both short-term and long-term loans, and various other contract types such as <a href="https://www.investopedia.com/terms/d/derivative.asp">derivatives</a>. </p>
<p>The largest financial institutions are also typically the most interconnected, providing and receiving credit from many others. When one or more of these large institutions suffer losses that cannot be covered by their capital, they become insolvent. This means they are unable to fully meet their obligations, for example if they owe money to another bank. These other banks will then also suffer losses which can spread even further, affecting their creditors and creating a potential cascade of failures. </p>
<p>The <a href="https://www.imf.org/en/Blogs/Articles/2018/09/05/blog-ten-years-after-lehman-lessons-learned-and-challenges-ahead">huge intervention in financial markets by US and European financial authorities</a> following the collapse of Lehman Brothers in 2008 aimed to avoid such contagion. In fact, the 2008 global financial crisis is a good example of the systemic risk that these large organisations with so many interconnections pose. They become “too big to fail” because their collapse will affect not only the financial system, but the whole global economy.</p>
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<img alt="Banking symbols on tiles, one bank is red, network is blocked." src="https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=386&fit=crop&dpr=1 600w, https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=386&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=386&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=486&fit=crop&dpr=1 754w, https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=486&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/516651/original/file-20230321-16-3xdwzv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=486&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Risk can be contagious because the banking industry is so interconnected.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/sanctioned-blocking-bank-exclusion-swift-economic-2266142725">Andrii Yalanskyi/Shutterstock</a></span>
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<h2>Information runs</h2>
<p>On the other hand, the recent banking crisis is an example of a systemic risk event caused by an information run. This is triggered when problems in one part of the system raise concerns about the financial robustness of other parts. </p>
<p>For example, <a href="https://ir.svb.com/news-and-research/news/news-details/2023/SVB-Financial-Group-Announces-Proposed-Offerings-of-Common-Stock-and-Mandatory-Convertible-Preferred-Stock/default.aspx#:%7E:text=SVB%20sold%20approximately%20%2421%20billion,the%20first%20quarter%20of%202023.">an announcement about SVB’s asset losses on March 8 2023</a> caused its customers with unprotected deposits to rush to the bank to withdraw their money. The eventual closure of SVB raised concerns that other banks might be suffering from similar losses. This encouraged investors around the world to sell banking shares, causing a rout in the industry’s stock. </p>
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Read more:
<a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next</a>
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<p>Information runs happen when investors and depositors don’t have the full picture about the banks whose shares they hold or in which they have deposited their money. This causes them to draw inferences about the financial health of these banks by observing what happens in the rest of the system. People make the reasonable assumption that banks around the globe are making similar investment decisions to the one that has just collapsed. </p>
<p>Understanding systemic risk and its implications for global markets has been an important research topic for financial economists for a long time. Last year, Douglas Diamond and Philip Dybvig were <a href="https://www.nobelprize.org/uploads/2022/10/popular-economicsciencesprize2022.pdf">awarded the Nobel Prize in Economics</a> for their research in this area. In 1983, they introduced a theoretical model that explains the mechanism by which rumours about banks can lead to their eventual collapse. </p>
<p>Unfortunately, 40 years later, the international banking system has just provided another striking example of the very instability that Diamond and Dybvig outlined in their work.</p>
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Read more:
<a href="https://theconversation.com/nobel-economics-prize-insights-into-financial-contagion-changed-how-central-banks-react-during-a-crisis-192208">Nobel economics prize: insights into financial contagion changed how central banks react during a crisis</a>
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<h2>Unintended consequences</h2>
<p>The complex interplay between the global economy and the international financial system implies that policies aiming to solve one problem can have unintended consequences – with potentially large systemic effects. </p>
<p>Recent inflationary pressure due to rising energy prices and the war in Ukraine has led central banks to raise interest rates to curb global demand and try to reduce inflation. However, rising interest rates caused a drop in the prices of fixed-income securities such as government bonds. These bonds are held by financial institutions like SVB that then see the value of a significant portion of their assets drop. This limits their ability to raise funds and satisfy the demands for liquidity from other banks, businesses and households.</p>
<p>Such issues can quickly spread throughout the financial system and, if they infect a large bank, the impact can multiply very quickly – as we have seen during the 2008 financial crisis and more recently.</p>
<p>The danger to the entire financial system from a few giant banks failing is well recognised. The irony is that, during both the global financial crisis and the recent financial turmoil, <a href="https://news.sky.com/story/high-street-banks-given-24-hours-to-rescue-silicon-valley-bank-uk-12831984">part of the solution</a> has been for failed institutions to be absorbed by even bigger banks. Such consolidation enhances systemic risk by potentially sowing the seeds of future crises.</p><img src="https://counter.theconversation.com/content/202174/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Spiros Bougheas does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There are two types of systemic risk that can infect the highly interconnected global banking system.Spiros Bougheas, Professor of Economics, University of NottinghamLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2021562023-03-20T16:30:59Z2023-03-20T16:30:59ZInterest rates: why the Federal Reserve and Bank of England should still raise them (a bit)<p>What will the Federal Reserve and Bank of England do with benchmark interest rates in the wake of the banking crisis? Traditionally, controlling inflation has been the prime mandate of central banks. </p>
<p>With annual inflation hitting double digits in the past year, many central banks have been hiking interest rates to try and bring it under control. The European Central Bank (ECB) raised its main rate from <a href="https://theconversation.com/the-european-central-bank-seems-to-have-got-away-with-raising-interest-rates-in-the-middle-of-a-banking-crisis-heres-why-202052">2.5% to 3%</a> on March 17, and all eyes are on the Fed and Bank of England (BoE) to see if they do likewise. The Fed is due to announce its decision on March 22, while the BoE takes its turn on March 23. </p>
<p>The trouble is that the calculus has changed over the past couple of weeks, as several banks have been pulled under by the strains caused by high rates. Most recently, Credit Suisse has been hastily taken over by <a href="https://www.cnbc.com/2023/03/19/ubs-agrees-to-buy-credit-suisse-as-regulators-look-to-shore-up-global-banking-system.html">fellow Swiss bank UBS</a>, while <a href="https://www.bbc.co.uk/news/business/market-data">bank stocks</a> are still tumbling around the world as investors fear there will be other casualties. So what do the central banks do next?</p>
<h2>Bank strain</h2>
<p>To raise or not to raise: that’s the Shakespearean dilemma facing the Fed and BoE. <a href="https://theconversation.com/are-interest-rates-really-going-to-keep-rising-sharply-201577">Inflation is still</a> running way above their 2% target level, but the banking turmoil is growing. The choice is to turn a blind eye to the turmoil and stay focused on price stability, or hold off and focus on helping to stabilise the financial system, even at the risk of inflation staying hot. </p>
<p>When <a href="https://news.bryant.edu/svb-banking-collapse-explained#:%7E:text=When%20Bryant%20University%20Professor%20of,uninsured%20deposits%2C%20and%20regulatory%20rollbacks">Silicon Valley Bank</a> (SVB) became the first casualty in this crisis several weeks ago, it was essentially because the value of its portfolio of bonds and other debt had been hit hard by rising interest rates. It started having cashflow problems and was left with no choice but to sell some of its portfolio at a loss, which caused a bank run. </p>
<p>In the aftermath, the Fed announced an emergency lending facility designed to shore up confidence in the US banking system. It enabled banks to borrow funds from the Fed against their bonds at face value, to ensure they had enough cash to operate – implying that they wouldn’t have to sell long-term government bonds at a loss, like SVB. </p>
<p>Cash-strapped banks in the US borrowed a total of <a href="https://cheddar.com/media/fed-lent-300b-in-emergency-funds-to-banks-in-the-past-week">US$300 billion</a> (£246 billion) from the Fed in the first week after this liquidity lifeline was launched. In Europe, Credit Suisse <a href="https://www.cbsnews.com/news/credit-suisse-to-borrow-54-billion-from-swiss-central-bank/#:%7E:text=Credit%20Suisse's%20shares%20soared%20as,from%20the%20U.S.%20to%20Europe.">borrowed US$54 billion</a> under a similar liquidity facility provided by Switzerland’s central bank, the Swiss National Bank (SNB) – though ultimately, this was not enough to avoid a takeover.</p>
<p>Taken together, it seems like a new form of quantitative easing has begun – this is the system of emergency liquidity creation used to prop up the global banking system for the past two decades. </p>
<p>Meanwhile, the central bank interventions have continued: the SNB offered a US$100 billion liquidity line to UBS to help it take on Credit Suisse’s operations. Then the <a href="https://www.thestreet.com/markets/fed-leads-global-liquidity-boost-with-swaps-as-bank-crisis-deepens">Fed announced</a> that it would be making US dollars available each day to the BoE, ECB, SNB and central banks of Canada and Japan. </p>
<p>These so-called daily swap lines, which replace the existing weekly ones, aim to ensure that everyone can get access to the dollars they need to help prevent further liquidity problems. The US dollar is the world reserve currency, meaning that it is the middle man in most transactions involving foreign currencies, so it’s absolutely vital for the global financial system. The new set-up will continue at least until the end of April. </p>
<h2>What to expect on rates</h2>
<p>Before all this banking turmoil, the Fed and BoE were widely expected to raise their benchmark rates by half a percentage point. Now, <a href="https://www.ft.com/content/ad5484b6-69a0-48bf-b24c-b1cbe7b285fb">many traders think</a> it will either only be 0.25 percentage points or no rise at all. </p>
<p>A pause in hiking rates will likely make investors worry that banks are in serious trouble. On the other hand, a more aggressive 0.5 percentage points rise could be more than many banks can handle right now. Not only would it further damage the value of their bond portfolios, it will push up their cost of borrowing to finance their operations. </p>
<p>In my view, the central banks should continue their efforts to squeeze out high inflation, but they also have to respond to the elevated stress among banks. That points to a 0.25 percentage points rise. At the same time, central banks should continue making additional liquidity available to the global banking system for as long as necessary to avoid bank runs, until confidence is restored.</p><img src="https://counter.theconversation.com/content/202156/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nikolaos Papanikolaou does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The two central banks were due to raise rates aggressively, but then came the banking crisis.Nikolaos Papanikolaou, Senior Lecturer in Finance, Newcastle UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2020522023-03-17T15:58:45Z2023-03-17T15:58:45ZThe European Central Bank seems to have got away with raising interest rates in the middle of a banking crisis – here’s why<figure><img src="https://images.theconversation.com/files/516053/original/file-20230317-14-iq3iqb.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Not for turning: ECB President Christine Lagarde. </span> <span class="attribution"><a class="source" href="https://www.alamy.com/christine-lagarde-director-of-the-imf-will-speak-during-a-pk-in-berlin-on-june-11-2018-automated-translation-image348632102.html?imageid=8FDBBBD4-C2DE-4EB9-A5B3-52CCFB946533&p=328602&pn=1&searchId=ce7a2df750b0c283e803dac07370d9c3&searchtype=0">Sueddeutsche Zeitung Photo</a></span></figcaption></figure><p>In the middle of a market panic that has felled two US banks and pushed several others to the brink, the European Central Bank (ECB) <a href="https://www.reuters.com/markets/europe/ecb-rate-hike-plans-clouded-by-financial-turmoil-2023-03-15/">has raised</a> interest rates by another 0.5 percentage points. The ECB’s president, Christine Lagarde, <a href="https://www.ft.com/content/83d44991-4988-4e4f-8143-81d34b2b4173">had been warning</a> this was necessary to bring eurozone inflation back to 2% by 2025. Unmoved by the fact that the banking crisis has been caused by higher rates, the ECB duly raised its main rate to 3% on March 16. </p>
<p><a href="https://www.theguardian.com/business/2023/mar/16/ecb-raises-interest-rates-despite-banking-fears-credit-suisse">Lagarde acknowledged</a> that several members of the ECB governing council were reluctant to support another hike, preferring to wait at least until the situation in the banking sector becomes clearer. </p>
<p>The markets <a href="https://www.bloomberg.com/news/articles/2023-03-15/jpmorgan-s-bob-michele-says-fed-will-pause-with-bank-woes-on-table?leadSource=uverify%20wall">had been expecting</a> the ECB to hold off on further hikes for the time being. Yet they responded positively to the move, with the German DAX index barely changing and France’s CAC 40 up on the day. So why didn’t it cause turmoil?</p>
<h2>Banks and higher interest rates</h2>
<p>Central banks have raised interest rates to their highest levels in 14 years in response to high inflation in the past year. Both sides of retail banks’ balance sheets <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">are affected</a> by these changes. </p>
<p>On the liability side, rate hikes make it more expensive for banks to borrow. In the years before the global financial crisis of 2007-09, they relied significantly on short-term debt to finance their operations. This put them at risk of suddenly running out of money if their nervous lenders took flight, which brought down the likes of <a href="https://www.bbc.co.uk/news/business-41229513">Northern Rock</a>.</p>
<p>After the crisis, regulators <a href="https://www.bis.org/fsi/fsisummaries/lcr.htm">established</a> minimum liquidity <a href="https://www.bis.org/bcbs/publ/d295.pdf">requirements</a> for banks, which have helped to make them more stable. However, rapid increases in interest rates can still adversely affect their access to liquidity – <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">as we have seen</a> with Silicon Valley Bank.</p>
<p>The asset side of bank balance sheets refers to how they use their funds. Banks give loans to customers and companies, while much of the rest is held in the form of supposedly safe investments like government bonds – but the value of these has been reduced by rising interest rates. </p>
<p>Retail banks’ main purpose is to use short-term deposits to make successful long-term investments that <a href="https://academic.oup.com/rfs/article-abstract/22/9/3779/1571440">enable them</a> to lend more, while always having enough to give depositors their money back. Unfortunately, this makes banks increasingly vulnerable to falling asset prices and deposit withdrawals as they grow. </p>
<p><a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">Silicon Valley Bank (SVB)</a> needed to raise more capital because interest rates had reduced the value of its holdings in government and corporate bonds, with the latter also dragged down by the tech industry downturn. When depositors suddenly panicked about whether SVB was financially viable, it triggered a bank run.</p>
<p>SVB’s quick collapse then caused fears to spread that other banks could be in similar trouble, prompting a heavy sell-off in bank stocks. New York bank <a href="https://www.reuters.com/business/finance/new-york-state-regulators-close-signature-bank-2023-03-12/">Signature also collapsed</a>, while California-based <a href="https://www.ft.com/content/daf5d4cc-8d0d-47a3-9d10-4526683e8a4e">First Republic</a> has needed a bailout. </p>
<h2>Basel III and deregulation in the US</h2>
<p><a href="https://academic.oup.com/rfs/article-abstract/24/8/2656/157359">The evidence</a> from previous banking debacles such as the 2007-09 crisis is that central banks need to cut interest rates to restore stability in such situations. In the wake of the SVB crisis, this is why the markets <a href="https://www.investmentweek.co.uk/news/4077448/central-banks-expected-pause-rate-hikes-following-svb-collapse">changed their assumptions</a> almost overnight about interest rates, from expecting a few more hikes to assuming rates are now near their peak. This was despite inflation remaining <a href="https://theconversation.com/are-interest-rates-really-going-to-keep-rising-sharply-201577">stubbornly high</a>, pointing to a need for more hikes. </p>
<p>The reason the ECB has not done what was expected is because it believes that the banks in the euro area can cope with more rate hikes. This is because they are following the tougher capital and liquidity requirements known as <a href="https://www.bis.org/bcbs/basel3.htm">Basel III</a>, which were gradually implemented by regulators after the global financial crisis. </p>
<p>These include tougher funding requirements for the world’s 30 largest banks, since they are considered globally systemically important – meaning they are such vital cogs that their failure would threaten a much wider collapse, like when <a href="https://corporatefinanceinstitute.com/resources/capital-markets/lehman-brothers/">Lehman Brothers</a> fell in 2008. </p>
<p>The Basel III requirements aim to establish a level global playing field. But countries have still had to introduce them via their own legislation, making any adjustments they think necessary for their banking sector. In the US, the stricter rules were originally applied by the <a href="https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm">Dodd-Frank Act of 2010</a> to all American banks with at least US$50 billion (£41 billion) in assets. </p>
<p>In 2018, however, amid concerns that these requirements were preventing banks from lending enough to the economy, the US government decided to deregulate. Now, only banks with at least US$250 billion in assets must follow the tighter rules, making mid-sized banks like SVB more vulnerable. Considering that global banking is <a href="https://www.investopedia.com/terms/i/interbankmarket.asp">largely interconnected</a> because banks lend money to one another, even a mid-sized collapse can threaten the wider global banking system. It’s still unclear what the collateral damage will be over SVB. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Woman going into SVB" src="https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/516058/original/file-20230317-22-pjcvu7.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">SVB was felled by looser US banking regulations.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/woman-walks-by-silicon-valley-bank-2274433297">Ringo Chiu</a></span>
</figcaption>
</figure>
<p>The euro area banking rules were not relaxed in same way, which is why the ECB believes EU banks can cope with more rate rises. The ECB directly supervises 111 significant banks of its member states that hold about 82% of the banking assets in the area. </p>
<p>As of 2022, the EU banks held <a href="https://www.newyorkfed.org/medialibrary/media/research/banking_research/quarterlytrends2022q1.pdf?la=en">between 2 and 3 percentage points</a> more risk-adjusted capital than US banks, which is significant. While <a href="https://www.bbc.co.uk/news/business-64964881">Credit Suisse</a> has also run into trouble in recent days, and has needed extra funding from the central bank of Switzerland, it was already struggling for various unconnected reasons. <a href="https://www.bankofengland.co.uk/statistics/banking-sector-regulatory-capital/2022/2022-q1">UK banks</a> have similar capital adequacy levels to EU banks. </p>
<p>It now appears that the US made a major mistake by loosening its banking rules in 2018. The ECB is now in a much better position to fight inflation than the US Federal Reserve. The Fed has already had to loosen monetary policy by <a href="https://www.kroll.com/en/insights/publications/the-federal-reserve-rides-to-the-rescue">setting up a facility</a> to lend to US banks using their devalued bonds as collateral, and it probably has much less room for manoeuvre over interest rates when it meets to decide whether to raise them in the coming days.</p><img src="https://counter.theconversation.com/content/202052/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>George Kladakis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The banking crisis has been caused by the interest rate rises, and further hikes were supposed to be a no no.George Kladakis, Lecturer in Financial Services, Edinburgh Napier UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2011582023-03-14T14:07:20Z2023-03-14T14:07:20ZWhy central banks are too powerful and have created our inflation crisis – by the banking expert who pioneered quantitative easing<figure><img src="https://images.theconversation.com/files/514968/original/file-20230313-18-ulpduz.jpg?ixlib=rb-1.1.0&rect=17%2C0%2C3794%2C2137&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/banking-service-background-bank-building-icon-1725594451">Iurii Motov/Shutterstock</a></span></figcaption></figure><p>Fifty years ago, a war broke out in the Middle East which resulted in a global oil embargo and a dramatic spike in energy prices.</p>
<p>The <a href="https://en.wikipedia.org/wiki/Yom_Kippur_War">war</a>, between Israel and an Arab coalition led by Egypt and Syria, began on October 6 1973 – the Jewish holy day of Yom Kippur. The <a href="https://en.wikipedia.org/wiki/1973_oil_crisis">oil embargo</a>, announced 11 days later by the Organisation of Petroleum Exporting Countries (Opec) under the leadership of Saudi Arabia, was followed by a <a href="https://moneyweek.com/370273/22-december-1973-opec-more-than-doubles-the-price-of-oil">major hike in the price of a barrel of oil</a> at the end of December 1973.</p>
<p>Many <a href="https://www.nationalarchives.gov.uk/cabinetpapers/themes/world-recession-oil-crisis.htm">historical accounts</a> suggest the decade of global inflation and recession that characterises the 1970s stemmed from this “oil shock”. But this narrative is misleading – and half a century later, in the midst of strikingly similar global conditions, needs revisiting.</p>
<p>In fact, inflation around the world had already been picking up well before the war (which lasted less than three weeks). The Federal Republic of Germany, Europe’s largest economy and biggest energy consumer, experienced its highest inflation rates of the decade throughout 1973 – first peaking at 7.8% in June that year, before the war and any hint of an oil price increase.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Israeli tank firing" src="https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=447&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=447&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513769/original/file-20230306-14-iwn77j.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=447&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The 1973 Yom Kippur war led to a hike in oil prices, but it did not cause the 1970s era of ‘Great Inflation’.</span>
<span class="attribution"><a class="source" href="https://commons.wikimedia.org/wiki/File:Yom_Kippur_War._VI.jpg">Wikimedia</a></span>
</figcaption>
</figure>
<p>So what was already driving inflation around the world at that time? A clue can be found in <a href="https://www.federalreserve.gov/pubs/feds/2002/200208/200208pap.pdf">a 2002 paper</a> written by MIT professor <a href="https://mitsloan.mit.edu/faculty/directory/athanasios-orphanides">Athanasios Orphanides</a> while he was on the board of the <a href="https://www.federalreserve.gov/aboutthefed.htm">US Federal Reserve</a> (America’s central bank, also known as the Fed). He wrote:</p>
<blockquote>
<p>With the exception of the Great Depression of the 1930s, the Great Inflation of the 1970s is generally viewed as the most dramatic failure of macroeconomic policy in the United States since the founding of the Federal Reserve … Judging from the dismal outcomes of the decade – especially the rising and volatile rates of inflation and unemployment – it is hard to deny that policy was in some way flawed.</p>
</blockquote>
<p>In reality, central bank decision-makers led by the Fed were largely <a href="https://www.investopedia.com/articles/economics/09/1970s-great-inflation.asp">responsible</a> for the Great Inflation of the 1970s. They adopted “<a href="https://www.investopedia.com/terms/e/easy-money.asp">easy money</a>” policies in order to finance massive national <a href="https://www.investopedia.com/terms/b/budget-deficit.asp">budget deficits</a>. Yet this inflationary behaviour went unnoticed by most observers amid discussions of conflict, rising energy prices, unemployment and many other challenges.</p>
<p>Most worryingly, despite these failings, the world’s central banks were able to continue unchecked on a path towards the <a href="https://www.thebritishacademy.ac.uk/publishing/journal-british-academy/2/central-banks-powerful-political-and-unaccountable/">unprecedented powers</a> they now hold. Indeed, the painful 1970s and subsequent financial crises have been repeatedly used as arguments for <a href="http://jamesforder.uk/central-bank-independence/">even greater independence</a>, and less oversight, of the world’s central banking activities.</p>
<hr>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/288776/original/file-20190820-170910-8bv1s7.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><strong><em>This article is part of Conversation Insights</em></strong>
<br><em>The Insights team generates <a href="https://theconversation.com/uk/topics/insights-series-71218">long-form journalism</a> derived from interdisciplinary research. The team is working with academics from different backgrounds who have been engaged in projects aimed at tackling societal and scientific challenges.</em></p>
<hr>
<p>All the while, central bank leaders have repeated the mantra that their “number one job” is to <a href="https://www.imf.org/en/About/Factsheets/Sheets/2023/monetary-policy-and-central-banking#:%7E:text=Central%20banks%20use%20monetary%20policy,are%20moving%20to%20inflation%20targeting.">achieve price stability</a> by keeping inflation low and stable. Unfortunately, as we continue to experience both <a href="https://www.bbc.co.uk/news/business-12196322">punishing inflation rates</a> and <a href="https://www.bbc.co.uk/news/live/business-64457377">high interest rates</a>, the evidence is all around us that they have failed in this job.</p>
<p>The latest crisis – beginning with the sudden <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">closure of Silicon Valley Bank</a> (SVB) in California – is a further indication that inflation, far from being brought to heel by the central banks, is causing chaos in the financial markets. Inflation pushes up interest rates, which in turn reduces the market value of bank assets such as bonds. With SVB’s many corporate depositors not covered by deposit insurance and fearing regulatory intervention, a catastrophic run on this solvent bank was triggered.</p>
<p>When the <a href="https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp">establishment of the Fed</a> was proposed more than a century ago, it was sold to Congress as the solution to this vulnerability in retail banking, as it could lend to solvent banks facing a run. In the event, the Fed did not lend to some 10,000 banks <a href="https://www.federalreservehistory.org/essays/banking-panics-1930-31">in the 1930s</a>, letting them fail, and this time around it did not lend to SVB until it was closed and taken over.</p>
<p>Now more than ever, I believe the role of central banks in our economies and societies demands greater scrutiny. This is a story of how they have become so powerful, and why it should concern us all.</p>
<h2>Myth busting 1: it’s not about the war</h2>
<p>In early 2023, the global financial picture feels disconcertingly similar to 50 years ago. Inflation and the cost of living have both risen steeply, and a war and related energy supply problems have been widely labelled as a key reason for this pain. In autumn 2022, inflation reached double-digits in <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2022">the UK</a> and across the <a href="https://www.euronews.com/next/2023/02/01/record-inflation-which-country-in-europe-has-been-worst-hit-and-how-do-they-compare#:%7E:text=In%20December%202022%2C%20inflation%20finally,estimated%20at%2010.1%20per%20cent.">eurozone</a>. <a href="https://www.reuters.com/markets/europe/italy-october-eu-harmonised-cpi-revised-126-yy-2022-11-16/">Italy</a> recorded 12.6% annual inflation while some countries, including <a href="https://www.telegraph.co.uk/business/2022/10/08/country-where-25pc-inflation-low-price-pay-see-russia/#:%7E:text=The%20governor%20of%20Estonia's%20central,more%20than%20a%20year%20ago.">Estonia</a>, saw inflation go as high as 25%.</p>
<p>In their public statements, central bank leaders have blamed this on a long (and movable) list of factors – most prominently, Vladimir Putin’s decision to send Russian troops to fight against Ukrainian armed forces. Anything, indeed, but central bank policy.</p>
<p>In October 2022, the president of the European Central Bank, Christine Lagarde, claimed in an <a href="https://www.youtube.com/watch?v=2YeJ8_WCA4U">interview on Irish TV</a> that inflation had “pretty much come about from nowhere”. Yet when we chart these inflationary patterns around the world, we find a similar puzzle to that seen 50 years ago.</p>
<p>Russia commenced its military operations in Ukraine on February 24 2022. An <a href="https://www.consilium.europa.eu/en/policies/sanctions/restrictive-measures-against-russia-over-ukraine/sanctions-against-russia-explained/#:%7E:text=What%20does%20the%20oil%20ban%20mean%20in%20practice%3F,-EU%20restrictions%20will&text=In%20June%202022%2C%20the%20Council,from%20Russia%20to%20the%20EU.">EU ban</a> on crude oil and refined petroleum products from Russia came into effect in December 2022, while Russian gas imports have never been banned by the EU (although they were discouraged politically). Yet as Figure 1 shows, inflation had <a href="https://www.ft.com/content/d5d68068-d3d7-4948-a13d-b36e8c2b8339">already been increasing</a> in the US and Europe long before Putin gave the order to move his troops across the border – indeed, as far back as 2020.</p>
<p><strong>Figure 1: inflation rates 2016-2022, US and eurozone</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=239&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=239&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=239&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=301&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=301&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513670/original/file-20230306-16-w8u15j.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=301&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://upload.wikimedia.org/wikipedia/commons/2/28/Inflation_rate%2C_United_States_and_eurozone%2C_January_2016_through_November_2022.png">Federal Reserve Economic Data via Wikimedia</a></span>
</figcaption>
</figure>
<p>By February 2022 (the month of Russia’s invasion), the UK’s 12-month Consumer Price Index inflation rate was already at <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/february2022#:%7E:text=historic%20modelled%20estimates.-,The%20Consumer%20Prices%20Index%20(CPI)%20rose%20by%206.2%25%20in,when%20it%20stood%20at%207.1%25.">6.2%</a>. At the same time, inflation was at 5.2% in <a href="https://www.destatis.de/EN/Press/2022/03/PE22_081_611.html">Germany</a> and 7.9% in the <a href="https://www.bls.gov/opub/ted/2022/consumer-prices-for-food-up-7-9-percent-for-year-ended-february-2022.htm#:%7E:text=The%20Consumer%20Price%20Index%20rose,month%20advance%20since%20July%201981.">US</a>.</p>
<p>But what about another “blue moon” event: COVID? The declaration of a <a href="https://twitter.com/WHO/status/1237777021742338049?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1237777021742338049&ref_url=https%3A%2F%2Fwww.who.int%2Femergencies%2Fdiseases%2Fnovel-coronavirus-2019%2Fevents-as-they-happen">pandemic</a> by the World Health Organization on March 11 2020 led to the shutting down of many economies and unprecedented restrictions on people’s movement. And the responses of central banks and governments to this unprecedented situation did add to the inflationary conditions that were <em>already</em> being created by the unwise (and coordinated) actions of the world’s central banks. But again, these pandemic responses were not the root cause.</p>
<p>To understand the real roots of our current inflation crisis, we must instead address another widely-held misconception: how money is created.</p>
<h2>Myth busting 2: where money really comes from</h2>
<blockquote>
<p>The process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent.</p>
</blockquote>
<p>This perceptive insight by the <a href="https://monneta.org/en/money-whence-it-came-where-it-went/">American economist J.K. Galbraith</a> in 1975 was supported some 35 years later when, along with my Goethe University students, I conducted a survey of more than 1,000 passers-by in central Frankfurt. We found that more than 80% of those interviewed believed that most of the world’s money is created and allocated by either governments or central banks. An understandable view, but wrong.</p>
<p>In fact, my <a href="https://www.sciencedirect.com/science/article/pii/S1057521914001070">empirical</a> <a href="https://www.sciencedirect.com/science/article/pii/S1057521915001477">studies</a> of our global monetary system have demonstrated that it is high-street or retail banks that produce the vast majority – around 97% – of the world’s money supply. Every time a bank grants a loan, it is creating new money that is added to the economy’s overall money supply.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Banks in a high street" src="https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=344&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=344&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=344&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=432&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=432&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513770/original/file-20230306-18-edh87x.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=432&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Retail banks currently produce the vast majority – around 97% – of the world’s money supply.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-february-2019-santander-lloyds-high-1754660432">William Barton/Shutterstock</a></span>
</figcaption>
</figure>
<p>In contrast, governments don’t create any money these days. The last time the US government issued money was in 1963, until President John F Kennedy’s assassination that year. The UK government stopped issuing money in 1927 and Germany even earlier, around 1910. Central banks, meanwhile, only create around 3% of the world’s money supply.</p>
<p>For growth to occur, more transactions need to take place this year than last. This can only happen if the supply of money available for these transactions increases – in other words, if retail banks issue more loans. If used correctly, it can be a powerful tool for increasing growth and productivity. This was the basis of <a href="https://eprints.soton.ac.uk/340476/1/Translation_Werner_QE_Nikkei_Sep_1995_final1.pdf">my proposal</a> to help <a href="https://en.wikipedia.org/wiki/Lost_Decades">Japan’s flatlining economy</a> in the 1990s, which would later become widely known as “<a href="https://www.ru.nl/publish/pages/750457/res_newsletter_werner_qe_qtc_july2013.pdf">quantitative easing</a>”, or QE.</p>
<p>However, such a strategy carries risks too – in particular, the potential for creating inflation, if this new money is used at the wrong time or for the wrong purposes.</p>
<h2>The birth of quantitative easing</h2>
<p>In 1995, while chief economist at Jardine Fleming Securities in Tokyo, I published an <a href="https://eprints.soton.ac.uk/340476/1/Translation_Werner_QE_Nikkei_Sep_1995_final1.pdf">article</a> in Japan’s leading financial newspaper, the Nikkei, entitled How to Create a Recovery through “Quantitative Monetary Easing”. It proposed a new monetary policy for the Bank of Japan that could stave off the country’s looming banking crisis and economic depression.</p>
<p>The core of the idea was increasing Japan’s total transactions in the economy by increasing the supply of money for the nation’s “<a href="https://en.wikipedia.org/wiki/Real_economy">real economy</a>”. This could be achieved by encouraging retail banks to issue more loans to companies for investment, thus stimulating economic recovery.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/p5Ac7ap_MAY?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">Feature-length film based on Richard Werner’s 2003 book, Princes of the Yen.</span></figcaption>
</figure>
<p>However, QE’s subsequent depiction as a form of “<a href="https://positivemoney.org/2013/03/our-magic-money-tree-fixing-the-financial-crisis/">magic money tree</a>” is misplaced. In my <a href="https://eprints.soton.ac.uk/36569/#:%7E:text=It%20is%20based%20on%20a,for%20all%20three%20%27anomalies%27.">1997 paper</a> and subsequent <a href="https://quantumpublishers.com/quantum_publishers_book_shop.html">book</a>, I stressed the difference between newly-created money when it is used for <a href="https://www.youtube.com/watch?v=psS9R_PsDgw">productive purposes</a> – in other words, for business investment that creates new goods and services or increases productivity – and when it is used for unproductive purposes such as <a href="https://www.investopedia.com/terms/f/financialasset.asp#:%7E:text=Investopedia%20%2F%20Mira%20Norian-,What%20Is%20a%20Financial%20Asset%3F,are%20examples%20of%20financial%20assets.">financial asset</a> and real estate transactions. These merely transfer ownership from one party to another without adding to the nation’s income.</p>
<p>If new bank credit is used for productive business investments such as loans to small firms, there will be job creation and sustainable economic growth without inflation. Furthermore, this growth – if pumped into the economy via many small retail banks to even more small firms – would have the additional benefit of leading to more equitable wealth distribution for all.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-uks-post-brexit-economy-hinges-on-small-businesses-and-innovation-80649">The UK's post-Brexit economy hinges on small businesses and innovation</a>
</strong>
</em>
</p>
<hr>
<p>By contrast, if new credit is used for unproductive purposes such as trading financial assets (including bonds, shares and futures) or real estate, this leads to <a href="https://en.wikipedia.org/wiki/Asset_price_inflation">asset price inflation</a>, a form of economic <a href="https://www.investopedia.com/terms/b/bubble.asp">bubble</a> which can trigger a <a href="https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/banking-crisis">banking crisis</a> if the boom is large enough. Similarly, if bank credit is created chiefly to support household <a href="https://www.britannica.com/topic/consumption">consumption</a>, this will inevitably result in <a href="https://data.oecd.org/price/inflation-cpi.htm">consumer price inflation</a>.</p>
<p>Unfortunately, in the UK and many other countries – especially those with only a few, very large retail banks – there has been a significant shift of bank credit away from lending for productive business investment to lending for asset purchases. As big banks want to do big deals, bank lending for asset purchases now accounts for the vast majority of lending (75% or more, according to my analysis of <a href="https://www.bankofengland.co.uk/statistics/tables">Bank of England data</a>).</p>
<p>In contrast, <a href="https://www.journals.uchicago.edu/doi/full/10.1086/690241">just before the first world war</a>, when there were many more small banks in the UK, more than 80% of bank lending was for productive business investment. This decline in bank lending for business investment has had many consequences, including falling economic growth and lower productivity in the UK. Other countries such as Germany that have maintained a system of many small, local retail banks have seen better levels of productivity as a result.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="German bank sign" src="https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513775/original/file-20230306-24-jujdtz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Germany has maintained a network of local retail banks serving small businesses.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/berlin-2022-berliner-volksbank-headquartered-largest-2168694789">Mo Photography Berlin/Shutterstock</a></span>
</figcaption>
</figure>
<p>Returning to the situation in Japan, having initially resisted my proposal, in March 2001 the Bank of Japan announced the introduction of the world’s first programme of QE. Unfortunately, it did not follow the policy I had recommended. Its approach – buying <a href="https://www.investopedia.com/terms/a/assetperformance.asp">well-performing assets</a> such as government bonds from retail banks – had no effect on the Japanese economy, because it did not improve retail banks’ willingness to lend to businesses. In other words, no new money was being created for productive purposes.</p>
<p>Nonetheless, over the two decades since, QE has become a monetary policy beloved of central banks across the world as they have sought to keep their economies looking strong in the face of serious economic challenges. The next major global test of this policy was the 2007-08 <a href="https://en.wikipedia.org/wiki/2007%E2%80%932008_financial_crisis">global financial crisis</a> and associated “<a href="https://en.wikipedia.org/wiki/Great_Recession">Great Recession</a>”.</p>
<h2>How the Fed tackled the 2008 financial crisis</h2>
<p>The Great Recession began with the freezing of the <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2374%7E1f36c32e02.en.pdf">interbank market</a>, as overextended retail banks (following years of lax oversight of their property lending) became doubtful about each other’s solvency. This was exacerbated by the <a href="https://escholarship.org/content/qt0hm9s8hk/qt0hm9s8hk_noSplash_22d8fefe65e52761c5bf56d88083e961.pdf?t=qp9dut">decision of the Fed</a> in September 2008 not to rescue or merge Lehman Brothers, but instead let it go <a href="https://www.theguardian.com/business/2008/sep/15/lehmanbrothers.creditcrunch">bankrupt</a>. The resulting, dramatic <a href="https://www.hbs.edu/ris/Publication%20Files/Bank%20LendingDuring%20The%20Financial%20Crisis%202008_423edf8e-e0ff-4791-8018-eb5287c5d12d.pdf">collapse in US retail bank lending</a> (the grey line in Figure 2) ensured that the US <a href="https://en.wikipedia.org/wiki/2000s_United_States_housing_bubble">housing bubble</a> burst, causing economic shockwaves across the world.</p>
<p><strong>Figure 2: credit creation by Fed and US retail banks, 1974-2023</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=359&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=359&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=359&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=451&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=451&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513681/original/file-20230306-14-j6yfmx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=451&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>The freezing of the interbank market threatened the world’s banking system and demanded urgent action by the Fed and other central banks. In response, the Fed – under its then-chairman Ben Bernanke, who had previously been involved in the discussions on how to revive the flagging Japanese economy in the 1990s – partly <a href="https://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm">adopted the “true” type of QE</a> that I had earlier proposed for Japan. This meant it took around 18 months for US retail banks to boost their lending again, causing a recovery after a further six months.</p>
<p>The Fed’s version of QE was to follow my recommendation to purchase <a href="https://www.investopedia.com/terms/n/nonperformingasset.asp#:%7E:text=A%20nonperforming%20asset%20(NPA)%20is,the%20form%20of%20interest%20payments.">non-performing assets</a> from banks – in other words, it purchased their bad debts, thus cleaning up their balance sheets. This did not inject any new money into the US economy and so did not create inflationary pressures. But it helped the retail banks – <a href="https://www.investopedia.com/insights/too-big-fail-banks-where-are-they-now/">those that had not failed</a>, at least – get off their knees and be ready to do normal business again, thus ending the credit crunch after the surge in defaulted loans.</p>
<p>As a result, US retail banks were issuing new loans by 2010 – earlier than in other countries where central banks did not adopt this strategy, but instead copied the failed Bank of Japan version of QE. We can see this in Figure 2, above, in the surge of the blue line (the Fed Leading Liquidity Index) in 2009, and the subsequent recovery of the grey line (retail bank loans) in 2010, thanks to which the US recovered first among major economies from the 2008 crisis.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513731/original/file-20230306-24-rigef9.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Outgoing Federal Reserve chairman Ben Bernanke at his final board meeting in January 2014.</span>
<span class="attribution"><a class="source" href="https://upload.wikimedia.org/wikipedia/commons/8/86/CB_VCY_board_ovation_112714_4995_%2812241510475%29.jpg">Federal Reserve/Wikimedia</a></span>
</figcaption>
</figure>
<p>When banking experts surveyed this vast QE programme undertaken by the Fed in late 2008 and subsequently, many feared it would lead to the return of inflation. It did not – principally because retail bank credit creation had contracted hugely as the interbank market had imploded (the grey line in Figure 2), and because the Fed adopted the aspect of QE that did not increase the money supply via new bank loans.</p>
<p>So, the Fed’s use of QE to bring the US economy “back to life” was regarded as a <a href="https://www.thebalancemoney.com/what-is-qe1-3305530">relative success</a>. Instead, the global media reserved most of its criticism on the damage done to economies by <a href="https://www.business-standard.com/article/markets/financial-crisis-explained-how-greedy-us-banks-crippled-world-economy-118090500388_1.html">“greedy” retail banks</a>.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/ecb-is-about-to-implement-the-wrong-type-of-quantitative-easing-36543">ECB is about to implement the wrong type of quantitative easing</a>
</strong>
</em>
</p>
<hr>
<p>This meant that quietly, following this global financial disaster, the central banks were able to further increase their powers again, in the name of greater scrutiny of the financial sector. The <a href="https://en.wikipedia.org/wiki/European_Central_Bank#:%7E:text=The%20ECB%20Executive%20Board%20enforces,approved%20by%20the%20ECB%20beforehand.">European Central Bank</a> was particularly successful in expanding its powers over the following decade.</p>
<p>At the same time, QE was seen by some as an apparent “miracle cure” for future financial crises. This came to a head in March 2020, when the central bankers began a programme of QE that is at the root of many of our current economic and societal difficulties.</p>
<h2>The real cause of our current inflationary crisis</h2>
<p>In May 2020, as I conducted my latest monthly analysis of the quantity of credit creation across 40 countries, I was startled to find that something extraordinary had been happening since March that year. The major central banks across the globe were boosting the money supply dramatically through a coordinated programme of QE.</p>
<p>This was the version of QE that I had recommended as the second policy step in Japan in the 1990s – namely, for the central bank to purchase assets from outside the banking sector. As these payments forced retail banks to create new credit in a massive burst of money supply not previously seen in the post-war era, firms and non-bank financial institutions that had sold to the Fed gained new purchasing power as a result.</p>
<p>Even the Bank of Japan, having previously argued for two decades that it could not possibly purchase assets from anyone other than banks, suddenly engaged in this unusual operation at the same time as other central banks, and on a massive scale.</p>
<p>The reasons for this coordinated policy are not immediately apparent, although there is some evidence that it was sparked by a proposal presented to central bankers by the multinational investment company <a href="https://www.blackrock.com/corporate/where-we-stand">Blackrock</a> at the <a href="https://www.kansascityfed.org/research/jackson-hole-economic-symposium/">annual meeting</a> of central bankers and other financial decision-makers in Jackson Hole, Wyoming in August 2019. Soon after this, difficulties in the Fed’s <a href="https://www.sifma.org/resources/research/us-repo-market-chart-book/#:%7E:text=The%20repo%20market%20enables%20market,than%20general%20balance%20sheet%20funding.">repurchase agreement (“repo”) market</a> in September 2019, <a href="https://riskyfinance.com/2019/12/17/how-jp-morgan-broke-the-repo-market/">triggered by private banking giant JP Morgan</a>, may have made up their minds.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="US company sign with two American flags" src="https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=318&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=318&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=318&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=400&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=400&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513781/original/file-20230306-1354-5w57bo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=400&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Global investment firm BlackRock’s New York headquarters.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/new-york-ny-usa-july-5-2231941451">Tada Images/Shutterstock</a></span>
</figcaption>
</figure>
<p>Apparently agreeing with my critique that pure fiscal policy does not result in economic growth <a href="https://www.sciencedirect.com/science/article/pii/S0261560614001132">unless it is backed by credit creation</a>, Blackrock had <a href="https://www.blackrock.com/corporate/literature/whitepaper/bii-macro-perspectives-august-2019.pdf">argued</a> at Jackson Hole that the “next downturn” would require central banks to create new money and find “ways to get central bank money directly in the hands of public and private sector spenders” – what they called “going direct”, bypassing the retail banks. The Fed knew this would create inflation, as Blackrock later confirmed in a <a href="https://www.blackrock.com/corporate/literature/whitepaper/bii-macro-perspectives-september-2020.pdf">paper which stated</a> that “the Fed is now committing to push inflation above target for some time”.</p>
<p>This is precisely what was implemented in March 2020. We know this both from <a href="https://fred.stlouisfed.org/series/DPSACBW027SBOG">available data</a> and because the Fed, largely without precedent, hired a private-sector firm to help it buy assets – <a href="https://www.nytimes.com/2020/03/27/business/coronavirus-blackrock-federal-reserve.html">none other than Blackrock</a>.</p>
<p>Having “cried wolf” about the inflationary risk of introducing QE in 2008, and following more than a decade of resolutely low global inflation, many banking and economic experts thought the Fed’s and other central banks’ similarly aggressive credit creation policy in 2020 would not be inflationary, again.</p>
<p>However, this time the economic conditions were very different – there had been no recent slump in the supply of money via retail bank loans. Also, the policy differed in a crucial aspect: by “going direct”, the Fed was itself now massively expanding credit creation, the money supply and new spending.</p>
<p>Meanwhile the COVID measures imposed by governments also focused on bank credit creation. In parallel with unprecedented societal and business lockdowns, retail banks were instructed to increase lending to businesses with governments guaranteeing these loans. Stimulus checks were paid out to furloughed workers, and both central banks and retail banks also stepped up purchases of government bonds. So both central and commercial banks added to the supply of money, with much of it being used for general consumption rather than productive purposes (loans to businesses).</p>
<p>As a result, the money supply ballooned by record amounts. The US’s <a href="https://data.oecd.org/money/broad-money-m3.htm#:%7E:text=Broad%20money%20(M3)-,Broad%20money%20(M3)%20includes%20currency%2C%20deposits%20with%20an%20agreed,index%20based%20on%202015%3D100.">“broad” money supply metric, M3</a>, increased by 19.1% in 2020, the highest annual rise on record. In the eurozone, money supply <a href="https://www.ecb.europa.eu/press/pr/stats/md/html/ecb.md2012%7Ecbd6f9f354.en.html">M1 grew by 15.6%</a> in December 2020. </p>
<p>All of this boosted demand, while at the same time the supply of goods and services was limited by pandemic restrictions that immobilised people and shut down many small firms and affected some supply chains. It was a perfect recipe for inflation – and significant consumer price inflation duly followed around 18 months later, in late 2021 and 2022.</p>
<p>While it was certainly exacerbated by the COVID restrictions, it had nothing to do with Russian military actions or sanctions on Russian energy – and a lot to do with the central banks’ misuse of QE. I believe the high degree of coordination of the central banks in adopting this QE strategy, and the empirical link with our current period of inflation, means their policies should be given more of a public airing. But the subsequent war has muddied the waters and deflected from important underlying questions.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="National debt counter sign in bus stop" src="https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=405&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=405&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=405&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=508&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=508&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513772/original/file-20230306-26-o2dfqp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=508&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Total US national debt displayed at a Washington DC bus shelter in September 2022.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/washington-dc-sept-8-2022-amount-2214425363">Rosemarie Mosteller/Shutterstock</a></span>
</figcaption>
</figure>
<p>For example, critics of the unprecedented levels of national debt in the world – with the US alone now owing more than <a href="https://www.usdebtclock.org/">US$31 trillion</a> – have long been warning that the likely way out for countries that have become “addicted to easy money” is an inflationary road that silently <a href="https://www.npr.org/2022/05/13/1098865220/could-inflation-be-a-good-thing-for-governments-in-debt">erodes the value of this debt</a>. But at what cost for the general public?</p>
<p>Meanwhile, the concentration of powers among central banks and a few favoured advisers, such as Blackrock, has led to <a href="https://insights.som.yale.edu/insights/are-we-asking-too-much-of-central-banks">widespread</a> <a href="https://knowledge.wharton.upenn.edu/podcast/knowledge-at-wharton-podcast/post-crisis-do-central-banks-wield-too-much-power/">questions</a> about the way the global economy is controlled by a few key figures. And the recent emergence of a new form of digital currency is another potentially significant chapter in this story of central bank dominance.</p>
<h2>A new tool to increase central bank control?</h2>
<p>At the same time as the UK government imposed the first lockdown in March 2020, the Bank of England (BoE) issued its <a href="https://www.bankofengland.co.uk/-/media/boe/files/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design.pdf">first major discussion paper</a> (and held a <a href="https://www.youtube.com/watch?v=EM7NB1_NtC4">first public seminar</a>) about its perceived need to introduce a central bank digital currency. (It is noticeable how many central banks seemed spurred on in their plans for digital currencies by the COVID <a href="https://theippo.co.uk/health-certificates-covid-19-global-review-research-evidence-implies-for-uk-vaccine-passport-policies/">digital vaccination passport</a> concepts that were advanced during the pandemic.)</p>
<p>Three years later and the BoE has published a <a href="https://www.bankofengland.co.uk/paper/2023/the-digital-pound-consultation-paper">consultation paper</a> in conjunction with the UK Treasury that sets out “the case for a retail central bank digital currency”. The paper explained that:</p>
<blockquote>
<p>The digital pound would be a new form of sterling … issued by the Bank of England. It would be used by households and businesses for their everyday payments needs. It would be used in-store, online and to make payments to family and friends.</p>
</blockquote>
<p>While the consultation lasts until June 7 2023, we are already being informed that a state-backed UK digital pound is likely to be launched “<a href="https://www.bbc.co.uk/news/technology-64536593">later this decade</a>” – possibly as soon as 2025.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/Ma56EQoocgw?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">Bank of England video introducing its central bank digital currency concept.</span></figcaption>
</figure>
<p>In fact, digital currencies have been used for decades - the bank type. However, as the name suggests, a <a href="https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp">central bank digital currency</a> (CBDC) – if widely adopted – would shift control of our money supply irrevocably away from the decentralised system we have, based on retail banks, in favour of the central banks.</p>
<p>In other words, the “umpires of the game” are preparing to step into the arena and offer current accounts to the general public, competing directly against the retail banks they are supposed to regulate – a clear conflict of interest. From the <a href="https://www.investopedia.com/us-cbdc-6740586">US</a> to <a href="https://www.boj.or.jp/en/paym/digital/dig230217b.pdf">Japan</a>, central banks – already more powerful and independent than ever before – have expressed their desire to create and control their own CBDCs, potentially using technology similar to cryptocurrencies such as Bitcoin. In my view, this poses many risks for the way economies and societies function.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-a-digital-pound-could-work-alongside-cryptocurrencies-199462">How a digital pound could work alongside cryptocurrencies</a>
</strong>
</em>
</p>
<hr>
<p>Unlike the unregulated cryptocurrencies, CBDCs would come with the full backing and authority of the central banks. In any future financial crisis, retail banks could struggle to withstand this unfair competition, with customers shifting their deposits to CBDCs thanks to their central bank and government support.</p>
<p>The conflict of interest is compounded as central banks set the policies that can make or break retail banks (see the recent <a href="https://theconversation.com/why-svb-and-signature-bank-failed-so-fast-and-the-us-banking-crisis-isnt-over-yet-201737">failures</a> of SVB and Signature Bank). Added to this, central banks seem to be favourably inclined towards <a href="https://www.france24.com/en/20101110-g20-summit-gsifis-list-20-too-big-to-fail-banks-finance">big bank</a> <a href="https://www.sciencedirect.com/science/article/abs/pii/S0304405X19302247">bailouts</a>, while small banks are seen as dispensable.</p>
<p>Some countries – perhaps even the eurozone – could be left with a Soviet-style monobank system, where the only bank in town is the central bank. This would be disastrous: the useful functions of retail banks are to create the money supply and allocate it efficiently via thousands of loan officers on the ground across the country.</p>
<p>This form of productive business investment, which creates non-inflationary growth and jobs, is best achieved via <a href="https://www.emerald.com/insight/content/doi/10.1108/ER-03-2020-0141/full/html">lending to small and medium-sized enterprises</a> (SMEs). Neither central banks nor cryptocurrencies fulfil these decentralised but crucial functions that are at the core of successful capitalism, from the US and Germany to Japan and China.</p>
<p>But the further concentration of powers into the hands of the central banks is not the only danger posed by CBDCs. Their biggest attraction for the central planners is that they facilitate “<a href="https://sites.duke.edu/thefinregblog/2021/09/21/cbdc-how-dangerous-is-programmability/">programmability</a>” – in other words, control over how an individual is permitted to use that currency. As Agustin Carstens, general manager of the <a href="https://en.wikipedia.org/wiki/Bank_for_International_Settlements">Bank for International Settlements</a> (which is owned by the central banks), <a href="https://www.youtube.com/watch?v=rpNnTuK5JJU">explained</a> in 2021:</p>
<blockquote>
<p>A key difference with the CBDC is that the central bank will have absolute control on the rules and regulations that will determine the use of that expression of central bank liability. And also, we will have the technology to enforce that.</p>
</blockquote>
<p>Critics of a central bank might suddenly find they are not allowed to pay for anything any longer – in a manner reminiscent of the way that protesting Canadian truckers were <a href="https://www.npr.org/2022/02/10/1080022827/a-canadian-judge-has-frozen-access-to-donations-for-the-trucker-convoy-protest">frozen out of their funds</a> by the Canadian government in February 2022.</p>
<p>Additionally, central planners could theoretically restrict purchases to a limited geographical area, or to only the “right” items in the eyes of the authorities, or only in limited amounts – for example, until you have used up your “carbon credit” budget. The much discussed idea of a “<a href="https://eppi.ioe.ac.uk/cms/Default.aspx?tabid=3856">universal basic income</a>” could serve as the carrot for people to accept a central electronic currency that could enact a Chinese-style social credit system and even, in the future, exist in the form of an <a href="https://www.npr.org/2018/10/22/658808705/thousands-of-swedes-are-inserting-microchips-under-their-skin">electronic implant</a>.</p>
<p>In contrast, no such control is possible with old-fashioned cash – now recognised by many as a <a href="https://campaigns.which.co.uk/freedom-to-pay/">beacon of freedom</a>. </p>
<h2>Why we should resist bank centralisation</h2>
<p>For those who think I am being alarmist, do these possibilities seem so far-fetched if we think about some parts of present-day China, for example?</p>
<p>But it is also worth noting that China’s recent history is not one of unwavering centralisation – at least in economic terms. When Deng Xiaoping became its paramount leader in December 1978, he recognised that the centralisation of banking under a Soviet-style monobank was holding back the country’s economic growth.</p>
<p>Deng quickly switched to decentralisation by creating thousands of commercial banks over the following years – mostly small local banks that would lend to small firms, creating jobs and ensuring high productivity. This allowed the creation of 40 years of double-digit economic growth, lifting more people out of poverty than ever before.</p>
<p>By contrast, the UK used to have <a href="https://en.wikipedia.org/wiki/Category:Defunct_banks_of_the_United_Kingdom">hundreds of county and country banks</a>, but they were all bought up by the major retail banks such that a century ago, the <a href="https://academic.oup.com/book/32839/chapter-abstract/275390111?redirectedFrom=fulltext">“Big Five” banks</a> had become dominant – and have largely remained so ever since. Over recent decades, these banks have been quick to close local branches.</p>
<p>The European Central Bank, meanwhile, has declared it wants to reduce the <a href="https://www.statista.com/statistics/940867/number-of-banks-in-europe-by-country/">number of retail banks</a> – to date, 5,000 have disappeared under its watch. And in the US, some 10,000 banks have disappeared since the 1970s. It is the small banks that disappear.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Sign in window of bank branch that is due to close" src="https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/513784/original/file-20230306-18-e981yh.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The UK’s retail bank chains have closed many high-street branches in recent decades.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/sign-high-street-shop-window-this-2086975036">William Barton/Shutterstock</a></span>
</figcaption>
</figure>
<p>Our empirical study of the US banking sector showed that big banks <a href="https://www.sciencedirect.com/science/article/pii/S0261560620302370">don’t want to lend to small firms</a>. However, <a href="https://www.oecd.org/cfe/smes/2090740.pdf">most employment in the economy</a> is with SMEs, which our study suggests will only thrive if we have a decentralised banking system with many small, local banks.</p>
<p>In Germany, these local community banks have survived for more than 200 years because they use the <a href="https://en.wikipedia.org/wiki/List_of_co-operative_banks_in_Germany#:%7E:text=German%20co%2Doperative%20banks%20are,compliance%20with%20German%20banking%20law.">co-operative voting system</a> of one shareholder one vote. That system of “economic democracy” prevents takeovers and hence explains why the German SMEs are by far the most successful in the world, contributing significantly to exports and Germany’s high productivity.</p>
<p>The absence of local banks in the UK should be a key part of any explanation of the nation’s “<a href="https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/labourproductivity/articles/whatistheproductivitypuzzle/2015-07-07">productivity puzzle</a>”, although talking about it is not encouraged by the big bank cartel known as the City of London. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/funding-devolution-lessons-from-germany-the-us-and-the-industrial-revolution-64458">Funding devolution: lessons from Germany, the US and the industrial revolution</a>
</strong>
</em>
</p>
<hr>
<p>In my view, it is time to re-introduce local banks in the UK. This will help us build a more decentralised banking system, and hence keep at bay the dangers of excessive centralisation of the economy, including from CBDCs. For this purpose, I established the social enterprise <a href="https://www.youtube.com/watch?v=rXtO3NRkHu8">Local First CIC</a>, which has helped found the budding <a href="https://hampshirebank.org/about/">Hampshire Community Bank</a> as a prototype.</p>
<p>The key focus of this bank is to help small firms in Hampshire, with all loan decisions being made on the ground by people in Hampshire, deposits being used to fund productive local lending, and most profits being returned to the people of Hampshire.</p>
<p>But wherever you live and whoever you bank with, I believe it is important that we resist the introduction of CBDCs, use cash as much as possible, and support our local small shops and local banks. Where there are no longer local banks, we should get together and establish new ones.</p>
<p>CBDCs are not a solution to a problem, but the latest goal in the multi-decade struggle by central planners for maximum powers – at the unnecessary cost of crises, inflation, economic dislocation and unemployment.</p>
<hr>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=112&fit=crop&dpr=1 600w, https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=112&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=112&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=140&fit=crop&dpr=1 754w, https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=140&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/313478/original/file-20200204-41481-1n8vco4.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=140&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p class="fine-print"><em><span>Richard Werner is affiliated with Local First Community Interest Company and the Hampshire Community Bank (in the process of obtaining bank authorisation).</span></em></p>The collapse of a US bank is the latest crisis for central banks to deal with. But rather than being saviours of the global economy, what if they are actually a big part of the problem?Richard Werner, Professor of banking and economics, University of WinchesterLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2016972023-03-13T15:58:46Z2023-03-13T15:58:46ZSilicon Valley Bank: how interest rates helped trigger its collapse and what central bankers should do next<p>A former prime minister of Britain, Harold Wilson, is famous for remarking that <a href="https://en.wiktionary.org/wiki/a_week_is_a_long_time_in_politics">a week is a long time in politics</a>. But in the world of finance, it seems everything can change in just two days. </p>
<p>Only 48 hours elapsed between <a href="https://ir.svb.com/news-and-research/news/news-details/2023/SVB-Financial-Group-Announces-Proposed-Offerings-of-Common-Stock-and-Mandatory-Convertible-Preferred-Stock/default.aspx">a statement from US-based Silicon Valley Bank (SVB)</a> on March 8 that it was seeking to raise US$2.5 billion (£2 billion) to repair a hole in its balance sheet, and the announcement by US regulator the Federal Deposit Insurance Corporation that <a href="https://www.fdic.gov/news/press-releases/2023/pr23016.html">the bank had collapsed</a>. </p>
<p>At its peak in 2021, <a href="https://www.ft.com/content/f55df9d1-386a-4643-8194-095228741054">SVB was worth US$44 billion</a> and managed over $200 billion in assets. America’s 16th largest deposit-taking institution just a week ago, it has now become the second biggest banking failure in US history. Only <a href="https://www.reuters.com/article/us-washingtonmutual-jpmorgannews1-idUSTRE48P05I20080926">the collapse of Washington Mutual</a> during the 2008 global financial crisis was larger.</p>
<p>Although SVB had been ailing for some time, the speed of its collapse took nearly all commentators – as well as its customers, mostly from the tech sector – by surprise. Tech firms around the world have their cash locked up in SVB deposits and were concerned about how they would pay their workers and their bills until <a href="https://www.cbsnews.com/sanfrancisco/news/us-government-moves-guarantee-silicon-valley-bank-depositors-funds/">government support was announced in the US</a>, alongside <a href="https://www.bbc.co.uk/news/business-64937251">HSBC’s deal to buy SVB’s UK arm</a>. </p>
<p>And it looks like the run on SVB that heralded its collapse – by some metrics the fastest in history – is spreading to other institutions with similar characteristics. On March 12, two days after SVB’s collapse, regulators in New York closed Signature Bank, <a href="https://www.fdic.gov/news/press-releases/2023/pr23018.html">citing systemic risk</a>.</p>
<p>But was what happened to SVB unpredictable, unpreventable and unavoidable? My research suggests not. My latest <a href="https://link.springer.com/book/10.1007/978-3-031-11914-9">book about the history of financial crises</a>, Calming the Storms: the Carry Trade, the Banking School and British Financial Crises Since 1825, was coincidentally launched the day before SVB failed and describes three situations in which a banking crisis may unfold.</p>
<h2>Why SVB collapsed</h2>
<p>One potential cause is when changes in interest rates between countries cause movements in capital flows to suddenly start or stop as investors chase better rates. This affects the availability of finance. This is what happened during the 2007 credit crunch that preceded the global financial crisis, but it wasn’t behind SVB’s collapse.</p>
<p>SVB’s failure does tie in with the other two situations I describe in my book. </p>
<p>The first is when interest rates rise rapidly. The cause may be a central bank reacting to <a href="https://www.bbc.co.uk/news/business-64639662">a surge of inflation</a>, a <a href="https://theconversation.com/how-the-war-in-ukraine-will-affect-food-prices-178693">war</a> or a <a href="https://www.aljazeera.com/economy/2023/1/4/us-labour-market-remains-tight-manufacturing-slows-down">tight labour market</a>. Indeed, the Federal Reserve, alongside other central banks, has <a href="https://www.cnbc.com/2023/03/07/fed-chair-powell-says-interest-rates-are-likely-to-be-higher-than-previously-anticipated.html">raised rates</a> from a band of 0.25%-0.5% to 4.5%-4.75% over the past 12 months. </p>
<p>Higher rates tighten credit conditions. This makes it harder for financial institutions to finance themselves, while also damaging the value of their existing loans and assets. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/inflation-unemployment-the-housing-crisis-and-a-possible-recession-two-economists-forecast-whats-ahead-in-2023-195797">Inflation, unemployment, the housing crisis and a possible recession: Two economists forecast what's ahead in 2023</a>
</strong>
</em>
</p>
<hr>
<p>The second is when short-term interest rates rise above long-term rates, as has happened in America over the past few months. During the pandemic, tech startups with spare cash from funding rounds in a world of easy money placed their deposits with SVB. With little demand for loans from this sector, SVB invested most of the money in long-term bonds – mostly mortgage-backed securities and US Treasuries. </p>
<p>In short, SVB was taking funds mainly on short-term deposit and tying them up in long-term investments. Then, over the past few months, short-term rates rose higher than the returns on longer-dated bonds (see chart below). This is because interest rates were soaring, thanks to the Fed’s rate hikes. </p>
<p><strong>US interest rate changes</strong></p>
<figure class="align-center ">
<img alt="Line graph showing long- and short-term US interest rates rising over time, with short overtaking long in 2022." src="https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=296&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=296&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=296&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=373&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=373&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514888/original/file-20230313-24-4ci4jq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=373&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.oecd-ilibrary.org/finance-and-investment/interest-rates/indicator-group/english_86b91cb3-en">Author provided from OECD data</a></span>
</figcaption>
</figure>
<p>With funding rounds harder to come by in a high-interest rate environment, tech firms began to withdraw and spend their deposits. At the same time, these higher rates resulted in falling prices for the bonds in which SVB had been investing. That squeezed SVB’s profit margins and put its balance sheet on shaky ground. </p>
<p>This situation was made worse because SVB needed to sell some of its longer-dated bonds at a loss to fund the deposits its customers were withdrawing from the bank. The news of the sales made depositors withdraw more funds, which had to be funded through more sales. A doom loop ensued. </p>
<p>The March 8 announcement that SVB was looking to raise US$2.5 billion to plug the hole in its balance sheet left by these asset fire sales triggered the bank run that finished it off.</p>
<h2>Concerns about systemic risk</h2>
<p>How worried should we be about the collapse of SVB? It is not a major player in the world’s financial system. It is also almost unique in modern banking in terms of its <a href="https://www.theguardian.com/business/2023/mar/12/why-silicon-valley-bank-was-so-important-to-uk-tech-sector">dependence on one sector</a> for its client base and the vulnerability of its balance sheet to interest rate rises.</p>
<p>But even if SVB’s collapse does not trigger a wider financial crisis, it should serve as an important warning. Rapidly rising interest rates over the past year <a href="https://theconversation.com/autumn-statement-2022-this-budget-may-not-cause-truss-level-chaos-but-it-could-still-provoke-markets-192903">have made the global economy fragile</a>. </p>
<p>The world’s central bankers are treading a narrowing path of trying to combat inflation without harming financial stability. Central bankers must manage interest rates more carefully, while regulators should discourage the finance sector from borrowing short to lend long without sufficient hedging of the risks this entails. </p>
<p>It is also important that central banks monitor the impact that interest rate differences and cross-border capital flows have on the credit that’s available to both banks and businesses. Even if the failures of SVB and Signature prove to be no more than “little local difficulties” (<a href="https://www.oxfordreference.com/display/10.1093/acref/9780191843730.001.0001/q-oro-ed5-00006970;jsessionid=A529BB39C9A6DDF89D7664AB3AAB4EB0#:%7E:text=little%20local%20difficulties">to quote another past UK prime minister, Harold Macmillan</a>), the systemic risks that their collapse have highlighted can no longer be ignored.</p><img src="https://counter.theconversation.com/content/201697/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Charles Read's research is funded by a British Academy postdoctoral fellowship grant.</span></em></p>The speed of SVB’s collapse was a surprise but central bankers can learn lessons from this failure.Charles Read, Fellow in Economics and History at Corpus Christi College, University of CambridgeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2015772023-03-10T16:21:08Z2023-03-10T16:21:08ZAre interest rates really going to keep rising sharply?<p>For anyone trying to understand where interest rates and inflation are heading, it has been a strenuous few days. <a href="https://www.aljazeera.com/economy/2023/3/7/us-feds-powell-opens-door-to-higher-faster-interest-rate-hikes">Jay Powell</a>, chairman of US central bank the Federal Reserve, warned senators he may have to do more to fight inflation than expected, indicating the prospect of interest rates rising more sharply again. Similarly Christine Lagarde, his counterpart at the European Central Bank (ECB), <a href="https://www.ft.com/content/83d44991-4988-4e4f-8143-81d34b2b4173">has said</a> that the eurozone is far from ready to declare victory over inflation. </p>
<p>But just as borrowing costs look set for uncomfortable new highs, there were signs of further complications in the form of a <a href="https://www.ft.com/content/47e3d4a7-70b6-4a4e-98b0-6322f8e8ba53">nasty sell-off</a> of US banking stocks amid fears that rising interest rates are damaging their balance sheets. This <a href="https://www.ft.com/content/82b70f3e-092f-449f-b32d-38b3dc66edaa">then dragged down</a> markets in Europe and Asia. </p>
<p>So where are we likely to be heading from here?</p>
<h2>The core inflation problem</h2>
<p>The world’s major economies have been fighting steep inflation for nearly two years now. After many years of prices only rising very slowly, annual inflation shot into double digits in many economies in 2022. This was thanks to supply chain disruptions in response to COVID-19 and the war in Ukraine, which drove up energy and food prices. </p>
<p>The ECB, Fed, Bank of England (BoE) and other central banks raised interest rates aggressively to try and bring inflation back within their 2% targets. The UK and US have raised their benchmark rates from near zero a year ago to 4% and 4.5% respectively, while the equivalent ECB rate is up to 2.5%. This has had a marked effect on banks’ lending rates, as anyone trying to borrow money in recent months will be well aware. </p>
<p><strong>UK, US and Eurozone interest rates</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing interest rate rises in UK, US and eurozone" src="https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=351&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=351&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=351&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=441&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=441&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514679/original/file-20230310-14-f094r.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=441&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Blue = US, yellow = UK, cyan = eurozone.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p>Until recently, it seemed likely that these rate rises were topping out because inflation had peaked. Headline inflation in the US <a href="https://www.theguardian.com/business/2023/feb/14/us-inflation-eases-seventh-consecutive-month">fell from</a> 9.1% in June to 6.4% by January partly thanks to easing food price pressures. This prompted the Fed to raise its benchmark interest rate by <a href="https://www.ft.com/content/b6ef76c6-b738-4006-8bcf-b2ff794d26d6">only 0.25 points</a> in February, having been raising it in increments of 0.75 points only a couple of months earlier. </p>
<p>In <a href="https://tradingeconomics.com/euro-area/inflation-cpi">the eurozone</a> and <a href="https://tradingeconomics.com/united-kingdom/inflation-cpi">UK</a>, inflation has been moving in the same direction, with decelerating energy prices particularly benefiting Europe, though it has still been judged high enough in both areas to warrant monthly rises of 0.5 points. Overall, however, it suggested that central banks were on target to get back to 2% in the coming year or so.</p>
<p><strong>Inflation rates in US, UK and eurozone</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing inflation rates in US, EU and UK" src="https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=349&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=349&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=349&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=439&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=439&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514677/original/file-20230310-14-21ks2b.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=439&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Blue = US, yellow = UK, cyan = eurozone.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p>Yet it may have been too soon to breathe a sigh of relief. While the most recent monthly inflation numbers were still ticking downwards, it turned out to be a different story with core inflation. This closely watched measure strips out volatile items such as food and energy to give a clearer sense of price behaviour across the economy. </p>
<p><a href="https://www.reuters.com/business/retail-consumer/view-euro-zone-core-inflation-surges-feb-keeps-euro-near-one-week-highs-2023-03-02/">In the eurozone</a> core inflation rose from 5.3% in January to 5.6% in February, while <a href="https://www.ubs.com/global/en/wealth-management/our-approach/marketnews/article.1586848.html">in the US</a> it went from 4.6% in December to 4.7% in January. Both of the most recent numbers were above what the markets had been expecting. <a href="https://www.ft.com/content/b03d237e-89ec-4bd7-96b7-71800a16d040">Only the UK’s</a> most recent core inflation has been below expectations, though at 5.8% it’s still much higher than the Bank of England would like. </p>
<p><strong>UK inflation vs core inflation</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing UK headline and core inflation rates" src="https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=347&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=347&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=347&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=436&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=436&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514678/original/file-20230310-457-hghv31.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=436&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Blue = headline inflation, red = core inflation.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p>The reason why core inflation is staying raised could be linked to the fact that <a href="https://www.ft.com/content/0097fbd7-96ae-4a75-876d-8df4d4379651">unemployment is so low</a>. In the <a href="https://www.ft.com/content/7475d8a8-f26d-4764-8107-c092b6b709cf">eurozone’s services sector</a>, for example, we’ve been seeing rising wages as companies compete to pay for workers. Another factor has been companies raising their prices more quickly than usual to maintain their profit margins. </p>
<h2>What it means</h2>
<p>As most consumers will know only too well by now, raised inflation erodes your living standards. It means that people can buy fewer items with the same amount of money, making weekly shopping increasingly stressful. </p>
<p>As Powell and Lagarde have been signalling, the latest inflation data point to a need for further aggressive interest rate rises to come. The ECB is due to make its next decision on rates on March 16, with the Fed and BoE meeting the week after. Lagarde has <a href="https://www.ft.com/content/83d44991-4988-4e4f-8143-81d34b2b4173">already said</a> it is “very, very likely” that the eurozone’s rate will rise by another 0.5 percentage points, while the <a href="https://www.cnbc.com/2023/03/09/powell-changed-everything-this-week-on-markets-view-of-interest-rates.html">market expects</a> a similar rise from the US. </p>
<p>The effects are simple: the higher interest rates, the more borrowers need to pay back. Mortgage holders with tracker mortgages or whose fixed deals are coming to an end will be paying more. There is the consolation that people will be paid more on their savings accounts, though there can be a lag. </p>
<p>The <a href="https://www.ft.com/content/4a97448f-2136-403f-9f58-0b7b093d6804">most recent data</a> is the latest US jobs figures (known as non-farm payrolls), which point to a slight decline in the unemployment rate from 3.5% in December to 3.4% in January. This would normally be good news but lower unemployment and increases in monthly salaries are providing the cushion for consumers to spend more in response to rising prices, which is of course adding to the problem. </p>
<p>On the other hand, bank stocks are selling off because the markets worry that banks’ financial positions are being compromised by the effect of rising rates on their vast bondholdings: the higher the rates, the lower the value of bonds. This is potentially a concern, but at least for now it’s probably not going to change the direction of travel. </p>
<p>Until core inflation is definitely under control, borrowing costs are going to rise more sharply than everyone was hoping. All eyes will be on the US inflation data in the coming days to see if there is any reason to change course.</p><img src="https://counter.theconversation.com/content/201577/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Supriya Kapoor does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central banks have been signalling that rate rises are going to get more aggressive again, but can the economy actually take it?Supriya Kapoor, Assistant Professor of Finance, Trinity College DublinLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1975182023-01-25T17:10:22Z2023-01-25T17:10:22ZInterest rate hikes: The Bank of Canada’s ‘resolute’ fight against inflation could threaten its credibility<figure><img src="https://images.theconversation.com/files/506473/original/file-20230125-22-dg8nu.JPG?ixlib=rb-1.1.0&rect=263%2C263%2C7963%2C5175&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Tiff Macklem, Governor of the Bank of Canada, holds a press conference at the Bank of Canada in Ottawa on Jan. 25, 2023.</span> <span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span></figcaption></figure><iframe style="width: 100%; height: 100px; border: none; position: relative; z-index: 1;" allowtransparency="" allow="clipboard-read; clipboard-write" src="https://narrations.ad-auris.com/widget/the-conversation-canada/interest-rate-hikes--the-bank-of-canada-s--resolute--fight-against-inflation-could-threaten-its-credibility" width="100%" height="400"></iframe>
<p>The <a href="https://www.bankofcanada.ca/2022/12/putting-resolute-resolutions-looking-ahead-lower-inflation/">Bank of Canada “resolutely” declared</a> it will fight inflation by raising interest rates. To demonstrate its unwavering commitment to reaching the bank’s two per cent inflation target, today’s eighth consecutive interest rate hike <a href="https://www.cbc.ca/news/business/bank-of-canada-january-rate-decision-1.6725283">brings the policy rate to 4.5</a> per cent. The bank <a href="https://www.cp24.com/news/bank-of-canada-hikes-key-interest-rate-again-but-plans-to-hold-rate-1.6245083">expects to hold the rate for now</a>, but is prepared to increase it again if needed to maintain its target rate.</p>
<p>The bank’s logic is this: when demand outpaces what the economy supplies, <a href="https://www.bankofcanada.ca/2020/08/understanding-inflation/">the result is inflation</a>. Based on this analysis, the Bank of Canada raises interest rates to “dampen demand so supply can catch up.” Using interest rates to fight inflation has been central banks’ boilerplate approach for years.</p>
<p>Higher interest rates deliberately slow the economy by discouraging borrowing. In a slowing economy, <a href="https://www.bankofcanada.ca/2022/11/restoring-labour-market-balance-and-price-stability/">labour demand eases and job vacancies decline</a>. This is a bitter pill to swallow for those already struggling to make ends meet, since deliberately encouraging higher unemployment exerts downward pressure on wage growth.</p>
<h2>‘Jawboning’</h2>
<p>Why does the central bank emphasize how resolutely committed it is to raising interest rates? In central banker lingo, this is called jawboning or forward guidance.</p>
<p><a href="https://oar.princeton.edu/bitstream/88435/pr14b4j/1/pandp.20181080.pdf">Jawboning is communication</a> intended to influence the expectations of the public. As <a href="https://www.brookings.edu/blog/ben-bernanke/2015/03/30/inaugurating-a-new-blog/">Ben Bernanke, former chairman of the United States Federal Reserve, once explained</a> — when he could talk more freely after leaving the bank — “monetary policy is 98 per cent talk and only two per cent action.” </p>
<p>By emphasizing its steadfast commitment to lowering inflation, the Bank of Canada hopes to persuade the public to expect lower inflation.</p>
<figure class="align-center ">
<img alt="The photo is focused on row of clear Canadian flag sticker in a window. In the background, a person walks past a tall, glass-fronted building." src="https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&rect=530%2C504%2C7462%2C5238&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503910/original/file-20230110-4890-qdt3z7.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">The Bank of Canada building is pictured in Ottawa in December 2022.</span>
<span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span>
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</figure>
<p>The bank is eager to influence our expectations about inflation because <a href="https://www.bankofcanada.ca/wp-content/uploads/2022/06/remarks-2022-06-02.pdf">expectations can be self-fulfilling</a>. If we expect future price increases, we are likely to bid up prices (and seek higher wages) in anticipation of impending price hikes. </p>
<p>If the Bank of Canada convinces us that it can and will beat inflation, we are more likely to refrain from actions that bid up prices, and thereby support the bank’s fight against inflation.</p>
<p>But <a href="https://economics.td.com/ca-perspective-01112023">central bank influence on expectations is a double-edged sword</a>. As Bernanke writes:</p>
<blockquote>
<p>“The ability to shape market expectations of future policy through public statements is one of the most powerful tools the Fed has. The downside for policymakers, of course, is that the cost of sending the wrong message can be high.”</p>
</blockquote>
<p>Jawboning only dampens inflationary expectations if the public has faith that the Bank of Canada is credible in its analysis and actions. But do we believe that raising interest rates is the right tool to control inflation?</p>
<h2>Beyond the central bank’s control</h2>
<p>As the bank itself acknowledges, there are other causes of inflation, such as the <a href="https://www.bankofcanada.ca/wp-content/uploads/2022/10/mpr-2022-10-26.pdf">war in Ukraine and supply disruptions caused by the pandemic</a>. These issues will not be solved by increasing interest rates.</p>
<p>Arguably, the public worries about many inflation causes that are beyond the Bank of Canada’s control. For instance, Canadians may be <a href="https://www.theguardian.com/commentisfree/2022/sep/25/inflation-price-controls-robert-reich">concerned about “greedflation”</a> that occurs when large companies exploit their extensive market power to boost prices excessively. </p>
<p>The <a href="https://www.ourcommons.ca/Committees/en/AGRI/StudyActivity?studyActivityId=11922390">recent Parliamentary inquiry</a> and <a href="https://ised-isde.canada.ca/site/competition-bureau-canada/en/how-we-foster-competition/promotion-and-advocacy/reports-and-studies/retail-grocery-market-study">Competition Bureau study of competition among grocery stores</a> was prompted by the possibility that food costs are impacted by this lack of competition.</p>
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<strong>
Read more:
<a href="https://theconversation.com/food-giants-reap-enormous-profits-during-times-of-crisis-184223">Food giants reap enormous profits during times of crisis</a>
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<p>The central bank has little control over many factors impacting inflation, such as <a href="https://www.bloomberg.com/news/articles/2022-12-08/la-nina-forecast-to-fade-by-april-easing-california-drought">extreme weather in areas that export food and raw materials</a> to Canada. There are also longer-term supply challenges with inflationary repercussions.</p>
<h2>Climate change and inflation</h2>
<p>Consider the future implications of the war in Ukraine and other geopolitical instability. Globalization has been extolled for keeping costs down, but global supply chains are vulnerable to disruption by anything from <a href="https://libertystreeteconomics.newyorkfed.org/2023/01/global-supply-chain-pressure-index-the-china-factor/">the COVID-19 situation in China</a> to <a href="https://www.forbes.com/sites/roberthart/2023/01/09/ship-refloated-after-getting-stuck-in-suez-canal-the-latest-incident-hitting-worlds-trade-artery/">ships getting stuck in the Suez Canal</a>. </p>
<p>To protect supply chains, companies may onshore or <a href="https://www.nytimes.com/2022/11/18/business/friendshoring-jargon-business.html">‘friendshore’</a> by moving production to locations viewed as more insulated from international turbulence. This could exert upward pressure on prices if it requires <a href="https://www.businessinsider.com/made-in-america-products-more-expensive-2022-12">building new facilities in higher-cost areas</a>.</p>
<figure class="align-center ">
<img alt="A massive cargo ship seen floating in canal" src="https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503914/original/file-20230110-11-4rzhaz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Ever Given, a Panama-flagged cargo ship, blocked the Suez Canal for six days after it got stuck sideways in the crucial waterway in March 2021.</span>
<span class="attribution"><span class="source">(AP Photo/Mohamed Elshahed)</span></span>
</figcaption>
</figure>
<p>Climate change also influences inflation. It may <a href="https://report.ipcc.ch/ar6/wg2/IPCC_AR6_WGII_FullReport.pdf">reduce crop yields</a>, for example. But fighting climate change also impacts inflation over the longer term. Living up to our climate commitments <a href="https://markets.businessinsider.com/news/stocks/dr-doom-nouriel-roubini-inflation-debt-crisis-crash-economic-outlook-2023-1">requires the transformation of energy production, manufacturing and transportation</a>. This will be expensive.</p>
<p>Ironically, higher interest rates may further increase the costs of responding to climate change, localizing supply chains and other longer-term challenges. Building new production, transportation and other infrastructure takes funding, and higher interest rates makes it more expensive to borrow money to invest in restructuring.</p>
<p>Given the array of publicly visible factors contributing to inflation, the Bank of Canada needs to consider the possibility that the public will not be persuaded that their approach to inflation fits these unprecedented times. </p>
<h2>Maslow’s hammer</h2>
<p>Effective jawboning requires credibility. This credibility is based on the public’s belief that the central bank is using the right tools for the job. The Bank of Canada does not want to appear to be <a href="https://archive.org/details/psychologyofscie00abra">suffering from Maslow’s hammer</a> — a bias against trying more appropriate tools because, as the saying goes, “if you only have a hammer, everything looks like a nail.”</p>
<p>Ultimately, the reputation of the Bank of Canada will be undermined if the public believes that it’s pounding away with a hammer that is not needed and causing much hardship in the process.</p>
<p>If the bank loses credibility, the public may conclude this hammering is preventing us from pursuing more constructive options. Paradoxically, inflationary expectations could be fuelled if the public believes we are relying on the wrong tool while neglecting better ones that might get the job done.</p>
<p>This is not to say that inflation has an easy fix. We may require all sorts of policy responses that are far beyond the Bank of Canada’s purview. </p>
<p>But so long as policymakers subscribe to the boilerplate analysis that concludes the hammer is the only tool worthy of consideration, we leave our whole toolbox on the shelf while the Bank of Canada behaves as though the only problem is a nail.</p><img src="https://counter.theconversation.com/content/197518/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ellen D. Russell receives funding from SSHRC. </span></em></p>The reputation of the Bank of Canada will be undermined if the public believes the bank’s method of controlling inflation is no longer the right move.Ellen D. Russell, Associate Professor, Faculty of Liberal Arts, Wilfrid Laurier UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1967402023-01-05T14:59:28Z2023-01-05T14:59:28ZGlobal economy 2023: how countries around the world are tackling the cost of living crisis<figure><img src="https://images.theconversation.com/files/503205/original/file-20230105-22-p9kpo5.jpg?ixlib=rb-1.1.0&rect=59%2C22%2C4922%2C3458&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Many countries are dealing with a rapidly rising cost of living.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/rising-cost-living-inflation-financial-crisis-2172152013">Billion Photos/Shutterstock</a></span></figcaption></figure><p><em>The <a href="https://www.imf.org/en/Publications/WEO/Issues/2022/10/11/world-economic-outlook-october-2022">rising cost of living</a> is biting businesses and households around the world. Editors from across The Conversation’s international network have asked local academic experts to explain how their countries and regions are tackling this issue, as well as the 2023 outlook for prices and interest rates where they live.</em></p>
<p><em>This article is the third in our series on where the global economy is heading in 2023. It follows recent articles on <a href="https://theconversation.com/global-economy-2023-why-central-banks-face-an-epic-battle-against-inflation-amid-political-obstacles-197088">inflation</a> and <a href="https://theconversation.com/global-economy-2023-how-governments-could-make-the-energy-crisis-worse-this-year-196986">energy</a>.</em></p>
<h2>UK: recession on the horizon</h2>
<p><em>Alan Shipman, Senior Lecturer in Economics, The Open University</em></p>
<p>At first sight, the UK’s cost of living crisis might look fairly mild compared to other countries. Its inflation rate was 10.7% in November 2022, <a href="https://ec.europa.eu/eurostat/documents/2995521/15701156/2-16122022-AP-EN.pdf/4eaa941a-8c7d-af89-37da-f29f1167c24c">compared to</a> 12.6% in Italy, 16.% in Poland and over 20% in Hungary and Estonia. But the Bank of England expects a recession in the UK this year – possibly <a href="https://www.theguardian.com/business/2022/nov/03/bank-england-warn-uk-economy-longest-recession-100-year-raise-rate-three-percent">lasting until mid-2024</a>.</p>
<p>This is because the proportion of UK households that lack insulation against financial setbacks is unusually large for a wealthy economy. One pre-pandemic survey found that <a href="https://www.reuters.com/article/britain-homeless-housing-idUKL5N2692VV">3 million people in the UK would fall into poverty</a> if they missed one pay cheque, with the country’s high housing costs being a key source of vulnerability. Another recently suggested that <a href="https://www.citizensadvice.org.uk/about-us/about-us1/media/press-releases/a-third-of-uk-adults-just-20-away-from-falling-into-crisis-warns-citizens-advice/#:%7E:text=warns%20Citizens%20Advice-,A%20third%20of%20UK%20adults%20just%20%C2%A320%20away,into%20crisis%2C%20warns%20Citizens%20Advice&text=New%20analysis%20from%20Citizens%20Advice,head%20into%20the%20new%20year">one-third of UK adults would struggle</a> if their costs rose by just £20 a month.</p>
<p>The pandemic saw over 4 million households <a href="https://www.jrf.org.uk/report/dragged-down-debt-millions-low-income-households-pulled-under-arrears-while-living-costs-rise">take on extra debt</a> with almost as many falling behind on repaying it. And recent jumps in energy and food bills will push many over the edge, especially if heating costs remain high when the present <a href="https://www.instituteforgovernment.org.uk/explainers/energy-price-cap">government cap on energy prices</a> ends in April.</p>
<p>UK governments have been stealthily raising taxes since 2010 and in real terms (adjusting for inflation) typical UK household income was already <a href="https://www.resolutionfoundation.org/app/uploads/2022/07/Living-Standards-Audit-2022.pdf">2% lower in 2018 than in 2007</a>. But real incomes have been further eroded over the past year since the UK’s 10.7% inflation rate (as of November) is far above the pay increases many employees have had to settle for in recent months. </p>
<p>But recent events have forced the government to make decisions that were not necessarily aligned with the looming recession. In September 2022, Liz Truss became prime minister with bold <a href="https://www.telegraph.co.uk/business/2022/08/18/liz-truss-right-britain-has-productivity-crisis-why/">pledges to cure the UK’s economic malaise</a>. The global financial markets responded dramatically to her tax cutting plans by hiking the interest they charge the UK government and businesses to borrow. This forced the newly installed chancellor Jeremy Hunt to embark on another round of public spending cuts and <a href="https://ifs.org.uk/articles/are-we-new-era-austerity">tax increases</a> in November – actions governments usually reserve for the height of a boom, not the eve of a slump. </p>
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<p>
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Read more:
<a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">How bonds work and why everyone is talking about them right now: a finance expert explains</a>
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<figure class="align-center ">
<img alt="A union jack, British flag, flies above the bank of england building in London." src="https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503092/original/file-20230104-129706-1ae668.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Bank of England, London.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/bank-england-your-travel-concept-704695771">aslysun / Shutterstock</a></span>
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<p>The Bank of England is also doing the opposite of what central banks prefer to do before a downturn. High inflation forced it to raise rates to <a href="https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate">3.5% in December</a>, with more rises expected in 2023. This boosts debt repayments for the millions who’ve borrowed to buy their homes, not to mention those with unsecured credit card or overdraft debt. </p>
<p>All of these additional costs subtract from a household’s disposable income. And because household consumption makes up <a href="https://commonslibrary.parliament.uk/research-briefings/sn02787/#:%7E:text=GDP%20by%20Expenditure,of%20the%20total%20in%202021">close to 60%</a> of all spending in the UK economy, this will inevitably lead to recession – which could well turn out to be very painful and very long.</p>
<h2>US: central bank signals caution</h2>
<p><em>John W. Diamond, Director of the Center for Public Finance at the Baker Institute, Rice University</em></p>
<p><a href="https://www.bls.gov/news.release/cpi.nr0.htm">Inflation increased significantly</a> in the US in late 2021 and early 2022, reaching levels higher than at any time in the last 40 years. The Federal Reserve responded by <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm">aggressively raising its benchmark rate</a> (the federal funds rate) seven times since March in an effort to stabilise prices. A couple of <a href="https://www.forbes.com/sites/simonmoore/2022/12/15/fed-sees-further-hikes-in-2023-heres-what-could-change-that/?sh=67ad46c15a17">smaller increases</a> are expected in 2023. </p>
<p>The US consumer price index, a standard measure of inflation, <a href="https://fred.stlouisfed.org/series/CPIAUCSL#0">shows that prices peaked</a> in June 2022, increasing by 9.1% over the previous year. The index has decreased every month since June, with the November data – the most recent available – indicating that US prices are 7.1% over the prior 12 months.</p>
<p>The <a href="https://fred.stlouisfed.org/series/FEDFUNDS">fed funds rate</a> serves as a benchmark for other interest rates, such as mortgage rates. Its recent increases have started to reduce demand for goods and services and investment. For example, existing home sales in November were <a href="https://www.nar.realtor/research-and-statistics/housing-statistics/existing-home-sales">7.7% lower than in October</a> and are down over a third from a year earlier. The underlying reason is that mortgage interest rates <a href="https://fred.stlouisfed.org/series/MORTGAGE30US">have more than doubled to over 6%</a>, after reaching 7% in October, from 3% in the beginning of 2021. </p>
<p>The ripple effects of the reduction in housing demand will continue to slow economic activity for months to come because some of the impacts of monetary policy occur with a lag.</p>
<figure class="align-center ">
<img alt="A for sale sign outside a family house." src="https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503095/original/file-20230104-129741-tpygfq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">US housing demand is falling.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/sale-sign-outside-family-house-1576779889">Juice Flair / Shutterstock</a></span>
</figcaption>
</figure>
<p>The Fed <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20221214a.htm">is now signalling</a> that it will continue to raise interest rates in early 2023 before pausing, a cautious approach that is justified by a variety of economic data. This is partly due to continued <a href="https://fred.stlouisfed.org/series/UNRATE">strength in the labour market</a> as unemployment remains low, wages that haven’t been adjusted for inflation <a href="https://www.bls.gov/ces/">continuing to rise</a>, and roughly 10 million jobs remaining open, according to the latest data. To the extent that companies have to raise wages to attract or keep workers, this may lead to higher prices and persistent inflation. </p>
<p>This issue is especially important given the <a href="https://acl.gov/sites/default/files/aging%20and%20Disability%20In%20America/2020Profileolderamericans.final_.pdf">ageing population</a> in the US and the effect it has on the labour market. At the same time, the recent <a href="https://www.theguardian.com/environment/2022/dec/29/european-gas-prices-fall-to-pre-ukraine-war-level">fall in energy prices</a> is unlikely to continue, so further reductions in inflation will have to come from declines in other areas, such as shelter and food. </p>
<h2>Australia and New Zealand: using restraint to ease inflation</h2>
<p><em>Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University</em></p>
<p>The regular survey of economic forecasts published by The Conversation Australia at the start of 2022 was <a href="https://theconversation.com/top-economists-expect-rba-to-hold-rates-low-in-2022-as-real-wages-fall-175054">titled</a>: Top economists expect RBA to hold rates low in 2022 as real wages fall.</p>
<p>This forecast for how the Reserve Bank of Australia would set rates in 2022 was spectacularly wrong. The second part turned out to be pretty right: <a href="https://www.theguardian.com/business/grogonomics/2022/dec/22/the-year-in-australian-economics-inflation-roars-interest-rates-bite-and-real-wages-fall-off-a-cliff#:%7E:text=real%20wages%20are%20falling">real wages did fall</a>, although not because they continued to barely grow as the experts had been expecting, but because their growth was dwarfed by an explosion in inflation.</p>
<p>After hovering below the Reserve Bank’s 2-3% target band for most of the previous five years, Australia’s annual rate of inflation began 2022 at 3.5% but shot up to 5.1% in March after Russia invaded Ukraine and reached 7.3% for the year to September. The bank expects <a href="https://www.rba.gov.au/publications/smp/2022/nov/economic-outlook.html#:%7E:text=Headline%20consumer%20price%20inflation%20is%20expected%20to%20peak%20around%208%C2%A0per%C2%A0cent%20at%20the%20end%20of%202022">something close to 8%</a> for the year to December when the figures are next updated in late January.</p>
<figure class="align-center ">
<img alt="A map of New Zealand and a red plane with a flag of New Zealand attached to its wings." src="https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=337&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=337&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=337&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=424&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=424&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503107/original/file-20230104-70338-iu5lp2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=424&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/map-new-zealand-red-plane-flag-1729818049">hyotographics / Shutterstock</a></span>
</figcaption>
</figure>
<p>Australia’s neighbour New Zealand has experienced much the same thing, with an <a href="https://www.stats.govt.nz/news/annual-inflation-at-7-2-percent/#:%7E:text=The%20consumers%20price%20index%20increased,in%20the%20March%202022%20quarter.">inflation rate that also hit 7.3%</a> and has since slipped to 7.2%. But its response has been dramatically different.</p>
<p>Whereas Australia’s Reserve Bank increased its rate in <a href="https://www.rba.gov.au/statistics/cash-rate/#:%7E:text=369%20entries%20found-,Interest%20Rate%20Decisions,-About%20the%20cash">eight small monthly steps from May</a>, either by 0.25 or 0.5 points, New Zealand’s Reserve Bank began pushing up rates much earlier and more aggressively – including <a href="https://www.rbnz.govt.nz/monetary-policy/monetary-policy-decisions">a recent 0.75 point hike</a>, even as it forecasts a New Zealand recession.</p>
<p>In Australia – unlike New Zealand, the US, the UK and much of the rest of the developed world – a recession isn’t commonly forecast, largely because of the bank’s restraint in the face of a three-decade inflation high. This approach has served Australia well over the 29 years until the COVID recession in 2020. The country avoided the “Great Recession” after the 2007-08 global financial crisis and the 2001 “tech wreck” recession that hit the US and much of the rest of the world in 2001.</p>
<p>This restraint also reflects a belief among authorities that <a href="https://www.afr.com/policy/economy/wage-spiral-like-1970s-not-likely-again-rba-20220915-p5bic1">a wage-price spiral isn’t taking hold in Australia</a>. Wage growth remains mired at 3.1%, well below New Zealand’s 7.4%. </p>
<p>And inflationary pressure seems to be easing. Global oil and wheat prices are down one-quarter to one-third from mid-2022 peaks following Russia’s Ukraine invasion. The Reserve Bank reckons Australian inflation will slide throughout 2023, slipping to 4.7% by the end of 2023, and to 3.2% by the end of 2024, almost back to its 2-3% target band.</p>
<p>By being less hawkish than its global counterparts, the bank hopes to remain on the right side of history.</p>
<h2>France: managing price increases relatively well (for now)</h2>
<p><em>Aymen Smondel, Maître de conférences en finance and Mohamad Hassan Shahrour, Maître de Conférences en Finance, Université Côte d'Azur, IAE Nice - Université Côte d'Azur</em></p>
<p>Inflation is an area where France appears to be more resilient than its neighbours. In December 2022, the country’s inflation rate (measured by the consumer price index) was 6.1%, compared with <a href="https://data.oecd.org/fr/price/inflation-ipc.htm">10% in Germany, 11.8% in Italy and 9.3% in the UK</a>.</p>
<p>The main challenge facing countries, and contributing to inflation – or even <a href="https://theconversation.com/1970s-style-stagflation-now-playing-on-central-bankers-minds-185868">stagflation</a> (which refers to a combination of inflation and low economic growth) in the case of some economies – is the huge increase in energy prices in recent years.</p>
<p>Faced with this rise, the total French state budget devoted to mitigating household energy bills is set to reach at least <a href="https://www.lemonde.fr/energies/article/2022/09/14/crise-energetique-l-executif-debloque-45-milliards-d-euros-pour-prolonger-le-bouclier-tarifaire_6141645_1653054.html">€75 billion</a> (£66 billion) across 2022 to 2023, through schemes including <a href="https://www.service-public.fr/particuliers/actualites/A15480?lang=en">energy vouchers and a tariff shield</a>.</p>
<p>These actions have kept the inflation rate well below that of most European economies. In addition, France is less reliant on fossil fuel products, and therefore less vulnerable to energy price fluctuations. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing that France's use of nuclear for electricity production is significantly higher than that of the UK and Germany." src="https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=502&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=502&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=502&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=630&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=630&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503026/original/file-20230104-22-tnm2gc.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=630&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://ourworldindata.org/electricity-mix">Our World in Data</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>While the chart above shows France’s use of domestic nuclear power sources, the chart below shows that other countries rely more on – often imported – fossil fuels. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing that the UK, Germany and Italy rely much more on fossil fuels for power generation." src="https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=502&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=502&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=502&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=630&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=630&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503057/original/file-20230104-22-3dekit.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=630&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://ourworldindata.org/electricity-mix">Our World in Data</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Energy issues aside, countries are also <a href="https://link.springer.com/article/10.1023/A:1009782809329">impacted by the global market</a> just like companies are affected by their <a href="https://journals.openedition.org/fcs/8844">institutional environment</a>. As a result, future changes in public policy could influence the inflation rate, which may or may not have peaked.</p>
<p>For example, the <a href="https://theconversation.com/us/topics/european-central-bank-ecb-128260">European Central Bank’s decision</a> to raise interest rates for the first time in a decade last July could weigh on countries’ budgets, giving governments less room for manoeuvre as they try to contain price increases.</p>
<p>Without some regional stability in terms of politics and economics, France may not be able to continue to outperform its neighbours in the coming months.</p>
<p><em>This is an edited excerpt from <a href="https://theconversation.com/inflation-why-france-is-holding-up-better-than-its-neighbours-for-now-192214">an article published in October 2022</a>.</em></p>
<h2>Spain: inflation, public spending, deficit and debt</h2>
<p><em>Luis Garvía Vega, Director del Máster Universitario en Gestión de Riesgos Financieros (MUGRF) en ICADE Business School, Universidad Pontificia Comillas</em></p>
<p>After beginning 2022 with <a href="https://www.ine.es/daco/daco42/daco421/ipcia1122.pdf">inflation at 6.1%</a>, Spain’s consumer price index peaked at 10.8% in July before closing out the year at a rate of 6.8%. Taking into account the 2021 inflation journey from 0.5% in January, to 2.9% in July and 6.5% in December, it now looks like price rises are being brought under control.</p>
<p>Core inflation (which excludes unprocessed food and energy) saw a more gradual but sustained rise. It was 2.4% in January 2022, peaked at 6.4% in August and fell to 6.3% in November. The closing gap with headline inflation during the final quarter of last year was mainly due to government measures to <a href="https://www.eldiario.es/economia/medidas-gobierno-energia-espana-sea-pais-zona-euro-crecen-precios_1_9758302.html">control the rise in energy prices</a>.</p>
<p><strong>Inflation in Spain, 2021-2022</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=261&fit=crop&dpr=1 600w, https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=261&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=261&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=329&fit=crop&dpr=1 754w, https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=329&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/502884/original/file-20230103-12-i5hc53.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=329&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Spain’s Consumer Price Index (the figure for November 2022 refers to the leading indicator).</span>
<span class="attribution"><a class="source" href="https://www.ine.es/dyngs/INEbase/en/operacion.htm?c=Estadistica_C&cid=1254736176802&menu=ultiDatos&idp=1254735976607">National Statistics Institute (INE), Spain</a></span>
</figcaption>
</figure>
<p>Like many other countries, <a href="https://datosmacro.expansion.com/estado/gasto/espana#:%7E:text=El%20gasto%20p%20C3%BAblico%20en%20Espa%20Espa%C3%B1a,51%2C9%25%20del%20GDP.">Spain lacks control and efficiency</a> when it comes to public spending. The country’s <a href="https://theconversation.com/retos-y-costes-de-la-reforma-de-las-pensiones-en-espana-174042">pension system</a> must support a rapidly growing older population; it is highly dependent on fossil fuels; the <a href="https://www.bankinter.com/blog/economia/previsiones-paro-espana#:%7E:text=Previsi%C3%B3n%20paro%20Espa%C3%B1a%20en%202023%20y%202024&text=La%20Tasa%20de%20Paro%20se,la%20creaci%C3%B3n%20de%20empleo%20neto.">unemployment rate has been above 10%</a> since 2008; and – again like other countries – it is suffering from deep political and social polarisation right now. A <a href="https://www.bankinter.com/blog/economia/prevision-deficit-publico-espana">high public deficit</a> has also helped inflate the <a href="https://www.bde.es/f/webbde/GAP/Secciones/SalaPrensa/NotasInformativas/22/presbe2022_106.pdf">Spanish debt bubble</a>. </p>
<figure class="align-center ">
<img alt="Aerial view of Cibeles fountain at Plaza de Cibeles in Madrid in a beautiful summer day, Spain" src="https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503091/original/file-20230104-22-xj2qsx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Spain’s unemployment rate has been above 10% since 2008.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/aerial-view-cibeles-fountain-plaza-de-262331123">Sergii Figurnyi / Shutterstock</a></span>
</figcaption>
</figure>
<p>But this is an election year for municipal, regional and general government and so major reforms will be difficult – particularly anything that affects Spain’s 9 million pensioners or its more than 3 million public workers.</p>
<p>Digitalisation and training could provide a solution by supporting more efficient management of resources. This could help to gauge available resources and develop ways to find savings while also addressing the needs of Spain’s people. It makes no sense that even though productivity is now higher thanks to technology, social inequality prevails. </p>
<p>Hopefully 2023 will see more discussion of digital identity and currencies or even universal income, and less of the words that characterised 2022: crisis, war and inflation.</p>
<h2>Indonesia: seven-year inflation high leads to massive layoffs</h2>
<p><em>Bhima Yudhistira Adhinegara, Direktur, Center of Economic and Law Studies (CELIOS)</em></p>
<p>While relatively low compared to other countries, Indonesia’s overall inflation rose to <a href="https://jakartaglobe.id/business/indonesia-inflation-jumps-to-the-highest-level-in-seven-years">its highest level in seven years</a>, reaching nearly 6% in September 2022. Ballooning food and subsidised fuel prices are behind this increase. </p>
<p>At the beginning of this year, Indonesia, the world’s biggest crude palm oil producer <a href="https://www.economist.com/asia/2022/04/02/indonesia-the-worlds-biggest-producer-has-a-palm-oil-crisis">struggled to control cooking oil prices</a> due to a supply bottleneck, despite enjoying <a href="https://www.thejakartapost.com/business/2022/07/24/experts-warn-of-overreliance-on-coal-cpo-in-exports.html">the financial benefits</a> of the commodity’s price increase.</p>
<figure class="align-center ">
<img alt="Banjarmasin, September 2012. A trader from lok baintan offer guava fruit in the Floating Culture Festival in Banjarmasin." src="https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=398&fit=crop&dpr=1 600w, https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=398&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=398&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/503210/original/file-20230105-12-nw1pdg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Rising prices for food and other commodities have impacted Indonesia’s economy.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/banjarmasin-september-2012-trader-lok-baintan-291274601">Robby Fakhriannur/Shutterstock</a></span>
</figcaption>
</figure>
<p>More generally, the <a href="https://en.tempo.co/read/1668719/mid-december-food-prices-rice-beef-and-onions-still-rising">prices of staple commodities</a> – from rice to spices – also rose on the back of failed harvests due to unpredictable weather. In addition, the ongoing war between Russia and Ukraine partially <a href="https://kumparan.com/kumparanbisnis/peternak-ayam-klaim-harga-telur-di-konsumen-saat-ini-sudah-normal-ini-alasannya-1ykUkJmRTg2">contributed to rising food prices</a>, especially food for animals, which became more expensive and affected livestock prices. The government’s decision to <a href="https://www.reuters.com/world/asia-pacific/indonesia-bites-bullet-fuel-prices-subsidies-soar-2022-09-03/">raise subsidised fuel prices by 30%</a> in September delivered a further blow to the country’s inflation rate.</p>
<p>This inflation has increased the cost of living as it has not been accompanied by a sufficient wage increases. In 2022, Indonesia’s minimum wage increased only by 1.09% – <a href="https://bisnis.tempo.co/read/1529672/pakar-ugm-sebut-rata-rata-kenaikan-ump-109-persen-terendah-sepanjang-sejarah">the lowest-ever recorded rate</a>. With annual inflation hitting 5.51%, it means that the purchasing power for those on lower incomes has declined by 4.42%. </p>
<p>Job opportunities are even more limited amid high inflation rates. Export-oriented manufacturing companies have begun to carry out <a href="https://www.cnnindonesia.com/ekonomi/20221214170325-92-887409/kemnaker-industri-manufaktur-dan-startup-paling-rentan-phk-di-2023">mass layoffs</a>. Digital startups, the hope of young people during the pandemic, have also <a href="https://jakartaglobe.id/tech/jdid-layoffs-reflect-struggles-in-indonesian-startup-industry">cut employee numbers</a>. At the same time, <a href="https://www.bps.go.id/pressrelease/2022/11/07/1916/agustus-2022--tingkat-pengangguran-terbuka--tpt--sebesar-5-86-persen-dan-rata-rata-upah-buruh-sebesar-3-07-juta-rupiah-per-bulan.html">four million new workers</a> joined the labour market between August 2021 and 2022, while Indonesia already has a <a href="https://www.macrotrends.net/countries/IDN/indonesia/youth-unemployment-rate">youth unemployment rate of 16%</a> – relatively high for southeast Asia.</p>
<p>Meanwhile, to curb inflation, the central bank <a href="https://www.cnbcindonesia.com/market/20221226071747-17-399979/dunia-putar-arah-suku-bunga-acuan-bi-loncat-jadi-55">raised interest rates by 2%</a> between July and December 2022, triggering an increase in lending rates. <a href="https://databoks.katadata.co.id/datapublish/2022/05/23/kpr-masih-jadi-pilihan-favorit-masyarakat-membeli-rumah-pada-triwulan-i-2022">More than 70% of house purchases</a> in Indonesia rely on mortgages and it might also now be more difficult for new businesses to access much-needed loans.</p>
<p>While state revenues from commodities are increasing due to the recent bonanza, inflation in 2023 is <a href="https://www.euromonitor.com/article/inflation-and-election-uncertainty-will-weigh-on-indonesian-consumers-in-2023">expected to remain high</a>, mostly due to elevated transport costs driven by volatile fuel prices. The Indonesian government now needs to rethink inflation policy and public service costs such as healthcare insurance fees and public transportation rates. These items affect most people and will trigger an additional inflationary impact.</p>
<h2>Canada: changing plans for parenthood and dating highlight cost concerns</h2>
<p><em>Wayne Simpson, Professor, Department of Economics, University of Manitoba</em></p>
<p>Like almost every other country in the world, there’s been no shortage of economic uncertainty in Canada over the past year. Russia’s invasion of Ukraine disrupted global fuel supplies, causing gas prices to reach record levels. The Bank of Canada’s aggressive interest rate hikes also caused recession jitters. Inflation and the cost of living remain big concerns for Canadians in 2023.</p>
<p>Canadians spent <a href="https://www.bnnbloomberg.ca/81-of-canadians-are-worried-about-a-recession-in-2023-survey-1.1862967">less on travel over the holiday season</a> because of these fears. And even though lower gas prices provided some relief over the same period, the price at the pumps still soared to record heights in 2022. Some experts predict they will <a href="https://www.cbc.ca/news/canada/calgary/bakx-oil-gas-fuel-evs-solar-wind-renewables-1.6693940">rise again in 2023</a>.</p>
<p>The price of groceries has also been <a href="https://abacusdata.ca/food-costs-canada-inflation/">a serious pain point</a> for Canadians, and <a href="https://www.dal.ca/sites/agri-food/research/canada-s-food-price-report-2023.html">grocery costs could soar</a> by up to 7% more in 2023. Rising food costs are in part a result of Ukraine-related disruptions in three major commodities: wheat, sunflower oil and especially fertilisers, which drove Canadian crop production costs up by 6-8% in 2022. Concerns have already been expressed about <a href="https://www.cbc.ca/news/health/food-prices-canada-health-impacts-1.6641322">the impact of rapidly rising food prices on Canadians’ health</a>, especially families with low incomes. </p>
<p>The silver lining to the economic volatility has been housing prices in Canada. Experts predict a continuing cooling trend in some of the hottest – and most unaffordable – housing markets in the country. One report forecasts <a href="https://www.bnnbloomberg.ca/td-sees-up-to-25-drop-in-canadian-home-prices-by-early-2023-1.1811945">the average price of a Canadian home could drop by 25%</a> in the first quarter 2023. Prohibitively high mortgage rates, low inventory and uncertainty about where the Bank of Canada’s interest rate cycle will finally peak could explain the slowdown.</p>
<p>Some reports suggest Canada’s higher cost of living <a href="https://financialpost.com/moneywise-pro/why-the-cost-of-living-has-some-canadians-delaying-parenthood-and-tips-for-how-to-afford-it">is even causing people to postpone parenthood</a>. And certain <a href="https://www.cbc.ca/news/business/inflation-dating-canada-1.6686287">dating apps report</a> that users are keeping dates simple and economical by suggesting casual activities rather than “fancy”, expensive or elaborate nights out.</p>
<p>The fact that prices in other G7 countries such as the US, UK, Germany and Italy <a href="https://www.ctvnews.ca/business/interest-rates-vs-inflation-rates-how-the-g7-countries-compare-to-canada-1.6139811">increased at an even faster rate than Canada in 2022</a> may be a small consolation to Canadian consumers. More sobering are <a href="https://thoughtleadership.rbc.com/past-the-peak/#:%7E:text=But%20fully%20returning%20inflation%20to,the%20end%20of%20next%20year.">forecasts of further inflation in 2023</a> before annual inflation settles back into the more familiar and comfortable range of 1-3% in 2024. </p>
<hr>
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<img alt="" src="https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/502930/original/file-20230103-20-riy0if.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><em>This article is part of <a href="https://theconversation.com/topics/global-economy-2023-132115">Global Economy 2023</a>, our series about the challenges facing the world in the year ahead. You might also like our Global Economy Newsletter, which you can <a href="https://theconversation.com/uk/newsletters/global-economy-and-business-115?utm_source=Global+Economy&utm_medium=linkback&utm_campaign=2023">subscribe to here</a>.</em></p><img src="https://counter.theconversation.com/content/196740/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Price inflation has hit countries differently, but most central banks and governments are concerned about the rising cost of living in 2023.Alan Shipman, Senior Lecturer in Economics, The Open UniversityAymen Smondel, Maître de conférences en finance, IAE de Nice, Université Côte d’AzurBhima Yudhistira Adhinegara, Direktur, Center of Economic and Law Studies (CELIOS)John W. Diamond, Director of the Center for Public Finance at the Baker Institute, Rice UniversityLuis Garvía Vega, Director del Máster Universitario en Gestión de Riesgos Financieros (MUGRF) en ICADE Business School, Universidad Pontificia ComillasMohamad Hassan Shahrour, Maître de Conférences en Finance, Université Côte d'Azur, IAE Nice - Université Côte d'AzurPeter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityWayne Simpson, Professor, Department of Economics, University of ManitobaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1965192022-12-13T16:53:57Z2022-12-13T16:53:57ZFive reasons why interest rates can’t go much higher<p>It’s decision time for central banks on interest rates again. The US Federal Reserve and European Central Bank (ECB) are set to announce their latest decisions on Wednesday 14, while the Bank of England (BoE) will go a day later. </p>
<p>After years of ultra-loose monetary policies, the Fed in particular has been aggressively raising interest rates during 2022 <a href="https://www.euronews.com/next/2022/11/30/record-inflation-which-country-in-europe-has-been-worst-hit-and-how-do-they-compare">to counteract</a> the <a href="https://www.bls.gov/opub/ted/2022/consumer-prices-up-9-1-percent-over-the-year-ended-june-2022-largest-increase-in-40-years.htm">inflation surge</a>. All three central banks increased their benchmark rates by 0.75 points at their meetings in late October/early November. </p>
<p><strong>Base rates in US, UK and eurozone</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing interest rates in US, UK and eurozone" src="https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=309&fit=crop&dpr=1 600w, https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=309&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=309&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=388&fit=crop&dpr=1 754w, https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=388&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/500738/original/file-20221213-19390-oz0t5e.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=388&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">US = blue; UK = orange; eurozone = turquoise.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/">TradingView</a></span>
</figcaption>
</figure>
<p><a href="https://www.richmondfed.org/publications/research/econ_focus/2022/q3_federal_reserve">The Fed</a> and <a href="https://www.ft.com/content/64e5dcdd-42a8-4013-a3bd-75a62cf8e6dc">BoE</a> have also been reducing the amount of money in the economy through what is known as quantitative tightening. This involves removing the money they “created” via quantitative easing, and the <a href="https://www.reuters.com/markets/europe/ecb-start-offloading-debt-fight-inflation-2022-12-02/">ECB is likely</a> to follow suit. </p>
<p>It is widely expected that the central banks will further increase rates at their latest meetings, but potentially at a slower rate of 0.5 points. Fed Chair <a href="https://www.reuters.com/markets/us/feds-powell-rate-hike-slowdown-possible-next-month-inflation-fight-far-over-2022-11-30/">Jay Powell signalled</a> a probable slowdown a couple of weeks ago, causing markets to surge in response. On the <a href="https://www.ft.com/content/ea6edbc9-2ee6-4e8a-8289-4ee071260d60">other hand</a>, there is still pressure to stay aggressive to keep on top of inflation: UK wage growth is a worry, for instance. </p>
<p>It boils down to a question of how many rate rises the world economy can take. Here’s what the potential damage looks like: </p>
<h2>1. Consumption</h2>
<p>Higher interest rates force people to pay more to service their debts, including mortgages, car loans, credit cards and more. With many debts, the damage is staggered because of short-term fixed rates below today’s market rates. But to take UK mortgages as an example, it is <a href="https://www.resolutionfoundation.org/press-releases/britains-26-billion-mortgage-hike-five-million-households-set-for-average-mortgage-bill-increases-of-5100-by-end-of-2024/#:%7E:text=Over%20five%20million%20families%20are,Saturday)%20by%20the%20Resolution%20Foundation">estimated that</a> the average household will be forking out an extra £425 a month by the end of 2024. In London, the average increase will be closer to £700. </p>
<p>In a largely stagnant economy where wages are not keeping up with inflation, spending more on debts means cutting back on consumption – particularly on unessential spending such as holidays, luxury clothes or new cars. Companies will therefore produce less, sell less and earn less, causing two nasty chain reactions in the global economy: higher unemployment and slower growth. The silver lining is that it will probably reduce inflation faster.</p>
<h2>2. Falling house prices</h2>
<p>An oft-repeated mantra is that house prices cannot fall when there’s a limited supply of properties coming on the market. It’s not true, though. With mortgages getting more expensive, people can’t afford to pay as much for a house. Even if there are dozens of buyers competing for a property, each will bid lower than a year ago. The average buyer’s borrowing capacity is even more important than the number of buyers in the market. </p>
<p>Higher interest rates could make rentals unprofitable for buy-to-let landlords, particularly since they typically pay higher interest rates than ordinary homeowners. A percentage of these landlords will sell, creating a temporary spike in the supply of properties on the market. </p>
<p>There’s also a self-fulfilling prophecy in that the more is written about falling prices, the more sellers will discount to sell quickly. Indeed, property prices have <a href="https://www.forbes.com/uk/advisor/personal-finance/2022/12/12/house-prices-updates/#:%7E:text=Price%20falls%20of%20up%20to,home%20now%20costs%20%C2%A3261%2C600">already started</a> to fall. UK house prices fell by <a href="https://www.fidelity.co.uk/markets-insights/markets/uk/why-are-houses-prices-falling/">more than 2%</a> in November, their third consecutive monthly fall and the sharpest since 2008. In the UK and also the US, analysts predict <a href="https://www.forbes.com/advisor/mortgages/real-estate/housing-market-predictions/">5% to 10% falls</a> within the next couple of years.</p>
<h2>3. Developing country defaults</h2>
<p>Most developing countries owe their debt in US dollars, not their local currency. Higher interest rates have strengthened the dollar – at least until it <a href="https://www.marketwatch.com/investing/index/dxy">eased off recently</a> – which has made their financial positions worse. This makes them seem like a riskier prospect to investors, making it more expensive for them to borrow on the international markets. </p>
<p>It doesn’t help that many developing countries already have weakened public finances due to the pandemic. And the prospect of falling global consumption, an impending recession and <a href="https://www.ey.com/en_cn/automotive-transportation/why-global-industrial-supply-chains-are-decoupling">reduced investment</a> is <a href="https://www.nytimes.com/2022/12/03/business/developing-countries-debt-defaults.html">not improving</a> their credentials. </p>
<p><a href="https://www.bbc.co.uk/news/business-61505842">Sri Lanka</a> has already defaulted on its debts, and numerous other countries <a href="https://blogs.worldbank.org/voices/are-we-ready-coming-spate-debt-crises">may soon follow</a>. Their citizens can expect hyperinflation, deep recessions and excessive taxes in the battle to get finances under control. It <a href="https://www.reuters.com/business/argentinas-economic-crisis-whack-a-mole-goes-into-overdrive-2022-06-28/">can take years</a> or even decades to recover, causing severe hardship. </p>
<h2>4. Falling markets</h2>
<p>Just like property prices are affected by tighter monetary policies, the same is true of financial assets in general. Higher rates make it more lucrative to save money and invest in bonds, which makes it less tempting to invest in the stock market and other riskier assets. The prospect of reduced consumption and higher unemployment does not encourage investors to take risks either. </p>
<p><strong>S&P 500 chart</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="S&P 500 chart" src="https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/500773/original/file-20221213-16226-ha011x.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.tradingview.com/">TradingView</a></span>
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</figure>
<p>This is why financial markets have <a href="https://investorplace.com/2022/10/stock-predictions-2022-when-will-stocks-go-back-up/">declined significantly</a> during 2022 – and why <a href="https://www.reuters.com/markets/global-markets-outlook-urgent-2022-11-28/">they rallied</a> on the news that rate hikes might decelerate. <a href="https://www.fitchratings.com/research/banks/major-european-banks-face-weaker-profits-after-strong-2021-31-03-2022">Banks have suffered</a> over the past year because of a decline in stock market returns, while those in Europe have also been exposed to the Russia sanctions. </p>
<h2>5. Political instability</h2>
<p>Economic developments tend to be followed by political ones. From the French revolution to the <a href="https://www.businessinsider.com/ukraine-russia-bread-food-prices-civil-unrest-arab-spring-egypt-2022-3?r=US&IR=T#:%7E:text=Food%20scarcity%20also%20played%20a,with%20corrupt%20political%20systems%20peaked">Arab spring</a>, high food prices have stirred revolutions. Brexit in the UK and the election of Donald Trump were also arguably reactions to economic insecurity. </p>
<p>So the higher that interest rates rise, the greater the risk of political instability. Don’t be surprised if citizens ramp up their opposition to global elites and weak groups such as <a href="https://www.amnesty.org/en/latest/news/2021/10/sri-lanka-authorities-must-end-violence-and-discrimination-against-muslims/">minorities and migrants</a>. Also expect more populism and governments resorting to distractions such as <a href="https://www.theguardian.com/world/2022/nov/20/turkey-confirms-airstrikes-kurdish-groups-syria-iraq-bombing">nationalist wars</a>.</p>
<h2>The role of governments</h2>
<p>Central banks will only actually reduce interest rates once inflation comes back to low levels. In the meantime, the global economy needs steady and wise governments to minimise the damage. </p>
<p>Loan repayment holidays for struggling households and otherwise healthy businesses can certainly help. Food banks and free school meals are also essential, while governments need to have the courage to make <a href="https://www.theguardian.com/us-news/2022/apr/13/wealthiest-americans-tax-income-propublica-investigation">billionaires</a>, <a href="https://www.prospectmagazine.co.uk/politics/uk-tax-corporate-rate-amazon-facebook-zero-havens">multinationals</a> and <a href="https://www.landlordtoday.co.uk/breaking-news/2021/10/hmrc-discovers-huge-numbers-of-landlords-avoiding-paying-tax">even landlords</a> pay their fair share of tax. Without policies like these, the next couple of years will be harder than is necessary.</p><img src="https://counter.theconversation.com/content/196519/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Central bankers are set to slow down their rate hikes.Alexander Tziamalis, Senior Lecturer in Economics, Sheffield Hallam UniversityJean-Philippe Serbera, Associate professor in Finance, ESC PauLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1914092022-11-01T12:45:59Z2022-11-01T12:45:59ZMen don’t trust female central bankers on inflation or the economy, survey data shows<figure><img src="https://images.theconversation.com/files/491393/original/file-20221024-25-falo6d.jpg?ixlib=rb-1.1.0&rect=80%2C80%2C3489%2C2526&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Photo ops of the world's central bankers and finance ministers typically involve a woman or two surrounded by men, such as this image from the G-7 in Germany in 2015.
</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/GermanyG7FinanceMinisters/cf67f8f5114d4b4ebf5525db88de75dc/photo?Query=g7%20canada%20finance%20minister&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=53&currentItemNo=36">AP Photo/Jens Meyer</a></span></figcaption></figure><p><em>The <a href="https://theconversation.com/us/topics/research-brief-83231">Research Brief</a> is a short take about interesting academic work.</em> </p>
<h2>The big idea</h2>
<p>Americans <a href="http://dx.doi.org/10.2139/ssrn.4186248">are less likely to trust statements</a> from the Federal Reserve about interest rates when a U.S. central bank official portrayed as a woman delivers the information as opposed to a man, according to our new study. </p>
<p>Women filled just <a href="https://doi.org/10.1016/j.ejpoleco.2022.102192">11% of the seats</a> on the boards of central banks around the world from 2000 to 2015. <a href="https://doi.org/10.1016/j.ejpoleco.2022.102192">Our previous work suggested</a> a key reason for this was that women are seen by lawmakers who fill those seats as less trusted to prioritize inflation fighting, as opposed to men, who are <a href="https://dx.doi.org/10.2139/ssrn.3441659">perceived as monetary policy</a> “hawks.”</p>
<p>To better understand how gender shapes public reactions to central bankers, we conducted a survey experiment in January 2022 in which we gave easy-to-understand summaries of contemporary Fed statements to a random sample of about 11,000 Americans, evenly split between men and women. </p>
<p>We randomly attributed those summaries to real people – either <a href="https://www.clevelandfed.org/people/profiles/m/mester-loretta-j">Loretta Mester</a>, president of the Cleveland Fed, or <a href="https://www.chicagofed.org/people/e/evans-charles">Charles Evans</a>, who heads the Chicago branch. This allowed us to gauge whether the words of a female central banker would be perceived differently than those of a male colleague. We also tweaked their titles, randomly referring to the male or female Fed official as either “President of a Federal Reserve Bank and a Ph.D. Economist” or simply as a “Federal Reserve Economist.” This allowed us to see if highlighting credentials minimized any gender bias as studies suggest that it can in <a href="https://www.jstor.org/stable/2096136">professional settings</a>. </p>
<p>We then asked participants a series of general questions, such as their level of education and self-reported economic literacy, as well as their level of trust in state and federal institutions. We followed with our main questions about trust in the Federal Reserve specifically, optimism about the economy and their concern about inflation and unemployment. </p>
<p>As expected, we found strong evidence of bias against female central bankers among male survey takers. Gender bias was most significant when we asked about confidence in the Fed. For example, 53% of male respondents said they had confidence in the central bank when Evans was cited as the source – with the full Fed title – compared with just 43% who said the same about a similarly credentialed Mester. Similarly, 32% said they were optimistic about the economy when the summary came from Evans, double the share for Mester.</p>
<p>We could also see this bias in the ability of male respondents to remember the gender of the official. Only 60% accurately recalled at the end of the survey the gender of the official when it was a woman, while 97% accurately recalled the gender of the man. </p>
<p>The results from female survey takers showed little or no gender bias – though women showed more confidence in Mester when they were given her full title. </p>
<figure class="align-center ">
<img alt="A white woman with gray hair and a blue shirt is seen next to a white man with gray hair, glasses and a dark suit and purple tie" src="https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&rect=62%2C134%2C6857%2C4481&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/490977/original/file-20221020-16-akv9yn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Janet Yellen was the first woman to become Fed chair.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/FinancialStability/27f6518c197e46ddb268958ac9461200/photo?Query=janet%20yellen%20federal%20reserve&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=1872&currentItemNo=21">Kevin Dietsch/Pool via AP</a></span>
</figcaption>
</figure>
<h2>Why it matters</h2>
<p>Women have made inroads in recent years into the male-dominated leadership roles of central banks around the world. </p>
<p>The <a href="https://doi.org/10.1016/j.ejpoleco.2022.102192">share of women on central bank boards</a> has increased from negligible in the late 1990s to over 15% in recent years. In the United States, half of the six members of the Fed’s <a href="https://www.federalreserve.gov/aboutthefed/bios/board/default.htm">Board of Governors</a> are currently women. And women, including Mester, serve as presidents of five of the 12 <a href="https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-banks.htm">regional Federal Reserve banks</a>. And in 2014, Janet Yellen <a href="https://www.theguardian.com/business/2020/nov/23/janet-yellen-fed-chair-treasury-secretary">became the first woman</a> to serve as chair of the Fed.</p>
<p>In <a href="https://doi.org/10.1016/j.ejpoleco.2022.102192">one of our papers</a> we suggested that a big reason for these gains is that developed countries like the U.S. <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2019/july/why-is-inflation-low-globally/">experienced very low inflation</a> for much of the 21st century, which negated the need to consider a nominee’s perceived inflation-fighting credentials as part of the appointment to a central bank. </p>
<p>That era is over as inflation soars across the globe. In the U.S., for example, <a href="https://www.bls.gov/news.release/cpi.nr0.htm">consumer prices are rising at about the fastest pace in 40 years</a>, forcing the Fed and other central banks to wage a global battle against inflation. </p>
<p>Since a key element of reducing inflation is convincing investors, companies and consumers to trust that the central bank can succeed, our study suggests female central bankers like Mester are at a disadvantage in generating public trust, which hurts their efficacy as communicators. This may also put the trend of more female central bankers at risk unless perceptions change.</p>
<h2>What’s next</h2>
<p>We have ongoing Japanese and European surveys underway to understand if we see the same types of gender bias in other countries.</p><img src="https://counter.theconversation.com/content/191409/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Men were significantly less likely to express confidence in the Federal Reserve and optimism about the economy when monetary policy information came from a woman versus a man.Cristina Bodea, Professor of Political Science, Michigan State UniversityAndrew Kerner, Assistant Professor of Political Science, Michigan State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1933712022-10-27T20:23:41Z2022-10-27T20:23:41ZThe Bank of Canada just hiked interest rates for the sixth time — is it too late?<figure><img src="https://images.theconversation.com/files/492171/original/file-20221027-24414-bvhojq.JPG?ixlib=rb-1.1.0&rect=64%2C12%2C8562%2C5729&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Bank of Canada Governor Tiff Macklem arrives at a press conference in Ottawa on Oct. 26, 2022.</span> <span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span></figcaption></figure><p>Following closely on the heels of the <a href="https://www.politico.eu/article/ecb-christine-lagarde-doubling-down-with-another-giant-rate-hike-despite-political-pressure/">European Central Bank</a> and the <a href="https://www.reuters.com/markets/us/feds-powell-eve-next-rate-hike-urged-protect-jobs-2022-10-25/">U.S. Federal Reserve Board</a>, the Bank of Canada has <a href="https://www.cbc.ca/news/business/bank-of-canada-rate-decision-1.6629901">raised its target interest rate by 50 basis points</a>. This is its sixth interest rate hike this year.</p>
<p>Central banks around the world have been <a href="https://www.pewresearch.org/fact-tank/2022/06/15/in-the-u-s-and-around-the-world-inflation-is-high-and-getting-higher/">trying to tame inflation, which has been running hot</a> — at close to a double-digit rate — in the past year. <a href="https://www.macleans.ca/politics/canadas-inflation-rate-hits-a-three-decade-high/">Canada’s inflation hit a three-decade high</a> in March 2022.</p>
<p>While <a href="https://globalnews.ca/news/9224623/bank-of-canada-employment-ndp-singh-inflation-interest-rate/">reactions about the interest rate increase have been mixed</a>, as an economist, I argue that the timing of the central bank interest hikes have been appropriate. These hikes are the only option the central bank has to counter rising inflation.</p>
<h2>Keeping inflation under control</h2>
<p>There are a few reasons why inflation needs to be kept under control by central banks. For one, not all workers’ wages increase proportionately with price increases. In Canada, news reports suggest that <a href="https://www.cbc.ca/news/business/food-cost-survey-1.6478695">25 per cent of the population have not been able to afford food and utilities</a>, and in many cases have been <a href="https://www.bnnbloomberg.ca/canadians-are-falling-deeper-into-debt-statistics-canada-1.1817663">forced to increase their debt</a>.</p>
<p>Worldwide, the United Nations estimated that the number of people affected by hunger in 2021 had risen by about 46 million since the year before, <a href="https://www.who.int/news/item/06-07-2022-un-report--global-hunger-numbers-rose-to-as-many-as-828-million-in-2021">and 150 million since the outbreak of the COVID-19 pandemic</a>. </p>
<p>Another reason to control inflation is that, for many retirees, <a href="http://www.uapp.ca/news/cost-of-living-adjustment/">pension increments do not fully adjust for inflation</a>. This means that many people’s pensions are not keeping up with inflation, which affects their standard of living.</p>
<figure class="align-center ">
<img alt="A woman stands with her back to the camera, facing a row of produce in the grocery store" src="https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=375&fit=crop&dpr=1 600w, https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=375&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=375&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=471&fit=crop&dpr=1 754w, https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=471&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/492167/original/file-20221027-1498-zoiijg.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=471&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Inflation is having a direct impact on food security for Canadians.</span>
<span class="attribution"><span class="source">(Shutterstock)</span></span>
</figcaption>
</figure>
<p>Rising interest rates typically lead to lower economic growth, as well as lower stock market valuations, meaning people that own stocks are hit hard during interest rate hikes. Because of this, central banks must balance the costs of food affordability for lower income households with declines in the wealth of higher income households. </p>
<p>Central banks are compelled to control inflation since it can quickly spiral out of control without their intervention. Feeding on itself, there is a risk of the formation of <a href="https://www.investopedia.com/terms/w/wage-price-spiral.asp">an inflationary wage-price spiral</a>. This occurs when workers negotiate greater wage increases, which puts more cash into their hands and leads to more inflation, which in turn leads to greater wage increases, and so on.</p>
<h2>Global inflation on the rise</h2>
<p>The current inflationary climate began during the worst of the COVID-19 pandemic in 2020. The second quarter of 2020 witnessed a <a href="https://www.oecd.org/sdd/na/gdp-growth-second-quarter-2020-oecd.htm">dramatic drop in the Gross Domestic Product of most countries</a>. <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/200828/dq200828a-eng.htm">Canada’s GDP fell by 11 per cent in April 2020</a>, the deepest plunge since the Great Depression. As lockdown-hit businesses suspended regular activity, many workers lost their jobs and <a href="https://globalnews.ca/news/7029601/canada-may-unemployment-rate/">the unemployment rate hit double digits</a>. In addition, <a href="https://www.mcgill.ca/business-law/article/understanding-supply-chain-disruptions-during-covid-19-pandemic">global supply chains broke down, leading to widespread shortages</a>.</p>
<p>Governments in most countries responded with multiple policy tools. Most countries responded with dual policy relief — monetary and fiscal — to alleviate the situation. <a href="https://www.bankofcanada.ca/2020/05/our-policy-actions-in-the-time-of-covid-19/#:%7E:text=Lowering%20interest%20rates,and%20savings%20accounts%20at%20banks.">Central banks cut short-term rates</a>, and increased the <a href="https://www.bankofcanada.ca/markets/market-operations-liquidity-provision/covid-19-actions-support-economy-financial-system/">purchase of government and corporate bonds to lower long-term rates.</a></p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/an-economist-explains-what-you-need-to-know-about-inflation-188959">An economist explains: What you need to know about inflation</a>
</strong>
</em>
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<p>At the same time, <a href="https://theconversation.com/better-income-assistance-programs-are-needed-to-help-people-with-rising-cost-of-living-190216">governments cut taxes and sent cash payments to lower- and middle-income households</a>. While some of the people who received these payments spent the handouts on food and essential items, many others purchased more expensive items, such as computers and electronics, <a href="https://www.federalreserve.gov/econres/notes/feds-notes/fiscal-policy-and-excess-inflation-during-covid-19-a-cross-country-view-20220715.html">and others just increased their cash balances</a>.</p>
<p>This increase in cash balances for a large proportion of the population was one factor that set up the start of the inflationary climate. During this same period, supply chain shortages also led to inflationary pressures.</p>
<p>By mid-2021, inflation had reached <a href="https://www.worlddata.info/inflation.php#:%7E:text=In%202021%2C%20the%20global%20inflation,are%20expected%20worldwide%20for%202022.">three to five per cent in Canada, the European Union and the U.S.</a> Meanwhile, labour markets recovered rapidly and wage growth picked up, especially for workers willing to change jobs. </p>
<h2>Appropriately timed rate increases</h2>
<p>The major central banks <a href="https://www.cbc.ca/news/business/bank-of-canada-benchmark-interest-rate-1.5834049">decided to delay rate increases early in the pandemic</a>, citing some of the inflationary pressures as temporary. But as inflationary pressures continued to increase into 2022, <a href="https://www.bnnbloomberg.ca/larry-summers-says-fed-forecasts-look-ridiculous-warns-on-rate-delay-1.1777285">central banks were criticized widely by economists and influential investors</a>. </p>
<p>The Bank of Canada <a href="https://www.reuters.com/business/finance/bank-canada-raises-rates-050-warns-russia-uncertainty-2022-03-02/">raised its interest rate to 0.50 per cent in March 2022</a> — its first interest rate increase since October 2018. Since then, it has been making up for lost time by increasing its rate by a cumulative 3.5 per cent with a sequence of jumbo 0.75 per cent hikes, while the Federal Reserve Board has so far raised them by 3.25 per cent. </p>
<p><a href="https://seekingalpha.com/news/3708118-mohamed-el-erian-fed-moving-too-slow">Critics have interpreted these jumbo hikes</a> to mean the central banks have admitted to their slow response to fight inflation in 2021. </p>
<figure class="align-center ">
<img alt="A man and a woman give a press conference to an audience of people who are taking notes" src="https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/492175/original/file-20221027-37112-p3x74s.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Governor of the Bank of Canada Tiff Macklem and Senior Deputy Governor Carolyn Rogers hold a press conference in Ottawa on Oct. 26, 2022.</span>
<span class="attribution"><span class="source">THE CANADIAN PRESS/Sean Kilpatrick</span></span>
</figcaption>
</figure>
<p>In mid-2021, there was considerable uncertainty about how the COVID-19 pandemic would evolve. Vaccines had been developed very rapidly, but no long-term effectiveness data was available yet. In addition, <a href="https://theconversation.com/why-new-covid-19-variants-are-on-the-rise-and-spreading-around-the-world-153530">the appearance of a series of new variants</a> added greater uncertainty on whether the vaccines would stop the disease. </p>
<p>While the vaccines have been hugely successful in hindsight, there was <a href="https://theconversation.com/coronavirus-why-experts-disagree-so-strongly-over-how-to-tackle-the-disease-135825">widespread disagreement about how to handle COVID-19 early on</a>. The central banks surely would have been blamed for raising rates in the midst of an economic recovery in 2021 if the pandemic had taken a turn for the worse, and the world economies had fallen back into hard times. </p>
<h2>Looking ahead</h2>
<p><a href="https://www.bnnbloomberg.ca/here-s-how-badly-central-banks-failed-to-spot-inflation-shock-1.1798675">A valid criticism of the central banks is that they failed to account for the inflationary pressures</a> created by fiscal policy, like tax cuts and cash handouts. Arguably, the actions taken by the central banks might have been strong enough to stimulate the economy without the fiscal policy actions taken by governments.</p>
<p>Going forward, there will be much debate about whether the central banks have moved too much, <a href="https://www150.statcan.gc.ca/n1/daily-quotidien/221019/dq221019a-eng.htm">as recent data shows that inflation has slowed since the summer</a>. Moreover, <a href="https://www.ctvnews.ca/politics/recession-likely-amid-global-economic-downturn-fiscal-restraint-needed-carney-1.6118082">many forecasters now predict a recession in 2023</a>, which might lead the central banks to reverse the rate increases. Nonetheless, they will be compelled to maintain higher rates, even if inflation slows to the five per cent range. </p>
<p>Uncertainty about future inflation remains high as some of the factors, such as COVID-related lockdowns, seem to be easing, while others, such as <a href="https://theconversation.com/how-the-war-in-ukraine-will-affect-food-prices-178693">disruptions in food supply from the Russian invasion of Ukraine</a>, may still cause some inflationary pressures in food and energy. </p>
<p>Most of the world has faced <a href="https://www.investopedia.com/terms/d/deflation.asp">deflationary pressure</a> since 2000. The forces of deflation, like low birth rates and high savings, will once again come to the forefront once the current problems are resolved.</p><img src="https://counter.theconversation.com/content/193371/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander David worked as a staff economist at the Federal Reserve Board from 1993 to 2001.</span></em></p>Because central banks delayed interest rate increases early in the pandemic, they have spent 2022 playing catch-up with runaway inflation.Alexander David, David E. Mitchell Professor of Finance, University of CalgaryLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1928232022-10-25T14:02:30Z2022-10-25T14:02:30ZThe UK is facing an economic crisis – here’s why it needs to find a global solution<figure><img src="https://images.theconversation.com/files/491630/original/file-20221025-14-i1ta6m.jpg?ixlib=rb-1.1.0&rect=0%2C84%2C5629%2C3663&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-great-britain-flag-united-kingdom-1842179239">Octus_Photography / Shutterstock</a></span></figcaption></figure><p>Recent <a href="https://news.sky.com/story/financial-markets-welcome-news-rishi-sunak-will-be-next-pm-12729240">changes</a> in the UK’s top job have had a positive effect on pound sterling and long-term sovereign bond yields. But the financial market reaction has been muted compared with the <a href="https://www.nytimes.com/2022/10/20/world/europe/liz-truss-britain-resigns.html">financial turmoil</a> blamed on former prime minister Liz Truss and ex-chancellor Kwasi Kwarteng in recent weeks. </p>
<p>After the <a href="https://www.bbc.co.uk/news/business-62920969">mini-budget</a> on September 23, the markets reacted to a bad policy: Truss’s strategy to undertake massive tax cuts without providing much certainty on <a href="https://ifs.org.uk/articles/mini-budget-response">how this would be funded</a>. Its <a href="https://theconversation.com/emergency-budget-announcement-expert-reaction-to-new-uk-chancellors-attempt-to-calm-financial-markets-192669">reversal</a> brought bond yields down from recent highs (essentially reducing the cost of government borrowing) and saw the pound appreciate. But overall, the market losses seen following the mini-budget have barely been recovered. </p>
<p>To investors, sound and stable economic policies matter much more than the person residing in Number 10. And that’s why, even with <a href="https://theconversation.com/prime-minister-rishi-sunak-who-is-he-and-how-did-he-end-up-with-the-top-job-in-british-politics-193151">a new prime minister</a>, recent market movements indicate investors continue to see more significant issues with the UK economy, both immediately and over the longer term.</p>
<p>In the short term, <a href="https://theconversation.com/how-bonds-work-and-why-everyone-is-talking-about-them-right-now-a-finance-expert-explains-191550">yields</a> on UK sovereign bonds have shot up after the <a href="https://commonslibrary.parliament.uk/research-briefings/cbp-9624/">mini-budget</a>, increasing the government’s cost of borrowing. The lack of an accompanying forecast by the Office of Budgetary Responsibility (OBR) exacerbated this negative reaction. </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"1580182299081027584"}"></div></p>
<p>Before this, the Bank of England had been <a href="https://www.bankofengland.co.uk/news/2022/september/statement-from-the-governor-of-the-boe">contemplating a bond-selling exercise</a> to try to bring rising inflation back to its 2% target by reducing the supply of money in circulation (this is known as quantitative tightening). Instead, it had to quickly <a href="https://www.bankofengland.co.uk/news/2022/september/bank-of-england-announces-gilt-market-operation">change course</a> after the mini-budget. It not only postponed this tightening, but also restarted quantitative easing and bond purchases, promising to buy up to <a href="https://www.bankofengland.co.uk/news/2022/october/boe-widens-gilt-purchase-operations-to-include-index-linked-gilts">£10 billion in gilts</a> per day to address a related crisis among pension funds.</p>
<p>Two things will now determine future sovereign bond yield dynamics and dictate government borrowing costs. </p>
<p>First, clarity on how long the Bank of England plans to continue its policy of quantitative easing (buying bonds to keep yields low) before it reverts to quantitative tightening again. Markets are watching these actions very carefully and any suggestion that this support by the Bank will be <a href="https://www.ft.com/content/d9e46bb3-6bdd-416e-9ec6-e43b8af5fb30">cut off</a> could make traders and investors nervous. </p>
<p>Second, the government’s medium-term fiscal plan, currently scheduled for October 31, will also affect bond yields. Unlike the mini-budget, this plan will come with an in-depth assessment from the OBR, giving markets more information. Plus, the current chancellor, Jeremy Hunt, has brought some of the fiscal plan measures forward to ease market concerns. </p>
<p>It’s still unclear what kind of plan it will be, however. A debt-cutting strategy from Hunt and the new government headed by Rishi Sunak should assure the markets about the UK’s fiscal stability, but it’s still unknown whether this would happen via more taxes or less spending. Some <a href="https://academic.oup.com/oep/article/73/1/317/5612127?login=true">evidence</a> on what would be best for the economy supports raising capital income taxes (capital gains tax and inheritance tax) rather than cutting public spending or raising income taxes.</p>
<p>In the long term, the UK’s major problems are stagnating growth and lack of productivity. And if the new government addresses current problems by raising taxes and cutting spending – alongside <a href="https://www.theguardian.com/business/2022/oct/20/interest-rates-unlikely-to-rise-5-bank-of-england-ben-broadbent">higher interest rates</a> from the Bank of England – there will be more economic pain. </p>
<h2>Changing global economy</h2>
<p>Many countries are suffering similar issues to the UK, contributing to a weak <a href="https://www.imf.org/en/Blogs/Articles/2022/10/11/policymakers-need-steady-hand-as-storm-clouds-gather-over-global-economy?fbclid=IwAR3Gbb9uQgMwrIY2JzNPAeSDOmxlukLONbmBJ65rwI0CJ1Oob2jUXBUM6tU">global economic outlook</a> in general right now. After a prolonged period of historically <a href="https://www.bis.org/statistics/cbpol.htm">ultra-low interest rates</a>, increases – so-called normalisation of monetary policy – were <a href="https://data.oecd.org/interest/short-term-interest-rates-forecast.htm">expected</a> in most countries. But a sharp surge in inflation due to Russia’s invasion of Ukraine and pandemic-era supply chain issues have caused most central banks to scramble to <a href="https://www.ft.com/content/2496105a-d211-4abe-ab5d-46a91876428f">tighten monetary policy</a> even further by increasing rates more rapidly. </p>
<p><strong>Recent rate changes by central banks</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing changes in central bank base rates over the past decade, with a sharp rise in early 2022." src="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=275&fit=crop&dpr=1 600w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=275&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=275&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=346&fit=crop&dpr=1 754w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=346&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/491648/original/file-20221025-18-seyy2h.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=346&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Interest rate changes by central banks in the UK, Japan, the US and the Eurozone between October 2012 and October 2022.</span>
<span class="attribution"><span class="source">Author's chart using Bank for International Settlements data.</span></span>
</figcaption>
</figure>
<p>These rate hikes and policy tightening strategies by central banks could create significant financial and fiscal instability. Already, the US Federal Reserve’s unwinding of its balance sheet from a peak of <a href="https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm">US$8.97 trillion</a> (£7.9 trillion) in April 2022, for example, caused the dollar to appreciate by more than <a href="https://www.marketwatch.com/investing/index/dxy">13%</a> in the last six months. This has created <a href="https://www.imf.org/en/Blogs/Articles/2022/01/10/blog-emerging-economies-must-prepare-for-fed-policy-tightening">challenges</a> for emerging market currencies, as well as major currencies – the yen, pound sterling and the euro – which have all <a href="https://www.x-rates.com/graph/?from=USD&to=EUR&amount=1">depreciated considerably</a> against the US dollar. </p>
<p>This has added to inflationary pressures, particularly in the Eurozone and UK, but it also affects <a href="https://www.ft.com/content/70e43592-30d0-4348-916b-673910ad7726">sovereign bond yields</a>, challenging economic stability in these countries. Since August, the cost of borrowing has more than doubled for many.</p>
<p><strong>The rising cost of government borrowing</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line graph showing the rising cost of borrowing in recent months for governments in the UK, US, Germany, Italy, Canada, France and Greece." src="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=335&fit=crop&dpr=1 600w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=335&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=335&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=421&fit=crop&dpr=1 754w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=421&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/491626/original/file-20221025-24-m5716u.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=421&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">10-year sovereign bond yields from August to October 2022.</span>
<span class="attribution"><span class="source">Author's chart using Thomson Reuters data.</span></span>
</figcaption>
</figure>
<p>But to address rising inflation, even more central banks will want to shrink their balance sheets by selling bonds. The total size of the asset purchase programmes of the main four central banks alone is about <a href="https://www.atlanticcouncil.org/global-qe-tracker/">US$26.7 trillion</a>. With a weak global economy and these other financial fragilities, this is going to be a <a href="https://www.omfif.org/2022/10/central-banks-struggle-to-reduce-bloated-balance-sheets/">painful exercise</a> for the global economy. </p>
<p>Indeed, such tightening will increase the cost of government borrowing further, creating major issues, particularly for <a href="https://data.oecd.org/gga/general-government-debt.htm">highly leveraged</a> governments, and those still paying off <a href="https://www.brookings.edu/blog/future-development/2021/10/20/navigating-the-debt-legacy-of-the-pandemic/">pandemic-era</a> support such as the UK and Eurozone. </p>
<p>The UK specifically, is also dealing with a shift in the <a href="https://onlinelibrary.wiley.com/doi/10.1111/j.1758-5899.2010.00066.x">global economic centre of gravity</a> away from its economy. In less than two decades, the UK has shrunk in relative terms from being an economy larger than China to being about <a href="https://www.imf.org/external/datamapper/PPPGDP@WEO/OEMDC/ADVEC/WEOWORLD">nine times</a> smaller. And the pound no longer enjoys the same status as the US dollar, meaning financial markets will <a href="https://www.reuters.com/markets/europe/sterling-falls-fifth-day-turmoil-dogs-bond-market-2022-10-11/">punish it severely</a> if it steps out of line.</p>
<p>This means the new UK government faces a tricky task in reigniting global investor confidence in its economic stability, even with a new prime minister widely seen as a <a href="https://www.ft.com/content/465f2031-84ba-4faa-9f46-c3265166d973">steady hand</a>.</p><img src="https://counter.theconversation.com/content/192823/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Muhammad Ali Nasir does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The new government faces both short- and long-term problems when trying to reignite investor confidence in the UKMuhammad Ali Nasir, Associate Professor in Economics, University of LeedsLicensed as Creative Commons – attribution, no derivatives.