tag:theconversation.com,2011:/us/topics/us-federal-reserve-256/articlesUS Federal Reserve – The Conversation2024-02-26T17:19:21Ztag:theconversation.com,2011:article/2240922024-02-26T17:19:21Z2024-02-26T17:19:21ZWhy economists are warning of another US banking crisis<p>March 2024 is <a href="https://www.barrons.com/articles/nycb-bank-failures-fed-btfp-0798fa18">making investors nervous</a>. A major scheme to prop up the US banking system is ending, while a second may be winding down. <a href="https://tavexbullion.co.uk/finnish-economist-who-predicted-the-spring-banking-crisisnew-bank-runs-are-coming/">Some economic commentators fear</a> another banking crisis. So how worried should we be?</p>
<p>The red letter day is March 11, when US central bank the Federal Reserve will end the <a href="https://www.investopedia.com/bank-term-funding-project-7367897">bank term funding program (BTFP)</a>, a year after it began in response to the failures of regional banks Signature, Silvergate and Silicon Valley. These banks were brought down by customers withdrawing deposits en masse, both because many were tech or crypto businesses that needed money to cover losses, and because there were better savings rates available elsewhere. </p>
<p>This damaged the banks’ profitability at a time when raised interest rates had already weakened their balance sheets by reducing the value of their holdings in government bonds. Silvergate failed first but Silicon Valley Bank’s collapse on March 10 was particularly memorable. It triggered a bank run <a href="https://www.reuters.com/business/finance/silicon-valley-bank-sell-stock-cope-with-cash-burn-2023-03-09/">by announcing</a> it needed to raise capital after being forced to sell bonds at a loss. </p>
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<a href="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Screenshot of WSJ's front cover when Silicon Valley collapsed" src="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=442&fit=crop&dpr=1 600w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=442&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=442&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=556&fit=crop&dpr=1 754w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=556&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/577942/original/file-20240226-28-jfojgh.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=556&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">Silicon Valley Bank’s demise put investors on high alert.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/march-10-2023-silicon-valley-bank-2274268829">Domenico Fornas</a></span>
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<p>There soon followed the failures <a href="https://www.forbes.com/sites/brianbushard/2023/03/13/what-happened-to-signature-bank-the-latest-bank-failure-marks-third-largest-in-history/">of Signature</a> and also Swiss bank <a href="https://edition.cnn.com/2023/04/24/investing/credit-suisse-bank-withdrawals-total/index.html">Credit Suisse</a>, which had to be taken over by <a href="https://www.ubs.com/global/en/media/display-page-ndp/en-20230612-ubs-credit-suisse-acquisition.html">neighbouring giant UBS</a>. There had been longstanding problems at Credit Suisse, but heightened anxieties on the back of the US upheaval delivered the final blow. </p>
<h2>How the BTFP works</h2>
<p>Investors then feared that other banks would fail. Most US banks were similarly exposed to customer withdrawals and underwater bond portfolios, while the Credit Suisse collapse demonstrated the potential for contagion. The Fed’s BTFP stopped the panic by allowing US banks to borrow from the central bank using their bonds as collateral. </p>
<p>Not only did this let them quietly access more funding, the scheme also priced the bonds at their original face value and not market value. This effectively negated the interest rate rises and reinflated banks’ balance sheets. Only one more bank, San Francisco’s <a href="https://www.forbes.com/sites/dereksaul/2023/05/01/first-republic-bank-failure-a-timeline-of-what-led-to-the-second-largest-bank-collapse-in-us-history/">First Republic Bank</a>, has since gone under. </p>
<p>So what will happen as the BTFP closes? I suspect it won’t lead to more bank collapses. Banks have had another year to adjust to higher interest rates, plus they can still borrow from the Fed through another facility called the <a href="https://www.investopedia.com/terms/d/discountwindow.asp">discount window</a>. </p>
<p>Nonetheless, the BTFP’s closure is <a href="https://www.bloomberg.com/news/articles/2023-12-21/demand-for-fed-s-bank-term-funding-facility-grows-to-record-high">likely to increase</a> banks’ borrowing costs, meaning their profit margins will fall. They might react with higher lending rates or by making less credit available to customers, potentially weakening the economy. This could combine with a second foreseeable change to create new dangers for the sector. </p>
<h2>Quantitative tightening</h2>
<p>That second change relates to the <a href="https://theconversation.com/why-central-banks-are-too-powerful-and-have-created-our-inflation-crisis-by-the-banking-expert-who-pioneered-quantitative-easing-201158">quantitative easing (QE) programme</a> by the Fed and other central banks, which broadly dates from the global financial crisis of 2007-09. It saw central banks essentially creating new money and using it to buy government bonds and other financial assets. They added more reserves to high-street banks as part of this process, enabling these institutions to lend more money as a result. </p>
<p>The most recent leg of QE <a href="https://www.brookings.edu/articles/fed-response-to-covid19/">began in March 2020</a> in response to the pandemic, then ended in 2022, when central banks began a reverse programme called quantitative tightening (QT). This involves selling bonds and other assets and removing the proceeds from the financial system. </p>
<p>It should be a drag on the economy, yet the effects have been tempered by a facility known as the overnight reverse repurchase agreement or “overnight reverse repo”. This essentially enables financial institutions to deposit their excess cash overnight with their central bank in exchange for government bonds. They earn extra money at very low risk, injecting more liquidity into the system. </p>
<p>The facility was extremely popular during the period of QE and ultra-low interest rates because these injected so much cash into the system. Its use <a href="https://www.reuters.com/markets/rates-bonds/new-york-fed-inflows-reverse-repo-facility-surge-hitting-1018-trillion-2023-12-29/#:%7E:text=The%20facility%20has%20seen%20big,30%2C%202022.">has been falling</a> since late 2022, since central banks have fewer bonds to lend while institutions have less money to park overnight. </p>
<p>Daily balances at the Fed’s overnight reverse repo <a href="https://www.reuters.com/markets/us/focus-sharpens-feds-disappearing-reverse-repo-mcgeever-2024-01-17/">have fallen</a> from over US$2.2 trillion (£1.7 trillion) in mid-2023 to below US$600 billion in January. However, while the positive balance continues, it offsets the need for the Fed to remove bank reserves as part of QT, since the bonds flowing out under that scheme are being partially replaced by bonds flowing in through the overnight reverse repo. </p>
<p>Only when the reverse repo balance reaches very low levels will the system feel the full effect of QT. At this stage, the Fed <a href="https://www.fitchratings.com/research/sovereigns/federal-reserve-to-continue-running-down-assets-until-end-2024-15-02-2024">has indicated</a> it will slow and then end that programme. </p>
<p>Nonetheless, the transition could be bumpy, with banks potentially raising lending rates and becoming less willing to lend. Many analysts expect the buffer to disappear in 2024, with a range of predictions from <a href="https://www.fitchratings.com/research/sovereigns/federal-reserve-to-continue-running-down-assets-until-end-2024-15-02-2024">late in the year</a> to as <a href="https://cryptohayes.medium.com/signposts-693ba565cd3e">soon as March</a>. </p>
<h2>Risky times</h2>
<p>Heightened interest rates <a href="https://www.federalreserve.gov/data/sloos/sloos-202401.htm">have already led</a> to the most stringent credit standards and weakest loan demand from consumers and businesses in a long time in the US. Meanwhile, banks are dealing with other major challenges such as the plunge in demand for office space as a result of home working. This has brought the medium-sized <a href="https://www.reuters.com/markets/us/real-estate-pain-us-regional-banks-is-piling-up-say-investors-2024-02-12/">New York Community Bank</a> to the brink in recent weeks, for instance. </p>
<p>The closure of the BTFP and the end of the reverse repo buffer, particularly if they coincide, could clearly make banks even more risk averse and profit-hungry. The danger is that this all damages the economy to the point that bad debts pile up and we hit another 2008-style liquidity crisis where banks become wary of lending to one another and the weaker ones become unviable. </p>
<p>The recent geopolitical tensions are an additional danger. If cross-border credit and investments dried up, it might further increase the risks of bad debts and could again hit bond prices, further reducing the value of banks’ assets and making their borrowing more expensive. </p>
<p>The Fed and other central banks need to be alert to these rising risks and get ready to end QT in the near future. The end of the BTFP is unlikely to put banks out of business, but it could be one of a series of blows that kicks off a new crisis in the months ahead.</p><img src="https://counter.theconversation.com/content/224092/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ru Xie 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 Ides of March will coincide with one or two changes to the financial system that could cause problems for banks and the economy.Ru Xie, Associate Professor in Finance, University of BathLicensed 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/2209892024-01-11T23:03:10Z2024-01-11T23:03:10ZWhen can we stop worrying about rising prices? The latest inflation report offers no easy answers<figure><img src="https://images.theconversation.com/files/568931/original/file-20240111-29-4eets5.jpg?ixlib=rb-1.1.0&rect=0%2C6%2C2136%2C1389&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Aisle be damned! Inflation is proving stubborn as the economy moves into 2024.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/handsome-asian-male-searching-for-groceries-from-royalty-free-image/1437990851?phrase=inflation+worry&adppopup=true">miniseries via Getty Images</a></span></figcaption></figure><p><em>Tired of thinking about inflation’s impact on your wallet? You’re not alone. But like it or not, higher prices continue to be an economic and – with the presidential race – a political issue as we enter the early months of 2024.</em></p>
<p><em>The Conversation asked two <a href="https://www.sciencedirect.com/science/article/pii/S0929119921002406">financial economists</a>, <a href="https://scholar.google.com/citations?user=VxWst50AAAAJ">D. Brian Blank</a> at Mississippi State University and Appalachian State University’s <a href="https://scholar.google.com/citations?user=FKJSqjEAAAAJ">Brandy Hadley</a>, what they make of the <a href="https://www.bls.gov/news.release/cpi.toc.htm">inflation report</a> that dropped on Jan. 11, 2024, and whether there might be a time before too long when we can all stop worrying about increasing costs.</em></p>
<h2>Was inflation higher or lower in December 2023?</h2>
<p>Both, unfortunately. </p>
<p><a href="https://www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html">Economists have many ways</a> of measuring how prices change over time. Two key measures are overall, or “headline,” inflation, which tracks the prices for a basket of goods and services, and “core” inflation, which tracks many of the same items but excludes those with unusually jumpy prices, such as gasoline. </p>
<p>In the Bureau of Labor Statistics’ Jan. 11 report, which measured how much prices changed in December 2023, these indicators <a href="https://www.bls.gov/news.release/pdf/cpi.pdf">moved in different directions</a>. In other words, the higher one, core CPI – short for consumer price index – declined from an annual rate of 4% in November to 3.9% in December. And the lower one, headline inflation, rose from 3.1% to 3.4%.</p>
<p>While previously <a href="https://twitter.com/LizAnnSonders/status/1745448037105963151/photo/1">falling prices</a> for clothing, alcohol, new vehicles and gas <a href="https://twitter.com/LizAnnSonders/status/1745448037105963151">reversed course</a> in December, core inflation finally fell below 4.0%.</p>
<h2>But what does all this inflation confusion mean?</h2>
<p>What everyone wants to know is when will inflation go back to normal, or at least closer to the Federal Reserve’s target of 2%. And while no one knows the answer, <a href="https://fortune.com/2023/12/15/congressional-budget-office-inflation-unemployment-2024-2025/">there are reasons to believe</a> <a href="https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value_month=202401">it may</a> <a href="https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_real_yield_curve&field_tdr_date_value_month=202401">happen soon</a>.</p>
<p>At this point, people should be <a href="https://www.goldmansachs.com/intelligence/pages/gs-research/macro-outlook-2024-the-hard-part-is-over/report.pdf">less worried about inflation</a> than they were in December 2022, when the <a href="https://fred.stlouisfed.org/graph/?g=rocU">headline figure was 6.4%</a>. While inflation is still higher than we have gotten used to over the past decade, it’s much lower than it has been over the past couple of years. </p>
<p>Hopefully, that indicates the Federal Reserve is <a href="https://www.usbank.com/investing/financial-perspectives/market-news/federal-reserve-tapering-asset-purchases.html">approaching the end of its battle</a> with inflation and may be able to <a href="https://newsroom.bankofamerica.com/content/newsroom/press-releases/2023/11/bofa-global-research-calls-2024--the-year-of-the-landing--.html">finally lower interest rates</a> later this year. Over the past two years, the <a href="https://www.cnbc.com/2023/12/13/the-federal-reserve-held-rates-steady-heres-what-that-means-for-you.html">central bank has raised rates 11 times</a> to tame consumer demand and prices.</p>
<p>But concerns remain about inflation persisting. <a href="https://www.gzeromedia.com/podcast/podcast-trouble-ahead-the-top-global-risks-of-2024">One risk factor</a> is <a href="https://www.lazard.com/research-insights/global-outlook-2024/">the impact that conflicts</a> in <a href="https://www.ssga.com/library-content/assets/pdf/global/global-market-outlook/2023/gmo-2024-full.pdf">Ukraine and now the Middle East</a> will have <a href="https://www.privatebank.bankofamerica.com/articles/what-rising-geopolitical-tensions-could-mean-for-the-markets-and-economy.html">on trade routes</a>, such as <a href="https://www.cnbc.com/2024/01/11/red-sea-crisis-could-jeopardize-inflation-fight-as-shipping-costs-spike-globally.html">those in the Red Sea</a>. Another area of concern may be <a href="https://twitter.com/biancoresearch/status/1745502587854709054/photo/1">home prices</a>, which builder <a href="https://finance.yahoo.com/quote/KBH/">KB Homes</a> reports <a href="https://www.barrons.com/articles/kb-homes-fourth-quarter-earnings-outlook-eb236fe0">may be rising more this year</a>.</p>
<p>Those worries could lead the Fed to wait <a href="https://abcnews.go.com/Business/inflation-expected-risen-slightly-december/story?id=106222654">just a bit longer</a> to make any big decisions on <a href="https://twitter.com/LizYoungStrat/status/1745495575070429639/photo/1">whether to ease off</a> the brakes any time soon.</p>
<h2>So why did headline inflation tick higher?</h2>
<p>Overall inflation came in higher than forecasts largely due to <a href="https://www.wsj.com/livecoverage/stock-market-today-cpi-report-inflation-01-11-2024/card/the-rent-is-too-damn-high-jCrjio72Nbm7L0TEaonc">the rising price of housing</a>.</p>
<p>Rent accounts for a <a href="https://www.reuters.com/markets/us/us-consumer-prices-unexpectedly-rise-november-2023-12-12/">huge part of inflation</a>, since it’s one of many people’s largest expenses. However, CPI is calculated using rental data over the past year, which means the <a href="https://en.macromicro.me/collections/5/us-price-relative/49740/us-cpi-rent-zillow-rent-yoy">data lags behind real-time rent changes</a>. What’s more, real estate marketplace Zillow’s estimates of rent <a href="https://www.zillow.com/research/december-2023-rent-report-33579/">are falling</a> – a trend that’s expected to continue as <a href="https://twitter.com/jayparsons/status/1742925447409947099/photo/1">more apartments are built this year</a>.</p>
<h2>What matters to people: Prices or inflation?</h2>
<p>Even though inflation is slowing, costs are <a href="https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator/consumer-price-index-1913-">18% higher than four years ago</a> and aren’t falling, which makes many people less optimistic about the economy than before the pandemic.</p>
<p>Some Wall Street forecasters and economists <a href="https://theconversation.com/economic-lookahead-as-we-ring-in-2024-can-the-us-economy-continue-to-avoid-a-recession-220007">struggle to understand people’s concerns</a> when labor markets are strong and the <a href="https://www.bnymellonwealth.com/content/dam/bnymellonwealth/pdf-library/articles/BNY_CMA_V4.4_21Nov2023.pdf">stock market is rising</a>. Still, consumer prices are near <a href="https://www.bls.gov/news.release/cpi.nr0.htm">all-time highs</a>, which is neither exciting for most people nor surprising to economists given that prices typically rise over time.</p>
<p>Despite high expenses, people still have a <a href="https://www.troweprice.com/content/dam/iinvestor/resources/insights/pdfs/tectonic-shifts-create-new-opportunities.pdf">degree of disposable income</a>. The cost <a href="https://wpde.com/news/nation-world/groceires-vs-going-out-what-may-be-behind-the-price-difference-consumer-price-index-food-home-away-sean-snaith-economic-forecasting-grocery-cost-servers-restaurants-wages-pay-thanskgiving-dinner">to eat out continues</a> to increase three times as fast as the <a href="https://www.businessinsider.com/food-prices-cheapest-option-groceries-restaurants-fast-food-2023-12">cost to eat at home</a>, which is both one of the largest differences on record and evidence that people <a href="https://www.pymnts.com/economy/2023/budget-constrained-consumers-prioritize-dining-out/">still have income to spend eating out</a>. </p>
<p>That shows the <a href="https://twitter.com/ConversationUS/status/1742516107133558804">mismatch between consumer behavior and “vibes”</a>: Americans <a href="https://fred.stlouisfed.org/series/CPIRECSL">have the money</a> to travel and go to restaurants, but still complain about <a href="https://www.bls.gov/news.release/cpi.t02.htm">airfare and menu prices</a>. </p>
<h2>When can we stop talking about inflation?</h2>
<p>We may have to wait until people stop feeling the <a href="https://www.privatebank.citibank.com/doc/investments/outlook/Citi_Wealth-Outlook-2024.pdf.coredownload.inline.pdf">inflation impacts</a> before they stop wanting to complain about it – and focus on it – each month. Could the Fed stop the inflation preoccupation <a href="https://saf.wellsfargoadvisors.com/emx/dctm/Research/wfii/wfii_reports/Investment_Strategy/outlook_report.pdf">by lowering rates</a>? Or does the Fed need to <a href="https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/mi-investment-outlook-uk-en.pdf">hold rates higher</a> for longer? <a href="https://www.morganstanley.com/ideas/global-investment-strategy-outlook-2024">Only time will tell</a>.</p><img src="https://counter.theconversation.com/content/220989/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>Two important inflation indicators are trending in different directions. What gives?D. Brian Blank, Associate Professor of Finance, Mississippi State UniversityBrandy Hadley, Associate Professor of Finance and the David A. Thompson Distinguished Scholar of Applied Investments, Appalachian State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2198572023-12-19T16:54:29Z2023-12-19T16:54:29ZInterest rates have stopped rising, but 2023 hikes could still cause recession for some economies<figure><img src="https://images.theconversation.com/files/566140/original/file-20231217-29-oomab8.jpg?ixlib=rb-1.1.0&rect=40%2C17%2C2946%2C1949&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central banks in the US, UK and Europe have been trying to slow inflation without creating a recession.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/inflation-reduction-act-by-fed-federal-2218228849">eamesBot/Shutterstock</a></span></figcaption></figure><p>Central banks on both sides of the Atlantic kept their main interest rates unchanged for the fourth successive month in December 2023. These rates are closely watched because they set the minimum interest at which your bank borrows and lends. This determines the cost of credit for all firms and households with mortgages or other loans. </p>
<p>The European Central Bank (ECB), the US Federal Reserve and the UK Bank of England have raised interest rates sharply since the start of 2022. This was in response to a surge in inflation – the annual increase in consumer prices – far above the 2% rate that all these central banks now target. </p>
<p>But UK inflation is taking longer to respond than that of the US or EU. This has renewed debate over <a href="https://theconversation.com/interest-rate-hikes-are-not-the-only-tool-to-fight-uk-inflation-heres-what-the-government-should-do-208697">whether rate cuts are the best or only way</a> to keep inflation under control. It has also caused a shift in opinions about which western economies are most at risk of recession in 2024.</p>
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Read more:
<a href="https://theconversation.com/is-the-uk-in-a-recession-how-central-banks-decide-and-why-its-so-hard-to-call-it-191237">Is the UK in a recession? How central banks decide and why it's so hard to call it</a>
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<p>Higher interest rates are designed to subdue inflation by reducing the amount people spend. Businesses and households are expected to save more when rates rise, in anticipation of greater interest payments (<a href="https://theconversation.com/interest-rates-why-your-mortgage-payments-are-going-up-but-your-savings-arent-and-how-better-monetary-policy-could-help-196528">although that doesn’t always happen</a>). It’s also hoped they’ll borrow less because of the extra interest they would be charged. Those with outstanding loans are left with less to spend on goods and services after paying their interest bill. </p>
<p>Governments are also affected. In the UK, interest on around a quarter of government debt is now <a href="https://www.nao.org.uk/press-releases/managing-government-borrowing/#:%7E:text=The%20type%20of%20debt%20that,to%20lenders%20rise%20with%20inflation.">linked to inflation</a>. This means more of the budget gets channelled into interest payments, leaving less to spend on public services, when the central bank raises rates.</p>
<p>This restraint doesn’t happen immediately, however. When borrowers take out fixed-rate loans, they aren’t affected by higher base rates until the deal expires. Almost a million UK borrowers, for example, are still on fixed rates of 2% or below that will only <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/housing/articles/howincreasesinhousingcostsimpacthouseholds/2023-01-09">come up for renewal</a> – at current, higher rates – in the first quarter of 2024. The resulting delay of a year or more before past interest rate rises kick in makes it hard for central bankers to know when they’ve raised rates enough to cool the economy.</p>
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Read more:
<a href="https://theconversation.com/uk-bonds-have-hit-a-25-year-high-heres-what-that-means-for-the-economy-215188">UK bonds have hit a 25-year high – here's what that means for the economy</a>
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<p>Raising interest rates can also restrain inflation by encouraging foreign investors to buy bonds and other financial assets in a country’s currency. The resulting inflow of capital is likely to strengthen its exchange rate. This makes imports cheaper and can help to slow the overall rise in prices. </p>
<p>A stronger currency is especially effective for curbing inflation for economies that consume a high proportion of imports, such as the UK. But it also hurts exporters, and only works if interest rates rise above those of comparable economies. This may be one reason why the Bank of England has raised its interest rates faster and further than the ECB since February 2022.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing the main central bank rates for UK, US, Europe staying low from 2012-2016 (except the US) and then rapidly rising at the end of 2021. Also shows Japan, which has stayed low thoughout." src="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566141/original/file-20231217-15-zjp7ej.jpeg?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"></a>
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<span class="attribution"><a class="source" href="https://www.statista.com/chart/21070/main-policy-interest-rates-in-selected-countries-and-regions/">Statista</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<h2>Divergence ahead</h2>
<p>Although they hiked rates in similar fashion in 2022-23, these central banks are set to go different ways in 2024. </p>
<p>US rates are set to fall as inflation drops back towards the 2% target, having already slowed to 3.1% in November 2023 (from 6.4% in January). The US Federal Reserve has signalled two likely interest rate reductions, totalling 0.75%, in 2024. That’s falling into line with investors’ expectations, which can be gauged by the prices they’re prepared to pay for <a href="https://www.chathamfinancial.com/insights/what-is-a-forward-curve">trading or swapping</a> debt due at a future date and by interest rates on <a href="https://data.oecd.org/interest/long-term-interest-rates-forecast.htm">government bonds that mature several years from now</a>.</p>
<p>While the ECB’s forward guidance is less clear, its governor <a href="https://www.ecb.europa.eu/press/pressconf/2023/html/ecb.is231214%7Edf8627de60.en.html">has hinted at</a> a similar downward path in 2024 because projections now point to headline inflation dropping to 2.1% in 2025 – a year earlier than previously predicted. Eurozone inflation has already slowed sharply, to 2.4% in November from 8.5% in February 2023, despite the ECB keeping its interest rates lower than the US and UK throughout the recent tightening phase. That’s largely because, even though member states set their own fiscal policy, EU rules keep them on <a href="https://economy-finance.ec.europa.eu/system/files/2023-04/COM_2023_240_1_EN.pdf">a tight rein</a> when it comes to spending and debt levels.</p>
<p>In contrast the Bank of England has warned that its base rate, already higher than the EU’s, is likely to stay at 5.25% <a href="https://www.ft.com/content/6425c756-0ff7-42f3-9022-01be30da07fd">“for an extended period of time”</a>. Inflation (on its targeted consumer price index) slowed to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">4.6% in October</a>, well down from its peak above 11% in October 2022, but the average household is braced for more cost of living increases including <a href="https://www.gov.uk/government/publications/energy-bills-support/energy-bills-support-factsheet-8-september-2022">a mid-winter 5% rise</a> in the energy price cap. The recent <a href="https://www.cnbc.com/2023/10/03/sterling-had-its-worst-month-for-a-year-and-it-may-fall-further.html">weakening of the pound</a> against the dollar has also added to industries’ raw material costs, and could worsen if UK interest rates fall too soon. </p>
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<strong>
Read more:
<a href="https://theconversation.com/inflation-has-affected-the-uk-us-and-europe-differently-heres-what-this-means-for-interest-rates-218561">Inflation has affected the UK, US and Europe differently – here's what this means for interest rates</a>
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<h2>Recession threat isn’t over</h2>
<p>The UK economy, while hardly growing this year, has defied the Bank’s earlier <a href="https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022">forecast of a recession</a> from the end of 2022. But because this encouraged the bank into another near-doubling of base rates – from 2.25% in October 2022 to 5.25% from August 2023 – a UK recession in 2024 is still <a href="https://www.fitchsolutions.com/bmi/country-risk/uk-recession-2024-sluggish-rebound-bond-rollovers-take-their-toll-27-10-2023">expected by some commentators</a>. Unfortunately, consumer spending has been <a href="https://www.imf.org/en/Publications/selected-issues-papers/Issues/2023/07/13/Enhancing-Business-Investment-in-the-United-Kingdom-536320">less affected</a> by higher borrowing costs than private and public investment, which ultimately drive economic growth. </p>
<p>More ominously for US president Joe Biden, current interest rate patterns suggest the US could also be <a href="https://www.usbank.com/investing/financial-perspectives/market-news/treasury-yields-invert-as-investors-weigh-risk-of-recession.html">heading for recession</a> in a presidential election year. Most US GDP forecasts for 2024 remain in the 1.5-2.0% range, but that’s well down from the <a href="https://www.bea.gov/news/2023/gross-domestic-product-third-quarter-2023-advance-estimate">4.9% reached in third-quarter 2023</a>. Against this backdrop, the eurozone’s official forecast of <a href="https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts/autumn-2023-economic-forecast-modest-recovery-ahead-after-challenging-year_en">1.2% growth in 2024</a> could be seen as a relatively strong performance since it’s not expected to slow as much as the US is predicted to in 2024.</p>
<p>So, borrowers already hit by higher costs can expect some relief in 2024. But that’s partly due to growing concern that, with <a href="https://blogs.worldbank.org/developmenttalk/commodity-markets-outlook-eight-charts-0">falling global commodity prices</a> already helping to subdue inflation, central bankers may have applied the brakes too hard since 2022, endangering a global recovery.</p><img src="https://counter.theconversation.com/content/219857/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>Market expectations for rate cuts sooner rather than later have been dashed but some economies remain in danger of recession.Alan Shipman, Senior Lecturer in Economics, The Open 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">
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<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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<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">
<figcaption>
<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/2182252023-11-21T10:08:58Z2023-11-21T10:08:58ZWhy further RBA rate hikes are less likely now than even 1 week ago<figure><img src="https://images.theconversation.com/files/560651/original/file-20231121-19-d1cauc.png?ixlib=rb-1.1.0&rect=878%2C761%2C2660%2C1388&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Since Australia’s Reserve Bank hiked interest rates two weeks ago, there have been two important developments – one in the United States and the other in the United Kingdom.</p>
<p>If it’s not clear to you why events overseas influence Australia’s interest rates, which are meant to be set to control Australian inflation, read on.</p>
<h2>US and UK inflation close to zero</h2>
<p>We haven’t been complete masters of our own destiny since the Australian dollar was floated <a href="https://www.smh.com.au/business/inside-the-floating-of-the-a-20131211-2z6ic.html">40 years ago next month</a>.</p>
<p>What happened in the US last Tuesday was news of dramatically lower US inflation. When increases and decreases in prices were taken together, overall US prices moved not at all in the month of October. That’s right, inflation was <a href="https://www.bls.gov/news.release/cpi.nr0.htm">zero</a>.</p>
<p>While zero movement in one month doesn’t mean zero over the entire year, it helps bring down the rate over the entire year. US inflation fell from 3.7% in the year to September to <a href="https://www.bls.gov/news.release/cpi.nr0.htm">3.2%</a> in the month to October.</p>
<p>Then the next day we got similar news from the UK. </p>
<p>Taken together, prices in the United Kingdom scarcely grew at all in October, climbing just <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">0.1%</a>. The screeching halt to UK monthly inflation took the annual rate down from 6.7% for the year to September to <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2023">4.6%</a> for the year to October.</p>
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<p>In both the <a href="https://www.smh.com.au/business/the-economy/mission-accomplished-fed-s-inflation-success-raises-hopes-for-rba-20231115-p5ek2k.html">US</a> and the <a href="https://www.reuters.com/markets/rates-bonds/bank-englands-pill-says-central-bank-may-be-able-reconsider-rates-stance-next-2023-11-06/">UK</a>, there’s talk there will be no need for further interest rate hikes, and very probably a case for interest rate cuts as soon as next year.</p>
<p>We don’t yet know what happened to Australia’s inflation rate in October – the Bureau of Statistics will tell us next week.</p>
<p>But we have an early indication.</p>
<p>The Melbourne Institute inflation gauge, which roughly tracks the bureau’s measure, <a href="https://tradingeconomics.com/australia/mi-inflation-gauge-mom">fell 0.1%</a> in October. If that is what the bureau finds – that overall prices barely moved (or fell) in October – Australia’s annual inflation rate should fall from 5.6% for the year to September to around 5.2% for the year to October. </p>
<h2>Inflation down all over</h2>
<p>All over the world, inflation is falling for much the same set of reasons: the price of oil is heading back down after Saudi Arabia and Russia tried to <a href="https://www.bbc.com/news/business-65804768">restrict supply</a> in the middle of the year, and the price pressures caused by shortages are easing.</p>
<p>As Australia’s Reserve Bank conceded in the <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2023/2023-11-07.html">minutes</a> of the November board meeting, in which it pushed up rates, there has been “an easing in supply chain pressures and raw materials prices”.</p>
<p>Not that this means the bank is relaxed about what’s happening to inflation; far from it.</p>
<p>In the minutes released on Tuesday and in <a href="https://rba.livecrowdevents.tv/MicheleBullockGovernorattheASICAnnualForum21nov/stream">remarks delivered at a conference</a> ahead of their release, Governor Michele Bullock said what concerned her was stronger-than-expected <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2023/2023-11-07.html">demand pressures</a>. Australians remained keen to spend.</p>
<p>And she drew attention to disturbing</p>
<blockquote>
<p>growing signs of a mindset among businesses that any cost increases could be passed onto consumers </p>
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<p>But what has just happened overseas will help, big time. Here’s why.</p>
<h2>Australians’ buying power just jumped</h2>
<p>As soon as the news of low US inflation came out last Tuesday, the US dollar <a href="https://www.reuters.com/markets/currencies/yens-slide-multi-decade-lows-keeps-markets-intervention-alert-2023-11-14">slid</a>. </p>
<p>Investors became less keen to hold US dollars when it became less likely that US interest rates would rise further, and a good deal more likely they would fall.</p>
<p>Against the Australian dollar, the US dollar fell 2%. From an Australian’s point of view, the buying power of an Australian dollar jumped from 63.7 to 64.9 US cents and has since jumped to 65.8 US cents. </p>
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<p><strong>A sudden jump in the value of the Australian dollar</strong></p>
<hr>
<p>This means that, for as long as it lasts, Australian dollars will buy more than they did. </p>
<p>Australians will pay less in Australian dollars for the goods and services ultimately paid for with US dollars. The changed interest rate outlook in the US will act to keep Australian prices low.</p>
<p>In this way, decisions made in the US not to increase interest rates or even to cut them make it easier for Australia’s Reserve Bank not to increase rates – or even to cut them.</p>
<h2>A higher dollar means lower inflation</h2>
<p>The effect isn’t big. The RBA believes it takes a 10% change in the value of the Australian dollar to move the Australian
inflation rate <a href="https://www.afr.com/markets/debt-markets/diverging-rate-outlook-turbocharges-a-as-us-inflation-eases-20231115-p5ek13">0.4 percentage points</a>.</p>
<p>But it is better than things moving in the other direction, which is what has been happening until now. </p>
<p>For more than a year now, whenever interest rates have climbed in the US, Australia’s Reserve Bank has been under pressure to push up its rates to stop the Australian dollar falling and prices climbing.</p>
<p>No longer. After last week’s news from the US and the UK, Australian financial markets began pricing in a <a href="https://www.asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker">close to zero</a> chance of further interest rate rises – with a fair chance of a rate cut next year.</p>
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<em>
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Read more:
<a href="https://theconversation.com/why-its-a-good-bet-the-melbourne-cup-day-rate-hike-will-be-the-last-217094">Why it's a good bet the Melbourne Cup Day rate hike will be the last</a>
</strong>
</em>
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<p>It’s always impossible to tell for sure what the Reserve Bank will do to rates. A lot will depend on what actually happens to inflation. </p>
<p>But for the first time in a long time, the Reserve Bank has tail winds from overseas, rather than headwinds.</p>
<p>For the first time in a long time, the bank won’t feel pressured to push up rates just because rates have been pushed up overseas.</p><img src="https://counter.theconversation.com/content/218225/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin is Economics Editor of The Conversation. </span></em></p>Australian financial markets are now pointing to a close to zero chance of further rate rises – with a fair chance of a rate cut next year. That’s thanks to the latest news from the US and UK.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2175232023-11-19T07:53:40Z2023-11-19T07:53:40ZKenya’s stock market has suffered steepest losses in the world: an expert view on why and how to reverse it<p>Kenya’s <a href="https://www.nse.co.ke/">stock market</a> <a href="https://www.bnnbloomberg.ca/kenya-s-stock-market-becomes-world-s-worst-performer-1.1979077">recently</a> suffered steep losses, making it the worst performing globally. The weak performance has persisted: the Nairobi Securities Exchange 20-share index stood at about 1420 on 10 November 2023, having <a href="https://tradingeconomics.com/kenya/stock-market">fallen</a> from 1509 on 29 September 2023, a drop of 6% over the six-week period. In better days, the index has <a href="https://tradingeconomics.com/kenya/stock-market">risen</a> above the psychological 5000 mark: for example, it was 5491 on 23 February 2015. </p>
<p>The stock market matters for the Kenyan public for several reasons. First, <a href="https://www.oecd.org/daf/fin/private-pensions/2021-Survey-Investment-Regulation-Pension-Funds-and-Other-Pension-Providers.pdf#page=81">up to 70%</a> of the retirement savings of Kenyans may be invested in the stock market. So the market’s <a href="https://www.reuters.com/article/kenya-stocks-idAFL8N1PB1VN">weakness</a> might inhibit retirement funds from meeting their pension obligations. Second, many Kenyan companies use the stock market to raise capital and weak market performance discourages them from doing so. </p>
<p>Given these benefits, it is important to understand reasons for stock market value fluctuations. Here, I discuss some possible reasons for the market’s dismal performance and suggest possible ways to reverse the trend. </p>
<h2>What moves markets</h2>
<p>Stock prices move in response to new information that conveys signals about the risks faced by investors. The new information may be something that an investor has uncovered, or that is known by company insiders (although trading on that knowledge is usually <a href="https://www.sciencedirect.com/science/article/pii/S1566014119304352">illegal</a>), or that is announced publicly by an authority like the central bank.</p>
<p>New information may be about something unique to the company, or something that affects the entire market. New information about a company often affects the company’s price without affecting the market index. However, in small markets such as Kenya’s, where the market index may reflect the presence of a few large companies (such as <a href="https://www.safaricom.co.ke/investor-relations-landing/stocks/shares">Safaricom</a> and <a href="https://markets.ft.com/data/equities/tearsheet/summary?s=KCB:NAI">KCB</a>), changes in the price of one firm’s stock may cause a noticeable change on the index value.</p>
<h2>What ails Kenya’s stock market?</h2>
<p>An important risk factor that affects the entire market is sovereign (country) risk. Sovereign risk may be responsible for the <a href="https://www.businessdailyafrica.com/bd/markets/capital-markets/foreign-investors-dump-over-four-billion-nse-shares--4165110">persistent selling off</a> of shares by international investors at the Nairobi bourse in recent months. </p>
<p>When there are more investors selling shares than those willing to buy, share prices, and the market index, fall. This is because sellers must lower their prices to appeal to the few buyers. In 2022, Kenya’s international investors <a href="https://www.businessdailyafrica.com/bd/economy/foreign-investors-pull-out-sh24-billion-from-nse-in-2022--4075842">sold</a> about US$158 million (KES 24 billion) worth of shares, slightly lower than the US$191 million recorded during 2020. </p>
<p>The sell-off may indicate deep-seated political issues affecting Kenya’s economy. These include fears of possible instability post-2022 presidential elections. The country has previously <a href="https://www.csis.org/blogs/smart-global-health/post-election-violence-kenya-and-its-aftermath">experienced</a> election related violence. </p>
<p>The sell-off may also speak to economic factors. For instance, when US interest rates increase, <a href="https://fred.stlouisfed.org/series/FEDFUNDS">as they have</a>, international investors tend to pull their money out of developing markets and invest it in US debt markets, a phenomenon called <a href="https://www.tandfonline.com/doi/abs/10.1080/1540496X.2022.2103399">flight to quality</a>. </p>
<p>Indeed, anecdotal evidence suggests that emerging stock markets <a href="https://www.bloomberg.com/news/articles/2023-09-26/dollar-gains-heap-pressure-on-emerging-market-stocks-currencies#xj4y7vzkg">slumped to their lowest</a> between March and September 2023 driven by expectations that US interest rates would remain high.</p>
<p>Third, the stock market jitters may be explained by the weakening Kenyan shilling. For international investors, investing in a Kenyan stock means taking a <a href="https://doi.org/10.1016/j.ememar.2014.08.005">risk</a> on both the stock and the value of the Kenyan shilling. If the shilling falls in value relative to the investor’s domestic currency (like the US dollar), it may wipe out all the gains on the stock and cause the investor to lose money. </p>
<p>The Kenya shilling lost 21% of <a href="https://za.investing.com/currencies/usd-kes-historical-data?end_date=1699712214&st_date=1662933600">its value</a> between 13 September 2022 and 10 November 2023. This has been largely attributed to capital flight and <a href="https://www.theeastafrican.co.ke/tea/business/kenyan-shilling-hits-new-low-against-dollar-4220396">reduced</a> inflow of foreign currency due to the low value of exports. </p>
<p>Then there’s Kenya’s <a href="https://theconversation.com/kenya-has-breached-its-public-debt-ceiling-how-it-got-there-and-what-that-means-190006">burgeoning public debt</a>. It’s the chicken-and-egg story: a falling shilling increases the burden of debt owed to outside lenders. And the rising cost of servicing debt in a foreign currency increases the supply of the shilling in the currency markets, weakening it further.</p>
<p>In an attempt to stem the slide in the shilling’s value, keep domestic inflation in check, and respond to rising US interest rates, Central Bank of Kenya, like its counterparts globally, has chosen to restrict money supply. </p>
<p>Consequently, the central bank rate, a policy interest rate that guides domestic loan pricing, <a href="https://www.centralbank.go.ke/statistics/interest-rates/">has increased</a> from 7% in March 2022 to 10.5% in November 2023. When interest rates rise, returns (yields) on debt assets like bonds also rise, making them more attractive than stocks. This induces investors to <a href="https://www.sciencedirect.com/science/article/pii/S0261560618305722?via%3Dihub">move</a> their money from stocks to bonds, causing a decline in stock prices. </p>
<h2>Expectations</h2>
<p>An important recent development is the enactment of Kenya’s <a href="https://kra.go.ke/images/publications/The-Finance-Act--2023.pdf">Finance Act</a> in June 2023. The Act imposes new taxes and tax increases. The World Bank <a href="https://www.theeastafrican.co.ke/tea/business/world-bank-urges-caution-on-new-levies-4268024">has warned</a> that higher taxation may discourage investment and increase unemployment. </p>
<p>So there’s an expectation of weaker economic performance and, concomitantly, weaker company performance (due, for example, to lower product demand). The expectation of weaker company performance causes investors to anticipate lower future cash flows (like dividends), which is reflected in lower company valuations today. </p>
<p>Expectations about public debt also matter for companies. Kenya is expected to borrow more, which will increase interest rates on government debt, making it more lucrative for banks to lend to the government than to the private sector. Reduced private sector lending discourages private investments and lowers company valuations.</p>
<h2>What should be done?</h2>
<p>There is no quick fix to a stock market collapse. Although stock market performance may be driven by <a href="https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.21.2.129">sentiment</a> in the short run, it is more beneficial to think long-term. </p>
<p>There’s a close relationship between the broader economy and the stock market. So, as a <a href="https://orcid.org/0000-0002-4011-0728">finance scholar</a>, I offer only one recommendation: diversify and grow the economy. </p>
<p>There is clear evidence of the long-term economic growth benefits of investing in human capital, boosting a country’s <a href="https://www.sciencedirect.com/science/article/pii/S0048733317300215">entrepreneurial orientation</a> and <a href="https://www.sciencedirect.com/science/article/pii/S1879933716301798">investing in infrastructure</a>. To grow the economy, therefore, the government’s policymakers should draw from such evidence. </p>
<p>Importantly, the need to <a href="https://www.sciencedirect.com/science/article/abs/pii/S1574068405010063">strengthen the country’s institutions</a> has never been stronger. This will have the effect of improving governance and accountability as well as investor confidence. With such actions, the stock market needs no intervention.</p><img src="https://counter.theconversation.com/content/217523/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Odongo Kodongo 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 negative investor sentiment and massive capital flight could be reversed by improved governance and accountability.Odongo Kodongo, Associate professor, Finance, University of the WitwatersrandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2170942023-11-07T05:48:11Z2023-11-07T05:48:11ZWhy it’s a good bet the Melbourne Cup Day rate hike will be the last<p>Australia just became the odd one out.</p>
<p>At its meeting last week, the <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20231101a.htm">US Federal Reserve</a> kept its official interest rate on hold. A week earlier, the <a href="https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.mp231026%7E6028cea576.en.html">European Central Bank</a> and the <a href="https://www.bankofcanada.ca/core-functions/monetary-policy/key-interest-rate/">Bank of Canada</a> kept their rates on hold, and, at their meetings before that, the <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/september-2023">Bank of England</a> and the <a href="https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/the-official-cash-rate#">Reserve Bank of New Zealand</a> did the same thing.</p>
<p>Throughout the Western world – with perhaps Australia as the only exception – financial markets have been assuming central banks were done with increasing rates and would soon start <a href="https://www.ft.com/content/c7e712e8-12be-4d25-82e5-e53bd3bb3311">pushing them down</a>.</p>
<p>Reserve Bank Governor Michele Bullock’s <a href="https://www.rba.gov.au/media-releases/2023/mr-23-30.html">statement</a> accompanying Tuesday’s hike in Australia’s cash rate makes it look as if we’re about to join that club. It makes it look as if this hike from 4.1% to 4.35% – a 12-year high – will be the last.</p>
<p>And with good reason. Inflation has been falling almost everywhere, and – notwithstanding the recent uptick associated with higher oil prices – is forecast by the International Monetary Fund to keep falling.</p>
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<h2>The RBA has taken out insurance</h2>
<p>So why did Australia’s Reserve Bank push up rates at all, at a time when none of its global peers were? </p>
<p>The statement makes it look as if it wanted to take out insurance.</p>
<p>While the bank still expects inflation to continue to fall, it says progress now looks “slower than earlier expected”.</p>
<p>Its revised set of forecasts, to be released <a href="https://www.rba.gov.au/publications/">on Friday</a>, still have inflation falling, but to around 3.5% by the end of next year, instead of 3.3%, then to around 3% by the end of 2025 instead of <a href="https://www.rba.gov.au/publications/smp/2023/aug/forecasts.html">2.8%</a>.</p>
<p>The bank is particularly worried that the prices of services – things such as service in a cafe, done by hard-to-find workers – are “continuing to rise briskly”. </p>
<p>And it mentions “uncertainties” four times in eight paragraphs. It isn’t that it thinks inflation won’t keep coming down; it’s that it wants to be <em>sure</em> it is.</p>
<h2>Australian hikes hit harder than in the US</h2>
<p>One argument the bank hasn’t used – and nor should it – is catch-up. The US, the UK, the EU, Canada and New Zealand all have higher official rates than Australia.</p>
<p>But they are all are different to Australia, in an important way.</p>
<p>When the US Federal Reserve pushes up its Federal Funds Rate, nothing much happens to US home borrowers. Here’s why: almost all US home borrowers are on <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">fixed rates</a>, meaning their required mortgage payments don’t increase. </p>
<p>In Australia, only about <a href="https://www.rba.gov.au/publications/bulletin/2023/mar/fixed-rate-housing-loans-monetary-policy-transmission-and-financial-stability-risks.html">one-third</a> of home loans are fixed.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Stack of US $100 notes" src="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=965&fit=crop&dpr=1 600w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=965&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=965&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1213&fit=crop&dpr=1 754w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1213&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/557939/original/file-20231107-17-o2ccma.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1213&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">In the US, mortgage rates are fixed for up to the life of the loan.</span>
<span class="attribution"><span class="source">Shutterstock</span></span>
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<p>And US fixed rates are nothing like Australian fixed rates. The <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">typical term</a> in the US is 30 years, rather than the two to three years common in Australia.</p>
<p>This means that, as long as borrowers in the US don’t refinance or move homes, their payments are fixed for the entire term of their loans. Americans never have to pay more just because the Fed jacks up rates. </p>
<p>At least when it comes to homebuyers, the US Fed has to do a good deal more than Australia’s Reserve Bank to have the same effect.</p>
<p>It means the US official rate of 5.25% has less immediate effect on ordinary Americans than Australia’s new rate of 4.35% will have on us.</p>
<p>That’s what the consumer spending figures show. </p>
<p>After a year of high US rates, American consumers are buying 2.9% <a href="https://www.census.gov/retail/sales.html"><em>more</em></a> goods and services than they were a year ago. </p>
<p>After a year of less-high Australian rates, Australian consumers are buying 1.7% <a href="https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/sep-2023#"><em>less</em></a>.</p>
<p>This means that, as relatively lightweight as our previous 4.1% cash rate had seemed, it might have been packing more punch than the higher 5.25% rate in the US; and also the higher rates in the UK, Canada and New Zealand, where most of the mortgages are <a href="https://www.rba.gov.au/publications/smp/2023/feb/pdf/box-a-mortgage-interest-payments-in-advanced-economies.pdf">also fixed</a>.</p>
<h2>‘Painful squeeze’</h2>
<p>In her statement, Governor Bullock acknowledged many households were experiencing “<a href="https://www.rba.gov.au/media-releases/2023/mr-23-30.html">a painful squeeze on their finances</a>”. She also noted others were benefiting from rising housing prices, substantial savings buffers and higher interest income. </p>
<p>Bank calculations suggest one in 20 variable-rate borrowers are now going backwards – paying more for essential expenses and housing than they earn. </p>
<p>Among borrowers with big loans relative to their incomes, it’s <a href="https://www.rba.gov.au/speeches/2023/sp-gov-2023-10-24.html">one in four</a>.</p>
<p>There’s nothing in the governor’s statement to suggest she is thinking of pushing up rates again. After today’s hike, the futures market assigned only a <a href="https://www.asx.com.au/markets/trade-our-derivatives-market/futures-market/rba-rate-tracker">30%</a> probability to another hike. </p>
<p>The best guess of people who bet on this for a living is that Australia is about to join the rest of the world and leave rates where they are for quite some time.</p>
<h2>A frugal Christmas, before possible rate drops in 2024</h2>
<p>Alternatively, rates could even begin coming down within 12 months.</p>
<p>The detail of the inflation figures shows monthly inflation surged to 0.8% for one month only, in August, when petrol and diesel prices jumped 9.1%, then fell back to <a href="https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/monthly-consumer-price-index-indicator/latest-release#data-downloads">0.3%</a> in September, which is where it was before petrol prices jumped.</p>
<p>It is also looking like prices scarcely increased at all last month. </p>
<p>The Melbourne Institute inflation gauge, which comes out ahead of the Bureau of Statistics gauge and broadly tracks it, fell 0.1% in October. This suggests that, when taken together, price falls (<a href="https://tradingeconomics.com/australia/mi-inflation-gauge-mom">slightly more than</a>) outweighed price increases.</p>
<p>It’s what you would expect if we were tightening our belts, <a href="https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/sep-2023#">as we are</a>. </p>
<p>At Big W discount department stories across Australia, sales are down <a href="https://cdn-api.markitdigital.com/apiman-gateway/ASX/asx-research/1.0/file/2924-02729605-2A1482720?access_token=83ff96335c2d45a094df02a206a39ff4">5.5%</a> on where they were a year ago. </p>
<p>Big W says shoppers have moved away from buying big-ticket items and are instead buying a <a href="https://www.afr.com/chanticleer/woolies-watching-housing-pain-as-cpi-stokes-rate-rise-fears-20231025-p5eez9">remarkable</a> number of small gifts, such as Hot Wheels toy cars. </p>
<p>They sell for $2 each, or five for $9.</p>
<p>It’s pointing to a frugal Christmas in which retailers are going to have to discount if they want to move goods, taking further pressure off inflation.</p>
<p>Should that happen, rates could turn down even sooner than financial market traders expect, perhaps by the middle of next year.</p>
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Read more:
<a href="https://theconversation.com/petrol-is-holding-up-inflation-the-7-graphs-that-show-whats-happening-to-prices-and-what-it-will-mean-for-interest-rates-215888">Petrol is holding up inflation – the 7 graphs that show what's happening to prices and what it will mean for interest rates</a>
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<img src="https://counter.theconversation.com/content/217094/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin is Economics Editor of The Conversation.</span></em></p>It’ll now be a frugal Christmas in many Australian homes. But there is a glimmer of good news: if we do tighten our belts, rates could start to come down by as early as the middle of next year.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2151882023-10-06T13:28:15Z2023-10-06T13:28:15ZUK bonds have hit a 25-year high – here’s what that means for the economy<figure><img src="https://images.theconversation.com/files/552531/original/file-20231006-19-z1l72a.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C4230%2C2811&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bank of England (headquarters on the left) is expected to hold interest rates, causing investors to sell UK bonds.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/london-november-3-2016-modern-red-509977993">lazyllama/Shutterstock</a></span></figcaption></figure><p>It’s been more than a year since the UK economy was thrown into crisis after then-prime minister Liz Truss suggested making a wealth of <a href="https://theconversation.com/only-a-u-turn-by-the-government-or-the-bank-of-england-will-calm-uk-financial-markets-191523">unfunded tax cuts</a> in her September 2022 mini-budget. But a recent bond market sell-off has now sent borrowing costs rocketing again, pushing the bond market even higher than after Truss’s announcement. </p>
<p>Yields on UK treasury bonds – the rate the UK government must pay to borrow money – have risen to approximately 4.6% for ten-year bonds. Yields on 30-year bonds hit 5.1%, the highest since 1998. </p>
<p>Banks also use this rate as a key benchmark to set commercial loan rates, so this means borrowing costs are rising for businesses, as well as for the government. Two-year and five-year treasury yields (which are used to set mortgage rates) are also above the budget-fuelled high of last year, and at levels not seen in over ten years. </p>
<p><strong>UK bond yields (30 year), 1998-2023:</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Line chart showing 30-year bond yields hitting highs last seen in 1998." src="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=297&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=297&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=297&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=373&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=373&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552545/original/file-20231006-29-k1z29z.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"></a>
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<span class="caption"></span>
<span class="attribution"><a class="source" href="https://tradingeconomics.com/united-kingdom/30-year-bond-yield">Trading Economics</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>The government issues treasury bonds at a particular interest rate that corresponds to a fixed value. Investors buy the bonds and the government uses the money to finance its spending. Since it’s a loan, the government repays the investors but also pays interest on the bond until repayment – this is the yield. </p>
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<em>
<strong>
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>For example, a 5% bond issued for a £100 earns the investor £5 interest. If the government issues a later bond at 6% for £100 (£6 interest), the 5% (£5) bond’s value drops. This is why when bond prices fall, the yield rises and vice versa. </p>
<p>Right now, UK treasury yields are rising because investors are trying to sell UK government bonds – falling demand makes the price drop. </p>
<p>And this isn’t just happening in the UK. The same is true <a href="https://www.reuters.com/markets/global-markets-wrapup-1-2023-10-04/">around the world</a>. US bonds, for example, recently hit <a href="https://www.cnbc.com/2023/10/03/us-treasury-yields-investors-weigh-economic-outlook.html">a 16-year high</a>. </p>
<h2>Why is this happening right now?</h2>
<p>This is a tale of two central banks navigating difficult economic conditions. In September, both the Bank of England and the Federal Reserve chose not to increase their main interest rates (which are at 5.25% and 5.5% respectively). The reasons for these decisions and the position of each economy are driving the bond market changes. </p>
<p>In terms of the economy, headline inflation is currently 6.7% (6.2% for core, which strips out more volatile items like energy) <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/august2023">in the UK</a>, and 3.7% (4.3% core) <a href="https://www.bls.gov/news.release/cpi.nr0.htm">in the US</a>. GDP growth is at 0.6% for the UK and 2.4% for US. So, the two economies are on different tracks. </p>
<p>These figures influence financial market expectations about what central banks might do next with interest rates. The divergence in growth rates and inflation between the two economies had signalled that the banks would take different routes at their September meetings.</p>
<p>Prior to the latest decision by the Bank of England, there was <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/">a general view</a> that UK <a href="https://www.reuters.com/markets/rates-bonds/boe-bank-rate-peak-seen-550-strong-chance-575-2023-08-24/">rates would rise</a> to 5.5%, but a lower-than-expected inflation rate was announced days before the bank met to decide on rates and this led them to hold rates instead. After the meeting, the Bank of England also indicated that, while it expected its rate to remain at 5.25% for some time, it did not <a href="https://www.theguardian.com/business/2023/sep/21/bank-of-england-keeps-interest-rates-hold">foresee a further rise</a>. </p>
<p>In contract, while the Federal Reserve also held rates in September, this was <a href="https://www.reuters.com/markets/us/fed-leave-rates-unchanged-sept-20-cut-unlikely-before-q2-2024-2023-09-12/">seen as a pause</a> and not a stop. US rates are widely expected to rise again this year.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Chart showing that 12 of the 19 FOMC members anticipate one more 25 basis point hike this year, seven expect no change before end of 2023." src="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552512/original/file-20231006-19-k0slke.jpeg?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"></a>
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<span class="caption">Twelve members of the Fed’s 19-person rate-setting committee expect one more 0.25% interest rate hike this year, while 7 FOMC members expect no change before the end of the year.</span>
<span class="attribution"><a class="source" href="https://www.statista.com/chart/29055/fomc-projections-for-the-federal-funds-rate/">Statista</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
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</figure>
<h2>What has this got to do with bond yields?</h2>
<p>The expected rise in US rates means investors do not want to hold US bonds whose value will fall as a result. As explained before, when newer bonds are issued at higher yields (to reflect the bank’s most recent interest rate decison), existing bonds (those previously issued with lower yields) will be valued less by investors because they will get less in interest payments for holding them.</p>
<p>This is why investors are selling US bonds. For a related, but slightly different reason, investors also don’t want to hold UK bonds. As US bonds will soon earn a higher yield, investors are selling UK bonds to reposition their portfolios towards the US, where they will be able to earn a higher yield.</p>
<p>This also has implications for the value of the pound. Since the Bank of England’s decision not to raise the interest rate in September, the value of the pound has <a href="https://www.cnbc.com/2023/10/03/sterling-had-its-worst-month-for-a-year-and-it-may-fall-further.html">fallen</a> versus the US dollar. This is because the same investors that are selling UK Treasuries and driving up yields, are also selling pounds to buy US dollars. </p>
<p>The UK is not alone in feeling this effect, the euro is also weakening and against the US dollar, while the Japanese yen is close to the same low that prompted <a href="https://www.reuters.com/markets/asia/japan-likely-spent-record-amount-october-prop-up-yen-2022-10-31/">an intervention by the Bank of Japan</a> around this time last year. </p>
<figure class="align-center ">
<img alt="Globe surrounded by currency symbols on different types of bank notes." src="https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/552529/original/file-20231006-15-r7s87l.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">Global currency markets.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/world-on-international-banknotes-currency-sign-2108080049">Dilok Klaisataporn/Shutterstock</a></span>
</figcaption>
</figure>
<p>In each case, the reason is the same: the strength of the US economy relative to other economies (0.5% GDP growth for the Eurozone and 1.6% for Japan) is attracting more investors. As with the UK, the policy rates for the Eurozone and Japan are below those of the US, with each central bank indicating an intention not to make further increases.</p>
<p>But both of these effects – higher treasury yields and a depreciating pound – spell bad news for the UK economy. </p>
<p>The higher yields imply higher borrowing costs, including interest payments for the government, as well as both mortgages and business loans. The fall in the value of the pound means that imports are more expensive. Together with the fact that many commodities (such as oil) are priced in US dollars, this can contribute to higher inflation. </p>
<p>Since the economy is also barely growing, both issues will continue to have a dampening effect on the UK.</p><img src="https://counter.theconversation.com/content/215188/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David McMillan 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>Rates are now higher than after Liz Truss’s 2022 mini-budget.David McMillan, Professor in Finance, University of StirlingLicensed 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/2122142023-09-04T15:33:57Z2023-09-04T15:33:57ZIs the US banking crisis over?<p>The <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">US banking crisis</a> triggered worries about the global banking system earlier in the year. Three mid-sized US banks, Silicon Valley Bank, Silvergate and Signature, fell in quick succession, driving down bank share-prices across the world. </p>
<p>America’s central bank, the Federal Reserve, <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm">made significant amounts</a> of cash available to the failed banks and created a lending facility for other struggling institutions. This calmed investors and prevented immediate contagion, with only one more US regional bank, <a href="https://www.forbes.com/sites/dereksaul/2023/05/01/first-republic-bank-failure-a-timeline-of-what-led-to-the-second-largest-bank-collapse-in-us-history/">First Republic</a>, collapsing a few weeks later. </p>
<p>Yet it’s far from clear whether the crisis is really over. As traders return from their summer holidays to a period <a href="https://www.bbc.co.uk/news/business-30793329">commonly associated</a> with upheaval in the markets, how are things likely to play out?</p>
<h2>Tight margins and dwindling deposits</h2>
<p>Central banks have continued to increase interest rates to counter sustained inflation in recent months. In July, the Fed raised its key interest rate to <a href="https://www.nbcnews.com/business/economy/interest-rate-hike-july-2023-how-much-higher-federal-reserve-rcna96210">as much as 5.5%</a>, the highest in 20 years. The rate was near zero as recently as February 2022. </p>
<p>Though the increases have slowed this year, such a sudden change can be <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">very harmful</a> for banks – <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4304896">particularly</a> as part of the sort of U-shaped movement in rates that we have seen since the global financial crisis of 2007-09. </p>
<p><strong>US benchmark interest rate, 2007-23</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US benchmark interest rates over the past 15 years" src="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=266&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=266&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=266&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=335&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=335&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546163/original/file-20230904-15-kr0mac.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=335&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://fred.stlouisfed.org/series/FEDFUNDS">St Louis Federal Reserve</a></span>
</figcaption>
</figure>
<p>Raising rates reduces the value of banks’ assets, increases what they have to pay to borrow, limits their profitability and generally increases their vulnerability to adverse events. Especially in the first half of 2023, banks have had to cope with low loan growth and high deposit costs, meaning the amount they have to pay out in relation to customers’ deposits. </p>
<p>This increased cost is partly because lots of customers have been withdrawing their money and putting it into places where they can make more interest, such as <a href="https://www.forbes.com/uk/advisor/investing/best-money-market-funds/">money market funds</a>. It forced banks to borrow more from the Fed to ensure they have enough money, and at rates much higher than they used to be. </p>
<p>This was one of the reasons for the banking collapses in the spring, destabilising them at a time when the value of the debt on their balance sheets had also fallen sharply. This saw more customers at other banks withdrawing deposits for fear that their money wasn’t safe either. In sum, US banks saw deposits declining between June 2022 and June 2023 <a href="https://fred.stlouisfed.org/series/DPSACBW027SBOG">by almost 4%</a>. Together with higher interest rates, this is generally bad news for the banking sector. </p>
<p>You can see the effect on banks’ profitability by looking at overall net interest margins (NIMs). These are a measure of what banks receive in interest income minus what they pay out to depositors and other funders. </p>
<p><strong>US banks’ net interest margins (%)</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US banks' net interest margins" src="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=320&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=320&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=320&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=402&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=402&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546178/original/file-20230904-19-t9hxsb.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=402&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Based on 641 banks.</span>
<span class="attribution"><a class="source" href="https://www.spglobal.com/marketintelligence/en/solutions/sp-capital-iq-pro">S&P Capital IQ</a></span>
</figcaption>
</figure>
<h2>Credit rating downgrades</h2>
<p>The ratings agencies have added further pressure. In early August, <a href="https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-01-08-2023#:%7E:text='%3B%20Outlook%20Stable-,Fitch%20Downgrades%20the%20United%20States'%20Long%2DTerm%20Ratings%20to%20',from%20'AAA'%3B%20Outlook%20Stable&text=Fitch%20Ratings%20%2D%20London%20%2D%2001%20Aug,AA%2B'%20from%20'AAA'.">Fitch downgraded</a> its rating of US government debt to AA+ from AAA. It cited a likely deterioration in the public finances over the next three years and the endless politicking around the debt ceiling, which is the maximum level that the government can borrow. </p>
<p>Sovereign downgrades often reflect problems in the wider economy. This can destabilise banks by making them seem less creditworthy, leading their credit ratings to be downgraded too. That can make it harder for them to <a href="https://academic.oup.com/rfs/article-abstract/29/7/1709/2607032?redirectedFrom=fulltext">borrow money</a> from the markets or potentially even from the Fed. This can then have knock-on effects <a href="https://www.sciencedirect.com/science/article/pii/S0378426617302066">in reducing</a> banks’ lending capacity, capital buffers for coping with bad debts, overall profitability and <a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/jmcb.12080">share prices</a>. </p>
<p><strong>US banks’ share prices 2023</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing US banks' share prices in 2023" src="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=347&fit=crop&dpr=1 600w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=347&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=347&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=436&fit=crop&dpr=1 754w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=436&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/546175/original/file-20230904-29-jduqa5.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">Bank of America = blue; Citigroup = orange; Goldman Sachs = pale blue; JP Morgan = yellow; Morgan Stanley = indigo; Regional banks = purple.</span>
<span class="attribution"><a class="source" href="https://www.tradingview.com">Trading View</a></span>
</figcaption>
</figure>
<p>Sure enough, a week after the Fitch announcement, <a href="https://www.reuters.com/business/finance/us-bank-stocks-slide-after-moodys-ratings-downgrade-2023-08-08/">Moody’s downgraded</a> the credit ratings of ten US mid-sized banks, citing growing financial risks and strains that could erode their profitability. It also warned that larger banks including Bank of New York Mellon and State Street were at risk of a future downgrade. </p>
<p>The other major ratings agency, S&P Global Ratings, has <a href="https://www.cnbc.com/2023/08/22/sp-downgrades-multiple-us-banks-citing-tough-operating-conditions.html">since followed suit</a>, while <a href="https://www.dailymail.co.uk/yourmoney/savings-and-banking/article-12409057/How-safe-bank-Fitch-warns-downgrade-dozens-firms-including-JPMorgan-Chase-Bank-America.html">Fitch is threatening</a> to do likewise. <a href="https://openaccess.city.ac.uk/id/eprint/28220/1/Kladakis_Skouralis_2022_CBR.pdf">Our research</a> suggests bank downgrades are associated with making them riskier and more unstable, particularly when accompanied by a sovereign downgrade. </p>
<p>Having said all that, there are positives for US banks. Both interest rates and bank deposits are at least <a href="https://www.fitchratings.com/research/banks/us-banks-deposit-challenges-to-pressure-profitability-credit-capital-09-05-2023">projected to</a> stabilise in the coming months, which should help the sector. Despite the overall decline in banks’ profitability, <a href="https://www.reuters.com/business/finance/us-banks-shares-spark-after-interest-income-boost-outlook-mixed-2023-07-18/">bigger banks</a> are reporting improved margins from charging higher interest on loans. Some of these banks also expect a boost from things like increased deal-making later in the year. Signs like those could help to bring more stability across the board. </p>
<p>In Europe, banks have seen <a href="https://www.ceicdata.com/en/indicator/european-union/total-deposits">reduced deposits</a> and <a href="https://data.ecb.europa.eu/data/datasets/SUP/SUP.Q.B01.W0._Z.I2120._T.SII._Z._Z._Z.PCT.C">net interest margins</a> in recent years, which helps to explain why <a href="https://edition.cnn.com/2023/04/24/investing/credit-suisse-bank-withdrawals-total/index.html">Credit Suisse</a> needed to be rescued by fellow Swiss bank UBS in March. Yet European deposits and profit margins have been recovering in the most recent couple of quarters. At the same time, the European Banking Authority’s recent <a href="https://www.ft.com/content/c6dbb3bf-2c41-4f4a-a178-1068ff704f28">stress tests</a> concluded that large EU banks are robust. </p>
<p>UK banks appear to be in a slightly worse condition than EU banks. They remain resilient on their balance sheets, but their <a href="https://www.ceicdata.com/en/indicator/united-kingdom/total-deposits#:%7E:text=in%20Jun%202023%3F-,United%20Kingdom%20Total%20Deposits%20was%20reported%20at%204%2C428.207%20USD%20bn,table%20below%20for%20more%20data.">deposits have not</a> recovered to quite the same extent as in Europe. They <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/uk-lenders-rejig-net-interest-margin-targets-as-central-bank-rate-hikes-continue-77193182">have also been</a> adjusting down their profit forecasts in anticipation of further rate hikes by the Bank of England.</p>
<h2>Regulatory intervention</h2>
<p>To strengthen the US sector, the regulators <a href="https://www.ft.com/content/d4d15a2a-1568-47db-bd29-937a478dc768">are planning</a> to further increase the minimum levels of capital that must be held by large US banks (with assets worth more than US$100 billion (£79 billion)). </p>
<p>These plans to increase banks’ capacity to absorb losses are encouraging, though will take more than four years to fully implement. The <a href="https://www.bis.org/publ/bcbsca.htm">Basel II</a> international banking rules were introduced to a similar end in 2004, but were not implemented in time to prevent the global financial crisis. </p>
<p>For the moment, the US banking system remains vulnerable both to shocks within the financial system and more general calamities. It will still be a few months before we can say with confidence that the worst is over.</p><img src="https://counter.theconversation.com/content/212214/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>A swift intervention by the US Federal Reserve has kept most banks on their feet, but September/October is often the time when financial crises come to a head.George Kladakis, Lecturer in Financial Services, Edinburgh Napier UniversityAlexandros Skouralis, Research Assistant, Bayes Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2125512023-08-30T15:13:33Z2023-08-30T15:13:33ZCentral banks say interest rates will stay high but it’s unclear if this will be enough to curb inflation<figure><img src="https://images.theconversation.com/files/545512/original/file-20230830-21-i0qm7l.jpg?ixlib=rb-1.1.0&rect=0%2C223%2C4019%2C2414&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Central bankers, policymakers and academics meet annually at Jackson Hole, Wyoming to discuss the economy.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/jackson-hole-wyoming-landscape-photos-2276541363">Sarah Hollemans/Shutterstock</a></span></figcaption></figure><p>The US central bank, the Federal Reserve, has recently signalled that it will keep interest rates high for as long as it takes to bring inflation down to its 2% target. </p>
<p>Other major central banks, such as the UK’s Bank of England and the European Central Bank (ECB), are likely to follow suit. But rate-setters face some dilemmas when it comes to balancing the use of interest rates to slow the economy versus the risk of a recession.</p>
<p>In an August 25 speech during <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">the annual Jackson Hole Symposium</a>, an <a href="https://www.nytimes.com/2023/08/24/business/economy/jackson-hole-economic-conference.html#:%7E:text=High%20on%20its%20list%20of,Fed%20event%20of%20the%20year.">influential summer gathering</a> of central bankers, policymakers and academics, chairman Jerome Powell indicated that the Fed is not yet convinced it has won the battle against inflation. This is despite the <a href="https://www.usinflationcalculator.com/inflation/current-inflation-rates/">US headline rate of inflation</a> falling from 8.5% in March 2022 (when the Fed started raising rates) to 3.2% in July.</p>
<p>Powell did suggest the central bank might start to slow the pace of rate rises after <a href="https://www.reuters.com/markets/rates-bonds/fed-poised-hike-rates-markets-anticipate-inflation-endgame-2023-07-26/#:%7E:text=The%20hike%2C%20the%20Fed's%2011th,exceeded%20for%20about%2022%20years.">11 consecutive rises</a> in interest rates to 5.5% in little more than a year. As in other regions, such as the UK and EU, recent rapid increases have reversed around <a href="https://www.macrotrends.net/2015/fed-funds-rate-historical-chart">a decade of ultra-low rates</a>. </p>
<p>This leads to even higher interest rates being charged by financial institutions, and so is designed to slow the economy. But if taken too far, it could also trigger a recession.</p>
<p>The Jackson Hole meeting is closely watched by financial markets, governments and the media for indications of the long-term direction of monetary policy, and for deeper insights into the challenges facing the world’s central banks. And so the speech was <a href="https://edition.cnn.com/business/live-news/markets-jackson-hole-fed-meeting/index.html#:%7E:text=Stocks%20fall%20as%20traders%20digest,and%20the%20Nasdaq%20dropped%200.3%25.">a disappointment to financial markets</a>, which have been rocked by recent sharp interest rates hikes. </p>
<p>For more than a decade, stock markets boomed on the back of near-zero interest rates, with the US Dow Jones Industrial Average (DJIA) <a href="https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart">quadrupling</a>. But as the Fed started raising rates, the DJIA plummeted by 20%, with a short-lived recovery that soon fizzled out. And so, market hopes for a rate cut this year have been dashed – although Powell did suggest that how far and how fast rates would rise remains up for debate. </p>
<p>Indeed, Powell warned of the potential for more pain to come for households and businesses either way. Reducing inflation inevitably leads to below-trend economic growth, which causes companies to reduce pay and hiring activity. Outlining central banks’ current balancing act, <a href="https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm">he said</a>: “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”</p>
<p>Similar sentiments were <a href="https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230825%7E77711105fe.en.html">echoed by ECB president Christine Lagarde</a> at Jackson Hole. The Eurozone is also in the middle of sharply raising interest rates, despite slumping economic growth. While Largarde emphasised that the ECB must aim to keep inflation at 2% in the medium term, she also said: “There is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one.”</p>
<p>Indeed, it remains to be seen if the world economy is entering a new phase of high inflation and weak growth, or whether the conditions that have led to the recent inflationary surge are temporary.</p>
<h2>Are we in a new economic era of high inflation?</h2>
<p>At Jackson Hole, Powell highlighted the need to ensure that public expectations of continued rapid inflation do not become entrenched. This could trigger a wage-price spiral that could get out of control. He warned that the cost of inaction would, therefore, be even higher.</p>
<p>Indeed, all of the major central banks, including the Fed, dramatically underestimated the effect of the pandemic on inflation. They have been <a href="https://www.reuters.com/world/uk/ex-officials-say-bank-england-was-too-slow-heed-inflation-warnings-2023-07-05/">criticised for not acting in time</a> and are now scrambling to rapidly increase interest rates. But why didn’t the central banks’ economic forecasting models predict rising inflation?</p>
<p>Gita Gopinath, the IMF deputy director, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9090/Remarks_by_Gopinath.pdf">argued at Jackson Hole</a> that central bank models are outdated because they underestimated the long-term effects of supply-side disruptions. She suggested that recent failures to stop inflation rises fast enough have seriously damaged central banks’ credibility. As a result, they can no longer hope to ignore short bursts of inflation without serious consequences. She also raised the possibility that, in the long term, weaker economic growth might indeed be the price of curbing inflation.</p>
<p>Several policymakers, including Barack Obama’s former economic adviser Jason Furman, <a href="https://www.kansascityfed.org/Jackson%20Hole/documents/9674/JH2022_Furman.pdf">also in attendance at Jackson Hole</a>, have even suggested that revising central banks’ target rate of inflation to 3% from 2% would be no bad thing. This is still heresy for most central bankers, who believe making such a significant change to their remit would damage their credibility even more.</p>
<h2>Dilemmas facing central banks</h2>
<p>The Jackson Hole meeting highlighted three key dilemmas for central banks.</p>
<p>First, is the medicine (rate rises) working? While inflation has fallen, core rates in the UK, EU and US are still well above the 2% target. It’s unclear whether slowing demand in the economy is the right approach when inflation has been caused by “supply-side disruption” (pandemic-era supply shortages and the commodity-related effects of Russia’s invasion of Ukraine left too much money chasing too few goods). </p>
<p>And since higher interest rates <a href="https://www.bankofengland.co.uk/-/media/boe/files/speech/2023/february/expectations-lags-and-the-transmission-of-monetary-policy-speech-by-catherine-l-mann.pdf">can take up to 18 months to work</a>, it is hard to judge yet whether economic growth has slowed enough due to higher rates.</p>
<p>Second, it’s unclear how much more economic pain it will take to contain inflation. This question is particularly acute for the ECB and the Bank of England – economic growth in the EU and UK has been much more anaemic and inflation higher than in the US.</p>
<p>Finally, central banks face real challenges in trying to restore their credibility. Given major uncertainty about the future of the world economy, they face the unenviable task of either taking a wait-and-see approach until trends are clearer, or taking pre-emptive action to re-assert their credibility and prevent the worst if inflation remains persistent. </p>
<p>As the global economy cools, particularly driven by recent <a href="https://www.vox.com/world-politics/2023/8/29/23845841/chinas-economy-xi-expert">weak economic growth in China</a>, these trade-offs will only become harder to make.</p><img src="https://counter.theconversation.com/content/212551/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Schifferes 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 world’s central banks face a range of dilemmas, not least whether high inflation – and therefore high interest rates – will become permanent.Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2100062023-08-01T12:25:30Z2023-08-01T12:25:30ZRate hikes may have slowed inflation in the US – but they have also heightened the risk of financial crises for lower-income nations<figure><img src="https://images.theconversation.com/files/540041/original/file-20230730-23-hvvs98.jpg?ixlib=rb-1.1.0&rect=28%2C63%2C4690%2C3077&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Sri Lanka is among the countries facing the risk of debt distress.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.co.uk/detail/news-photo/street-vendor-sells-prawns-and-sea-food-at-her-kiosk-at-the-news-photo/1248858886?adppopup=true">Ishara S. Kodikara/AFP via Getty Images</a></span></figcaption></figure><p>The campaign to fight U.S. inflation by upping <a href="https://www.npr.org/2023/07/26/1190093285/fed-federal-reserve-interest-rates-borrowing-inflation">interest rates</a> has been going on for a year and a half – and its impacts are being <a href="https://apnews.com/article/covid-health-business-international-monetary-fund-sri-lanka-ab562cd9e16592e40ec8c6d842c74b7a">felt around the world</a>.</p>
<p>On July 26, 2023, the Federal Reserve announced <a href="https://www.cnn.com/2023/07/26/economy/fed-july-interest-rate-decision-final/index.html">another quarter-point hike</a>. That means U.S. rates have now gone up 5.25 percentage points over the past 18 months. While inflation is now coming down in the U.S., the aggressive monetary policy may also be having significant longer-term impact on countries across the world, especially in developing countries. And that isn’t good.</p>
<p>I <a href="https://polisci.msu.edu/people/directory/bodea-cristina.html">study how economic phenomena</a> such as banking crises, periods of high inflation and soaring rates affect countries around the world and believe this prolonged period of higher U.S. interest rates has increased the risk of economic and social instability, especially in lower-income nations.</p>
<h2>Ripples around the world</h2>
<p>Monetary policy decisions in the U.S., such as raising interest rates, have a ripple effect in low-income countries – not least because of the central role of the dollar in the global economy. Many emerging economies <a href="https://www.reuters.com/breakingviews/global-markets-breakingviews-2023-02-28/">rely on the dollar for trade, and most borrow</a> in the U.S. dollar – all at rates influenced by the Federal Reserve. And when U.S. interest rates go up, many countries – and especially <a href="https://african.business/2023/05/african-banker/interest-rates-hikes-exact-high-price-in-africa">developing ones – tend to follow suit</a>.</p>
<p>This is largely out of concern for <a href="https://www.imf.org/en/Blogs/Articles/2022/10/14/how-countries-should-respond-to-the-strong-dollar">currency depreciation</a>. Raising U.S. interest rates has the effect of making American government and corporate bonds look more attractive to investors. The result is footloose foreign capital <a href="https://theconversation.com/three-reasons-why-the-us-federal-reserve-bank-holds-the-world-in-its-hands-190936">flows out of emerging markets</a> that are deemed riskier. This <a href="https://apnews.com/article/covid-health-business-world-bank-international-monetary-fund-71aa7e9c225e973ec16a962fe6d53773">pushes down the currencies</a> of those nations and prompts governments in lower-income nations to <a href="https://african.business/2023/05/african-banker/interest-rates-hikes-exact-high-price-in-africa">scramble to mirror</a> U.S. Federal Reserve policy. The problem is, many of these countries already have high interest rates, and further hikes limit how much governments can lend to expand their own economies – heightening the risk of recession.</p>
<p>Then there is the impact that raising rates in the U.S. has had on countries with large debts. When rates were lower, a lot of lower-income nations took on <a href="https://www.aljazeera.com/features/2023/7/4/is-a-global-debt-bomb-about-to-explode">high levels of international debt</a> to offset the financial impact of the COVID-19 pandemic and then later the effect of higher prices caused by war in Ukraine. But the <a href="https://www.theguardian.com/business/2022/oct/02/high-interest-rates-paid-by-poorer-nations-spark-fears-of-global-debt-crisis">rising cost of borrowing</a> makes it more difficult for governments to cover repayments that are coming due now. This condition, called “<a href="https://www.imf.org/en/Publications/fandd/issues/2020/09/what-is-debt-sustainability-basics">debt distress</a>,” is affecting an increasing number of countries. Writing in May 2023, when he was still president of the World Bank, David Malpass estimated that <a href="https://www.wsj.com/articles/the-world-economy-needs-to-get-its-growth-back-group-of-seven-developing-countries-debt-financing-yield-curve-private-sector-innovation-4113e720">some 60% of lower-income countries</a> are in or high risk of entering debt distress.</p>
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<img alt="A man hold aloft a crate of fish." src="https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/540292/original/file-20230731-247744-e58okb.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">Mozambique is among the countries facing extra financial stress.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.co.uk/detail/news-photo/fisherman-balances-a-crate-of-fishes-on-his-head-on-news-photo/1230026981?adppopup=true">Alfredo Zuniga/AFP via Getty Images)</a></span>
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<p>More broadly, any attempt to slow down growth to lower inflation in the U.S. – which is the intended aim of raising interest rates – will have a knock-on effect on the economies of smaller nations. As borrowing costs in the U.S. increase, businesses and consumers will find themselves with less cheap money for all goods – domestic or international. Meanwhile, any fears that the Fed has pulled on the brakes too quickly and is risking recession will suppress consumer spending further.</p>
<h2>The risk of spillover</h2>
<p>This isn’t just theory – history has shown that in practice it is true.</p>
<p>When then-Fed Chair <a href="https://theconversation.com/paul-volcker-helped-shape-an-independent-federal-reserve-a-vital-legacy-thats-under-threat-128660">Paul Volcker</a> fought domestic inflation in the late 1970s and early 1980s, he did so with aggressive interest rate hikes that pushed up the cost of borrowing around the world. It contributed to <a href="https://www.bloomberg.com/view/articles/2019-12-10/paul-volcker-death-he-left-a-complicated-legacy-in-latin-america?in_source=embedded-checkout-banner&sref=Hjm5biAW">debt crises for 16 Latin American countries</a> and led to what became known in the region as the “lost decade” – a period of economic stagnation and soaring poverty.</p>
<p>The current rate increases are not of the same order as those of the early 1980s, when rates <a href="https://www.bankrate.com/banking/federal-reserve/history-of-federal-funds-rate/">rose to nearly 20%</a>. But rates are high enough to prompt fears among economists. The World Bank’s most recent <a href="https://openknowledge.worldbank.org/server/api/core/bitstreams/6e892b75-2594-4901-a036-46d0dec1e753/content">Global Economic Prospects</a> report included a whole section on the spillover from U.S. interest rates to developing nations. It noted: “The rapid rise in interest rates in the United States poses a significant challenge to [emerging markets and developing economies],” adding that the result was “higher likelihood” of financial crises among vulnerable economies.</p>
<h2>Widening the wealth gap</h2>
<p>Research <a href="https://doi.org/10.1016/j.worlddev.2021.105635">I conducted with others</a> suggests that the kind of financial crises hinted at by the World Bank – currency depreciation and debt distress – can rip the social fabric of developing countries by increasing poverty and income inequality.</p>
<p>Income inequality is at an all-time high – both within individual countries and between the richer and developing countries. The 2022 <a href="https://wir2022.wid.world/">World Inequality Report</a> notes that, currently, the richest 10% of individuals globally take home 52% of all global income, while the poorest half of the global population receives a mere 8.5%. And such a wealth gap is deeply corrosive for societies: Inequality of income and wealth has been shown to both <a href="https://doi.org/10.1017/S0043887109990074">harm democracy</a> and <a href="https://www.journals.uchicago.edu/doi/abs/10.1017/S0022381613001229">reduce popular support for democratic institutions</a>. It has also been linked to <a href="https://doi.org/10.1177/0022343313503179">political violence</a> and <a href="https://www.jstor.org/stable/4145353">corruption</a>.</p>
<p>Financial crises – such as the kind that higher interest rates in the U.S. may spark – increase the chance of economic slowdowns or even recessions. Worryingly, the World Bank has warned that developing nations face a “<a href="https://www.worldbank.org/en/news/press-release/2023/01/10/global-economic-prospects">multi-year period of slow growth</a>” that will only increase rates of poverty. And history has shown that the impact of such economic conditions fall hardest on lower-skilled low-income people.</p>
<p>These effects are <a href="https://www.investopedia.com/terms/a/austerity.asp">compounded by government policies</a>, such as cuts in spending and government services, which, again, disproportionately hit the less well-off. And if a country is struggling to pay back sovereign debt as a result of higher global interest rates, then it also has less cash to help its poorest citizens.</p>
<p>So in a very real sense, a period of higher interest rates in the U.S. can have a detrimental effect on the economic, political and social well-being of developing nations.</p>
<p>There is a caveat, however. With inflation in the U.S. slowing, further interest rate increases may be limited. It could be the case that regardless of whether Fed policy has threaded the needle of slowing the U.S. economy but not by too much, it has nonetheless sown the seeds of more potentially severe economic – and social – woes in poorer nations.</p><img src="https://counter.theconversation.com/content/210006/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Cristina Bodea 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>Almost two-thirds of low-income countries are at risk of debt distress – in part because of higher borrowing costs. And that isn’t the only problem.Cristina Bodea, Professor of Political Science, Michigan State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2070572023-06-20T08:51:47Z2023-06-20T08:51:47ZWhy US ‘dollar doomsayers’ could be wrong about its imminent demise<figure><img src="https://images.theconversation.com/files/531167/original/file-20230609-15-iblgu4.jpg?ixlib=rb-1.1.0&rect=107%2C83%2C7748%2C4371&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">phanurak rubpol/Shutterstock</span></span></figcaption></figure><p>The position of the US dollar in <a href="https://data.imf.org/?sk=e6a5f467-c14b-4aa8-9f6d-5a09ec4e62a4">the global league table of foreign exchange reserves</a> held by other countries is closely watched. Every <a href="https://uk.style.yahoo.com/natural-way-diversify-janet-yellen-125500087.html#:%7E:text=Fed%20decides%20to%20pause%3A%20Impact%20on%20investors%2C%20markets&text=The%20U.S.%20dollar%20saw%20an,days%20of%20dominance%20are%20over.">slight fall in its share</a> is interpreted as confirmation of its imminent demise as <a href="https://www.cnbc.com/video/2023/06/08/expect-us-dollars-dominance-to-stay-for-foreseeable-future-moodys.html">the preferred global currency</a> for financial transactions. </p>
<p>The recent drama surrounding <a href="https://newrepublic.com/article/170703/debt-ceiling-dollar-reserve-currency">negotiations about raising the limit on US federal government debt</a> has only fuelled these predictions by “dollar doomsayers”, who believe <a href="https://www.investopedia.com/terms/d/debt-ceiling.asp#:%7E:text=Debt%20Ceiling%20Showdowns%20and%20Shutdowns">repeated crises over the US government’s borrowing limit</a> weakens the country’s perceived stability internationally. </p>
<p>But the real foundation of its dominance is global trade – and it would be very complicated to turn the tide of these many transactions away from the US dollar.</p>
<p>The international role of a global currency in financial markets is ultimately based on its use in non-financial transactions, especially as <a href="https://www.imf.org/en/Publications/WP/Issues/2020/07/17/Patterns-in-Invoicing-Currency-in-Global-Trade-49574">what’s called an “invoicing currency” in trade</a>. This is the currency in which a company charges its customers. </p>
<h2>Global network of supply and trade</h2>
<p>Modern trade can involve many financial transactions. Today’s supply chains often see goods shipped across several borders, and that’s after they are produced using a combination of intermediate inputs, usually from different countries. </p>
<p>Suppliers may also only get paid after delivery, meaning they have to finance production beforehand. Obtaining this financing in the currency in which they invoice makes trade easier and more cost effective. </p>
<p>In fact, it would be very inconvenient for all participants in a value chain if the invoicing and financing of each element of the chain happened in a different currency. Similarly, if most trade is invoiced and financed in one currency (the US dollar at present), even banks and firms outside the US have an incentive to denominate and settle financial transactions in that currency. </p>
<p>This status quo becomes difficult to change because no individual organisation along the chain has an incentive to switch currencies if others aren’t doing the same. </p>
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<a href="https://theconversation.com/five-ways-that-the-super-strong-us-dollar-could-hurt-the-world-economy-186654">Five ways that the super-strong US dollar could hurt the world economy</a>
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<p>This is why the US dollar is <a href="https://www.wto.org/english/res_e/reser_e/ersd201210_e.pdf">the most widely used currency in third-country transactions</a> – those that don’t even involve the US. In such situations it’s called a vehicle currency. The euro is used mainly in the vicinity of Europe, whereas the US dollar is widely used <a href="https://www.jstor.org/stable/23352320">in international trade among Asian countries</a>. Researchers call this <a href="https://www.aeaweb.org/articles?id=10.1257/aer.20171201">the dominant currency paradigm</a>.</p>
<p>The convenience of using the US dollar, even outside its home country, is further buttressed by the openness and size of US financial markets. They make up <a href="https://www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb">36% of the world’s total</a> or five times more than the euro area’s markets. Most trade-related financial transactions <a href="https://blogs.worldbank.org/trade/greasing-wheels-commerce-trade-finance-and-credit">involve the use of short-term credit</a>, like using a credit card to buy something. As a result, the banking systems of many countries must then be at least partially based on the dollar so they can provide this short-term credit. </p>
<p>And so, these banks need to invest in the US financial markets to refinance themselves in dollars. They can then provide this to their clients as dollar-based short-term loans.</p>
<p>It’s fair to say, then, that the US dollar has not become the premier global currency only because of US efforts to foster its use internationally. It will also continue to dominate as long as private organisations engaged in international trade and finance find it the most convenient currency to use.</p>
<h2>What could knock the US dollar off its perch?</h2>
<p>Some governments such as that of China might try to offer alternatives to the US dollar, but they are unlikely to succeed. </p>
<p>Government-to-government transactions, for example for crude oil between China and Saudi Arabia, could be denominated in yuan. But then the Saudi government would have to find something to do with the Chinese currency it receives. Some could be used to pay for imports from China, but <a href="https://oec.world/en/profile/country/sau/?yearlyTradeFlowSelector=flow0">Saudi Arabia imports</a> a lot less from China (about US$30 billion) than it exports (about US$49 billion) to the country.</p>
<p>The US$600 billion <a href="https://www.pif.gov.sa/en/Pages/AboutPIF.aspx">Public Investment Fund</a> (PIF), Saudi Arabia’s sovereign wealth fund, could of course use the yuan to invest in China. But this is difficult on a large scale because Chinese currency remains only partially “convertible”. This means that the Chinese authorities still control many transactions in and out of China, so that the PIF might not be able to use its yuan funds as and when it needs them. Even without convertibility restrictions, few private investors, and even fewer western investment funds, would be keen to put a lot of money into China if they are at the mercy of the Communist party.</p>
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Read more:
<a href="https://theconversation.com/war-in-ukraine-might-give-the-chinese-yuan-the-boost-it-needs-to-become-a-major-global-currency-and-be-a-serious-contender-against-the-us-dollar-205519">War in Ukraine might give the Chinese yuan the boost it needs to become a major global currency -- and be a serious contender against the US dollar</a>
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<p>China is of course the country with the strongest political motives to challenge the hegemony of the US dollar. A natural first step would be for China to diversify its foreign exchange reserves away from the US by investing in other countries. But this is easier said than done. </p>
<p>There are few opportunities to invest hundreds or thousands of billions of dollars outside of the US. <a href="https://stats.bis.org/statx/srs/table/c1?f=pdf">Figures from the Bank of International Settlements</a> show that the euro area bond market – a place for investors to finance loans to Euro area companies and governments – is worth less than one third of that of the US. </p>
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<img alt="Full-colour US dollar and Chinese yuan notes torn in half and pictured beside each other over a grey map of the world." src="https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/531169/original/file-20230609-5641-6c2xc8.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>
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<span class="attribution"><span class="source">NothingIsEverything/Shutterstock</span></span>
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</figure>
<p>Also, in any big crisis, other major OECD economies like Europe and Japan are more likely to side with the US than China – making such a decision is even easier when they are using US dollars for trade. It was said that states <a href="https://www.piie.com/blogs/realtime-economics/much-global-south-ukraines-side">accounting for one half of the global population</a> refused to condemn Russia’s invasion of Ukraine, but this half does not account for a large share of global financial markets. </p>
<p>Similarly, it shouldn’t come as a surprise that democracies dominate the world financially. Companies and financial markets require trust and a well-established rule of law. Non-democratic regimes have no basis for establishing the rule of law and every investor is ultimately subject to the whims of the ruler.</p>
<p>When it comes to global trade, currency use is underpinned by a self-reinforcing network of transactions. Because of this, and the size of the US financial market, the dollar’s dominant position remains something for the US to lose rather for others to gain.</p><img src="https://counter.theconversation.com/content/207057/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Daniel Gros 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 much international trade happens in dollars that it would be very difficult to turn the tide against the currency any time soon.Daniel Gros, Professor of Practice and Director of the Institute for European Policymaking, Bocconi UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2076932023-06-14T21:28:23Z2023-06-14T21:28:23ZWhy the Federal Reserve’s epic fight against inflation might be over<figure><img src="https://images.theconversation.com/files/532057/original/file-20230614-15-ee7899.jpg?ixlib=rb-1.1.0&rect=195%2C252%2C7456%2C4852&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Time to press the stop button?</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/playing-music-on-analog-cassette-player-royalty-free-image/1411640170?phrase=pause%20button%20stereo">iStock/Getty Images</a></span></figcaption></figure><p>The Federal Reserve’s decision to <a href="https://www.bloomberg.com/news/live-blog/2023-06-14/fomc-rate-decision-and-fed-chair-news-conference?srnd=premium&sref=Hjm5biAW">hold rates steady signals</a> that central bankers believe it is time to hit pause, at least temporarily, on their aggressive campaign to tame runaway inflation. </p>
<p>The latest data, not to mention several other factors, however, suggests it’s time for a full stop. </p>
<p>On June 14, 2023, the Fed <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230614a.htm">chose not to lift rates</a> <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm">for the first time in 11 meetings</a>, leaving its target interest rate – a benchmark for borrowing costs across the global economy – at a range of 5% to 5.25%. Over 10 consecutive hikes beginning in March 2022, the Fed had raised rates a whopping 5 percentage points. </p>
<p>“Holding the target range steady at this meeting allows the committee to assess additional information and its implications for monetary policy,” the central bank said in a statement. The Fed indicated <a href="https://www.bloomberg.com/news/live-blog/2023-06-14/fomc-rate-decision-and-fed-chair-news-conference?srnd=premium&sref=Hjm5biAW">it still expects</a> to raise rates two more times by the end of the year.</p>
<p>As an <a href="https://scholar.google.com/citations?user=Liju3o8AAAAJ&hl=en&oi=ao">economist who follows</a> the central bank’s actions closely, I believe there’s good reason to think the Fed’s brief hiatus is likely to turn into a permanent vacation. </p>
<h2>Inflation is lower than it appears</h2>
<p>The <a href="https://fred.stlouisfed.org/graph/?g=166Wg">fastest rate of inflation since the 1980s</a> is what prompted the Fed to hike interest rates so much. So it makes sense that inflation would be a key indicator of when its job is complete. </p>
<p>The latest consumer price index data, released on June 13, showed core inflation – the Fed’s preferred measure, which excludes volatile food and energy prices – <a href="https://www.bls.gov/news.release/cpi.nr0.htm">falling to an annual rate of 5.3%</a> in May 2023, the <a href="https://fred.stlouisfed.org/graph/?g=1694c">slowest pace since November 2021</a>. That’s down from a peak of 6.6% in September 2022.</p>
<p>While the data shows inflation remains well above the <a href="https://theconversation.com/fed-wants-inflation-to-get-down-to-2-but-why-not-target-3-or-0-195500">Fed’s target</a> of around 2%, there’s good reason to believe that it will continue to fall regardless of what the Fed does. </p>
<p>Shelter, a measure of the cost of owning or renting a home, <a href="https://www.brookings.edu/blog/up-front/2022/05/18/how-does-the-consumer-price-index-account-for-the-cost-of-housing/#:%7E:text=How%20does%20BLS%20calculate%20the,landlord%20on%20the%20tenant%27s%20behalf.">is the largest component of the consumer price index</a>, accounting for more than one-third of the total. In its latest report, the Bureau of Labor Statistics reported shelter costs rose 8% from a year ago. After stripping that out, inflation was up just 2.1%. </p>
<p>The thing is, the data reported by the bureau doesn’t reflect the reality of what’s happening in the current housing market. </p>
<p>The Bureau of Labor Statistics <a href="https://www.brookings.edu/blog/up-front/2022/05/18/how-does-the-consumer-price-index-account-for-the-cost-of-housing/#:%7E:text=How%20does%20BLS%20calculate%20the,landlord%20on%20the%20tenant%27s%20behalf.">relies on a survey</a> that gauges rental prices from 50,000 leases, many of which were signed during the rental bubble in 2021 and 2022. A better measure of current market rents is the <a href="https://www.zillow.com/research/data/">Zillow Observed Rent Index</a>. That index suggests rates are declining – <a href="https://www.zillow.com/research/may-2023-rent-report-32734/">rents rose 4.8%</a> year over year in May, aligning with pre-pandemic rates. </p>
<p>Comparing the two measures suggests the official consumer price index data lags behind the market by four to six months. Using current rents would put inflation much closer to where the Fed wants it to be. Jason Furman, former chair of the government’s Council of Economic Advisors, created a modified version of <a href="https://twitter.com/jasonfurman/status/1668600964822228992?s=20">core inflation</a> – which uses a market-based measure of shelter prices – at 2.6%. </p>
<figure class="align-center ">
<img alt="A man stands before a podium in front of U.S. and fed flags at a press conference" src="https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/532058/original/file-20230614-25-cqnm9x.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">Federal Reserve Chair Jerome Powell wants to assess the data before making his next move.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/FederalReservePowell/277e9ba6db9842eeb416735b24a29a7f/photo?Query=federal%20reserve&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=10228&currentItemNo=4">AP Photo/Jacquelyn Martin</a></span>
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<h2>The risk of more rate hikes</h2>
<p>Moreover, it is likely that further rate hikes will do more harm than good – particularly to the banking sector – and without helping lower inflation below its current trajectory. </p>
<p><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">Several regional lenders</a>, including Silicon Valley Bank and First Republic, collapsed earlier this year following bank runs. Combined, they had <a href="https://www.washingtonpost.com/business/2023/06/06/2023-banking-crisis-key-lessons-from-the-svb-first-republic-collapses/2f5e2cc2-048f-11ee-b74a-5bdd335d4fa2_story.html">over a half-trillion dollars</a> in assets.</p>
<p>While there were several factors behind the banks’ demise, an important one was the Fed’s aggressive rate hikes, which caused the value of many of their assets to fall. The banks catered to depositors with accounts that exceeded the US$250,000 threshold protected by the Federal Deposit Insurance Corporation. These depositors ran for the hills when they learned about the extent of the bank losses.</p>
<p>This turmoil, in tandem with higher rates, <a href="https://www.nytimes.com/2023/03/22/business/banking-crisis-interest-rates-lending.html">is also cooling business activity</a>. This means the Fed <a href="https://twitter.com/paulkrugman/status/1636644254972870658?s=20">doesn’t need to go</a> as high on rates as it otherwise would have.</p>
<p>Further troubles loom over the banking sector. In recent days, notable figures in the finance industry, such as <a href="https://www.cnbc.com/2023/06/12/goldman-sachs-ceo-solomon-commercial-real-estate-write-downs.html">Goldman Sachs CEO David Solomon </a> and former <a href="https://fortune.com/2023/06/12/larry-summers-inflation-us-economy-hot-commercial-real-estate/">U.S. Treasury Secretary Larry Summers</a>, have warned that nearly <a href="https://www.wsj.com/articles/interest-only-loans-helped-commercial-property-boom-now-theyre-coming-due-c3754941">$1.5 trillion in commercial real estate loans</a> will require refinancing over the next three years.</p>
<p>The combination of already high interest rates and <a href="https://www.nytimes.com/2023/05/05/nyregion/nyc-office-space-vacancy-rates.html">low office occupancy rates</a> will likely force banks to absorb hundreds of billions of dollars in loan losses, inevitably putting more banks on the brink of failure.</p>
<p>And if the Fed keeps raising rates, the situation is likely to get a lot worse.</p>
<h2>Don’t make the same mistakes</h2>
<p>The Fed was behind the curve in 2021 and 2022 in realizing inflation was getting out of control, and it has been historically slow in recognizing the impact of rental rates on inflation. </p>
<p>The June pause in raising rates should give the Fed time to take a break, look at the data and, I hope, realize inflation is closer to its target than it appears. </p>
<p>But if it continues to raise rates, I believe the central bank will be repeating the same mistakes it made in the past.</p><img src="https://counter.theconversation.com/content/207693/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ryan Herzog 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 Fed said it’s pausing its aggressive rate-hiking campaign as it collects more data on the impact.Ryan Herzog, Associate Professor of Economics, Gonzaga UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2071612023-06-13T14:03:11Z2023-06-13T14:03:11ZThe US role in the global financial system is changing – here’s how it could affect the world’s economy<figure><img src="https://images.theconversation.com/files/531025/original/file-20230608-29-va8wnb.jpg?ixlib=rb-1.1.0&rect=109%2C58%2C5262%2C3581&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/paper-plane-on-travel-map-symbolizing-52674835">Anneka/Shutterstock</a></span></figcaption></figure><p>The last-minute resolution of <a href="https://www.bbc.co.uk/news/world-us-canada-65744615">the US debt ceiling crisis</a> recently has led to a collective sigh of relief in global financial markets. But the way it was resolved has renewed concerns about the <a href="https://apnews.com/article/debt-limit-congress-world-economy-recession-biden-52df635e9b89f4b1677176fc8d59eff0">the dominant role of the US in the world economy</a> at a time of unprecedented challenges including low growth, high inflation and worries about the stability of the banking system.</p>
<p>There is a high degree of uncertainty about how these issues will play out. But the political paralysis in Washington, the rise of populism and a retreat from free trade means that the US may not have either the means or the will to deal with another global crisis as effectively as it once did. </p>
<p>As a BBC economics reporter during the 2008 global financial crisis, I saw first hand the dominant role the US played, both domestically and internationally, in resolving the situation. There is little evidence of the same commitment from the US today.</p>
<p>The US Federal Reserve Bank played a <a href="https://www.federalreserve.gov/econres/feds/files/2019039pap.pdf">crucial role</a> in 2008. It stabilised the global banking system by lending over US$1 trillion (£796 billion) to other central banks <a href="https://www.grips.ac.jp/r-center/wp-content/uploads/11-18.pdf">through so-called “swap lines”</a>, which pumped money into the financial system. </p>
<p>This facilitated the bailout of the European banking system by lending much-needed dollars. This year, at the height of the banking crisis in March, the <a href="https://www.federalreserve.gov/monetarypolicy/central-bank-liquidity-swaps.htm">Fed intervened again</a> to provide daily currency swaps to other central banks. </p>
<p>During the 2008 crisis, the US was also <a href="https://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2010/11/cj30n3-5.pdf">the driving force</a> behind urging the major industrial countries to introduce expansionary policies to grow their economies in order to avoid a global recession. </p>
<p>It also enabled the International Monetary Fund (IMF) <a href="https://www.imf.org/en/News/Articles/2015/09/28/04/53/sonew040309a">to make a further US$1 trillion</a> available to stabilise the threat to the financial system and help emerging market and <a href="https://www.imf.org/external/np/lic/2009/072909.htm">low-income countries</a>. And the US took the lead, through the G20, in creating the <a href="https://www.fsb.org/about/history-of-the-fsb/">global financial regulator</a>, the Financial Stability Board (FSB), to ensure the stability of large global banks.</p>
<p>More recently, the world’s financial system has been shaken by another financial crisis, although it has been smaller in scope: the failure of several US regional banks and the rescue of Swiss bank Credit Suisse. The latter is one of only 30 <a href="https://www.fsb.org/wp-content/uploads/P211122.pdf">global systemically important financial institutions</a> identified by the FSB as likely to cause a financial crisis if they fail. </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>It is by no means clear that <a href="https://www.theguardian.com/business/2023/may/02/is-the-banking-crisis-coming-to-an-end-as-jp-morgan-ceo-notes-risks-linger">the latest banking crisis has run its course</a>. There are concerns about the so-called <a href="https://home.treasury.gov/news/press-releases/jy1376">shadow banking system</a>, largely unregulated financial institutions that now make up <a href="https://www.imf.org/en/Publications/GFSR">half of all</a> global financial assets. For example, in the US many people invest in <a href="https://www.nytimes.com/2023/04/21/business/money-market-funds.html?referringSource=articleShare">money market funds</a>, which pay higher interest than banks, but provide no deposit insurance. </p>
<p>Meanwhile, the international regulatory system created in 2008 has been either ineffective or weakened. Political pressures led <a href="https://www.arnoldporter.com/en/perspectives/advisories/2018/06/passage-of-the-economic-growth-act-modifies">the US to reduce regulation and capital requirements</a> for its regional banks, <a href="https://www.brookings.edu/research/no-dodd-frank-was-neither-repealed-nor-gutted-heres-what-really-happened/">during the Trump administration</a>, while <a href="https://www-forbes-com.cdn.ampproject.org/c/s/www.forbes.com/sites/mayrarodriguezvalladares/2023/04/17/what-to-watch-for-with-us-regional-banks-this-week/amp/">worries about their soundness</a> remain. Internationally, geopolitical tensions within the G20, <a href="https://www.bbc.co.uk/news/world-asia-india-64781836">due to differences</a> between emerging market countries and G7 countries on Ukraine, have furthered weakened the impact of FSB recommendations.</p>
<figure class="align-center ">
<img alt="Globe on international banknotes, currency signs including dollar, euro, yen, yuan, pound, financial charts." src="https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/531022/original/file-20230608-21-swwjfx.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">Global economy.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/world-on-international-banknotes-currency-sign-2108080049">Dilok Klaisataporn/Shutterstock</a></span>
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</figure>
<h2>The future of US global economic influence</h2>
<p>There are strong reasons to <a href="https://www.politico.com/news/2022/10/15/domestic-inflation-global-recession-00061927">doubt whether the Fed would be willing or able</a> to lead another large-scale 2008-style bank rescue. In the first place, in contrast to the <a href="https://www.statista.com/statistics/191077/inflation-rate-in-the-usa-since-1990/">relatively low inflation in 2008</a>, the Fed is now facing <a href="https://theconversation.com/federal-reserve-bows-to-bank-crisis-fears-with-quarter-point-rate-hike-letting-up-a-little-in-its-fight-against-inflation-202307">conflicting pressures</a>, having sharply raised interest rates to curb inflation. </p>
<p>This might surge again if the Fed is forced to cut rates to save banks which lent heavily during the recent period of low rates and are now seeing a rise in bad debts as rates rise and borrowers struggle to manage their repayments. For the same reason, the Fed would be reluctant to support a further expansion of the US economy, which could add to inflationary pressures.</p>
<p>Finally, the US’s ability to mount a major bank rescue, either domestically or internationally, is limited by the fact that the Fed still has a huge balance sheet overhang remaining from the 2008 rescue, which it is trying to reduce <a href="https://www.federalreserve.gov/monetarypolicy/policy-normalization.htm">by US$30 billion, and soon US$60 billion, per month</a>. And the Fed’s authority to issue swaps to other central banks <a href="https://www.npr.org/sections/money/2020/04/21/839374663/why-is-the-fed-sending-billions-of-dollars-all-over-the-world">could also be challenged</a> by politicians who might question the need to help the US’s economic rivals. </p>
<p>The twin threats of inflation and slow growth have not yet been tamed, either in Europe or the US. This calls the credibility of central banks – which is key to their ability to manage the economy – <a href="https://www.theguardian.com/business/2023/may/19/central-banks-trust-inflation-bank-of-international-settlements?CMP=Share_iOSApp_Other">into question</a> as never before. </p>
<p>Meanwhile, the value of financial assets that underpin the global financial system, particularly US Treasury bonds, have seen <a href="https://www.reuters.com/markets/rates-bonds/dysfunction-wildly-illiquid-bond-markets-unnerves-investors-officials-2023-03-17/">dramatic fluctuations</a> due to the banking and debt ceiling crisis, as well as concerns about the huge size of fast-rising US government debt. </p>
<p>Recent attempts by right-wing House Republicans to <a href="https://www.reuters.com/world/us/mccarthy-faces-sudden-challenge-hardliners-after-us-debt-ceiling-bill-2023-06-07/">block the passage</a> of some spending bills could ultimately lead to a government shutdown. This would further weaken the US government’s credit rating.</p>
<p>All of this has put unprecedented pressure on the stability of the banks around the world. The growing tensions within the globalised financial system, coupled with a weakened US in retreat from its global role, could spell danger for world economy.</p><img src="https://counter.theconversation.com/content/207161/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Schifferes 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 the US may not always be able to lead global economic rescue efforts.Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2055192023-06-01T12:30:26Z2023-06-01T12:30:26ZWar in Ukraine might give the Chinese yuan the boost it needs to become a major global currency – and be a serious contender against the US dollar<figure><img src="https://images.theconversation.com/files/528317/original/file-20230525-29-2upko8.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">China and the U.S. compete to be the world's largest economy, but the dollar dominates the yuan as a currency.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/sino-us-trade-war-royalty-free-image/1216692156">peng song/Moment Collection/Getty Images</a></span></figcaption></figure><p>The Chinese economy’s sheer size and rapid growth are impressive.</p>
<p>China maintained one of the <a href="https://www.worldbank.org/en/country/china/overview#1">highest economic growth rates</a> in the world for more than a quarter of a century, helping lift <a href="https://www.worldbank.org/en/news/press-release/2022/04/01/lifting-800-million-people-out-of-poverty-new-report-looks-at-lessons-from-china-s-experience">over 800 million people</a> out of poverty in just a few decades. The country is the <a href="https://wits.worldbank.org/CountrySnapshot/en/CHN">largest exporter in the world</a> and the most important trading partner of Japan, Germany, Brazil and many other countries. It has the <a href="https://www.imf.org/external/datamapper/NGDPD@WEO/OEMDC/ADVEC/WEOWORLD">second-largest economy</a> after the U.S., based on the market exchange rate, and the largest <a href="https://databankfiles.worldbank.org/public/ddpext_download/GDP_PPP.pdf">based on purchasing power</a>.</p>
<p>And yet the yuan still lags as a major global currency. The war in Ukraine, which started in February 2022, may change that. </p>
<p>As a <a href="https://www.loyola.edu/sellinger-business/faculty-research/directory/chuluun">professor of finance</a> and <a href="https://www.mheducation.com/highered/product/international-financial-management-eun-resnick/1264413092.html">expert on international finance</a>, I understand how this geopolitical conflict may put China’s currency on the next phase of its path to becoming a global currency – and prompt the onset of the decline of the U.S. dollar from <a href="https://www.bis.org/statistics/rpfx22_fx.htm">its current dominance</a>. </p>
<h2>Chinese yuan’s slow progress</h2>
<p>China has long wanted to make the yuan a global force and has mounted significant efforts to do so in recent years. </p>
<p>For example, the Chinese government <a href="https://www.reuters.com/article/uk-china-economy-yuan/china-launches-yuan-cross-border-interbank-payment-system-idUKKCN0S204320151008">launched the Cross-Border Interbank Payments System</a>, or CIPS, in 2015 to facilitate cross-border payments in yuan. Three years later, in 2018, it launched the world’s <a href="http://www.xinhuanet.com/english/2018-03/26/c_137065815.htm">first yuan-denominated crude oil futures contracts</a> to allow exporters to sell oil in yuan. </p>
<p>China has also emerged perhaps as the <a href="https://hbr.org/2020/02/how-much-money-does-the-world-owe-china">world’s largest creditor</a>, with the government and state-controlled enterprises extending loans to dozens of developing countries. And China is <a href="https://www.cnn.com/2023/04/24/economy/china-digital-yuan-government-salary-intl-hnk/index.html">developing a digital yuan</a> as one of the world’s first central bank digital currencies. Even the trading hours for the yuan were <a href="https://www.reuters.com/article/china-yuan-trading/update-1-china-to-extend-fx-market-trading-hours-to-further-internationalise-yuan-idINL1N33K0GJ">recently extended</a> on the mainland.</p>
<p>Thanks to these efforts, the yuan is now the <a href="https://www.bis.org/statistics/rpfx22_fx.htm">fifth-most-traded currency</a> in the world. That is a phenomenal rise from its <a href="https://www.bis.org/publ/rpfx02.htm">35th place in 2001</a>. The yuan is also the <a href="https://www.swift.com/our-solutions/compliance-and-shared-services/business-intelligence/renminbi/rmb-tracker/rmb-tracker-document-centre">fifth-most-actively used currency</a> for global payments as of April 2023, up from 30th place in early 2011. </p>
<p>Rankings can be misleading, though. The yuan’s average trading volume is still <a href="https://www.bis.org/statistics/rpfx22_fx.htm">less than a 10th</a> of the U.S. dollar’s. Moreover, almost all trading was against the U.S. dollar, with little trading against other currencies.</p>
<p>And when it comes to global payments, the actual share of the yuan is a <a href="https://www.swift.com/our-solutions/compliance-and-shared-services/business-intelligence/renminbi/rmb-tracker/rmb-tracker-document-centre">mere 2.3%</a>, compared with 42.7% for the dollar and 31.7% for the euro. The yuan also constituted <a href="https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4">less than 3%</a> of the world foreign exchange reserves at the end of 2022, compared with 58% for the dollar and 20% for the euro.</p>
<figure class="align-center ">
<img alt="Two men shake hands in front of Russian and Chinese flags" src="https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=425&fit=crop&dpr=1 600w, https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=425&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=425&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=534&fit=crop&dpr=1 754w, https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=534&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/528318/original/file-20230525-27-sg2yw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=534&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Russian Prime Minister Mikhail Mishustin meets with Chinese President Xi Jinping in Beijing on May 24, 2023, with the two countries signing a new set of trade agreements.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/russian-prime-minister-mikhail-mishustin-meets-with-chinas-news-photo/1257684729">Alexander Astafyev/Sputnik/AFP</a></span>
</figcaption>
</figure>
<h2>US dollar’s dominance questioned</h2>
<p>The U.S. dollar has reigned supreme as the dominant global currency for decades – and concern about how that benefits the U.S. and potentially hurts emerging markets <a href="https://scholar.harvard.edu/gopinath/publications/dominant-currency-paradigm-0">is not new</a>. </p>
<p>The value of the <a href="https://www.reuters.com/markets/currencies/recession-worries-could-support-dollar-after-monstrous-2022-rally-2022-12-08/">U.S. dollar appreciated significantly</a> against most other currencies in 2022 as the Federal Reserve hiked interest rates. This had negative consequences for residents of almost any country that borrows in dollars, pays for imports in dollars, or buys wheat, oil or other commodities priced in dollars, as these transactions became more expensive. </p>
<p>After Russia invaded Ukraine in early 2022, the U.S. and its Western allies put sanctions on Russia, <a href="https://www.swift.com/news-events/news/message-swift-community">including cutting Russia’s access</a> to the global dollar-based payments system known as the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. That clearly displayed how the dollar can be weaponized. </p>
<p>With Russia largely cut off from international financial markets, it stepped up its trade with China. Russia began <a href="https://www.cnn.com/2022/09/06/energy/china-russian-gas-payments-ruble-yuan/index.html">receiving payments for coal and gas in yuan</a>, and Moscow <a href="https://www.reuters.com/markets/currencies/permitted-share-chinas-yuan-russian-wealth-fund-doubled-60-finmin-2022-12-30/">increased the yuan holdings</a> in its foreign currency reserves. Russian companies like Rosneft <a href="https://www.rosneft.com/press/releases/item/212071/">issued bonds denominated in yuan</a>. According to Bloomberg, the yuan is now the <a href="https://www.bloomberg.com/news/articles/2023-04-03/china-s-yuan-replaces-dollar-as-most-traded-currency-in-russia">most-traded currency in Russia</a>.</p>
<p>Other countries took notice of Russia’s increasing use of the yuan and saw an opportunity to decrease their own dependency on the dollar.</p>
<p><a href="https://www.reuters.com/business/energy/bangladesh-pay-russia-yuan-nuclear-plant-2023-04-17/">Bangladesh is now paying Russia in yuan</a> for the construction of a nuclear power station. <a href="https://www.nasdaq.com/articles/china-completes-first-yuan-settled-lng-trade">France is accepting payment in yuan for liquefied natural gas</a> bought from China’s state-owned oil company. A Brazilian bank controlled by a Chinese state bank is becoming the first Latin American bank to <a href="https://www.bloomberg.com/news/articles/2023-03-30/brazil-takes-steps-to-transact-in-yuan-as-ties-with-china-grow#xj4y7vzkg">participate directly in China’s payments system, CIPS</a>. <a href="https://www.bloomberg.com/news/articles/2023-02-22/iraq-pivots-to-yuan-for-china-imports-in-defense-of-own-currency#xj4y7vzkg">Iraq wants to pay for imports from China in yuan</a>, and even Tesco, the British retailer, <a href="https://www.economist.com/leaders/2013/02/09/yuan-for-the-money">wants to pay for its Chinese imported goods in yuan</a>. </p>
<p>The combined dollar amount of these transactions is still relatively small, but the shift to yuan is significant.</p>
<h2>Yuan still not freely available</h2>
<p>China keeps <a href="https://www.safe.gov.cn/en/2023/0222/2067.html">a tight grip</a> on money coming in and out of the country. Such capital controls and limited transparency in Chinese financial markets mean China still lacks the deep and free financial markets that are required to make the yuan a major global currency. </p>
<p>For the yuan to achieve a truly global standing, it needs to be freely available for cross-border investment and not just serve as a payment medium to accommodate trade. </p>
<p>But the war in Ukraine may have just made it feasible for the yuan to eventually join the ranks of the dollar and the euro – even if the volume isn’t there yet. And any U.S. policy decisions that weaken the reputation and strength of U.S. institutions – such as <a href="https://theconversation.com/voters-want-compromise-in-congress-so-why-the-brinkmanship-over-the-debt-ceiling-206465">the recent drama over raising the debt ceiling</a>, which brought the government to the brink of default – will accelerate the rise of the yuan and decline of the dollar.</p><img src="https://counter.theconversation.com/content/205519/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Tuugi Chuluun 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>Despite China’s economic power, the yuan lags as a major global currency. Here’s why current US interest rates and sanctions on Russia may change that.Tuugi Chuluun, Associate Professor of Finance, Loyola University MarylandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2055372023-05-16T17:34:27Z2023-05-16T17:34:27ZWar rooms and bailouts: How banks and the Fed are preparing for a US default – and the chaos expected to follow<figure><img src="https://images.theconversation.com/files/526339/original/file-20230515-21691-8klpm5.jpg?ixlib=rb-1.1.0&rect=53%2C80%2C3534%2C2308&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">'Default doomscrolling' again, Mr. Powell?
</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/JapanG7Finance/c9f9b3cb0a3542858fc79ab85ea9d5f7/photo?Query=Jerome%20powell&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=2123&currentItemNo=20">Kimimasa Mayama/Pool Photo via AP</a></span></figcaption></figure><p><a href="https://www.bloomberg.com/news/articles/2023-05-11/jpmorgan-convenes-weekly-war-room-over-us-debt-ceiling-standoff?srnd=premium">Convening war rooms</a>, <a href="https://www.axios.com/2023/04/19/fed-debt-ceiling-default-playbook">planning speedy bailouts</a> and <a href="https://www.reuters.com/markets/us/how-wall-street-is-preparing-possible-us-debt-default-2023-05-15/">raising house-on-fire alarm bells</a>: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.</p>
<p>“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, <a href="https://www.cnn.com/2023/02/06/investing/bank-of-america-ceo-brian-moynihan-debt-default/index.html">said in a television interview</a>. </p>
<p>The doomsday planning is a reaction to a <a href="https://apnews.com/article/debt-limit-biden-mccarthy-white-house-meeting-c613984327ba0fc039853c057878f7e7#:%7E:text=WASHINGTON%20(AP)%20%E2%80%94%20House%20Speaker,raise%20its%20legal%20borrowing%20limit.">lack of progress</a> in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – <a href="https://www.nytimes.com/2023/05/16/us/politics/biden-mccarthy-debt-ceiling.html">another round of negotiations</a> took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.</p>
<p>What happens if a default occurs is an open question, but economists – <a href="https://www.bakerinstitute.org/expert/john-w-diamond">including me</a> – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety <a href="https://theconversation.com/link-198395">would be further tarnished</a>. </p>
<p>But how do you prepare for an event that <a href="https://www.nytimes.com/2023/03/07/us/politics/debt-default-economy.html">many expect would trigger</a> the worst global recession since the 1930s? </p>
<h2>Preparing for panic</h2>
<p>Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s <a href="https://www.bloomberg.com/news/articles/2023-05-11/jpmorgan-convenes-weekly-war-room-over-us-debt-ceiling-standoff?srnd=premium&sref=Hjm5biAW">been convening a weekly war room</a> to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the <a href="https://www.reuters.com/markets/us/us-may-run-short-cash-after-june-1-without-debt-limit-hike-treasury-2023-05-01/">U.S. might run out of cash</a> – nears. </p>
<p>Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad. </p>
<p>“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.</p>
<p>That’s when rational decision-making <a href="https://www.brookings.edu/blog/ben-bernanke/2018/09/13/financial-panic-and-credit-disruptions-in-the-2007-09-crisis">gives way to fear and irrationality</a>. Markets overtaken by these emotions are chaotic and leave lasting economic scars.</p>
<p>Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the <a href="https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath">financial crisis in 2008</a> or the <a href="https://www.bakerinstitute.org/research/reflecting-budget-control-act-2011-and-its-relevance-now">debt ceiling showdowns of 2011</a> and <a href="https://www.nytimes.com/2013/10/17/us/congress-budget-debate.html">2013</a>. </p>
<p>One important way banks can prepare is by <a href="https://www.bloomberg.com/news/articles/2022-10-10/the-most-powerful-buyers-in-treasuries-are-all-bailing-at-once">reducing exposure</a> to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds. </p>
<p>The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was <a href="https://www.npr.org/2023/03/19/1164531413/bank-fail-how-government-bonds-turned-toxic-for-silicon-valley-bank">prompted primarily by a drop</a> in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks <a href="http://dx.doi.org/10.2139/ssrn.4387676">at risk of failure</a> as of March 2023.</p>
<p>Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy <a href="https://www.investopedia.com/terms/c/creditdefaultswap.asp">credit default swaps</a>, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default <a href="https://www.bloomberg.com/news/articles/2023-05-10/us-default-insurance-cost-eclipses-brazil-mexico-as-x-day-nears">is higher than that of Brazil, Greece and Mexico</a>, all of which have defaulted multiple times and have much lower credit ratings. </p>
<p>But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default. </p>
<figure class="align-center ">
<img alt="Four white men sit on white couches in a large office filled with presidential portraits." src="https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/526341/original/file-20230515-31621-7oogjm.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">Little has come out of fiscal negotiations between Mitch McConnell, left, Kevin McCarthy, second from left, President Joe Biden, second from right, and Chuck Schumer.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/CongressDebtLimit/96a3bb6abb544bc98158ccfb77f4c61d/photo?Query=biden%20mccarthy&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=666&currentItemNo=1">AP Photo/Evan Vucci</a></span>
</figcaption>
</figure>
<h2>Keeping the financial plumbing working</h2>
<p>Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.</p>
<p>The Securities Industry and Financial Markets Association, for example, <a href="https://www.reuters.com/markets/us/how-wall-street-is-preparing-possible-us-debt-default-2023-05-15/">has been updating</a> <a href="https://www.sifma.org/wp-content/uploads/2018/01/SIFMA-Treasury-Payment-Disruption-Playbook-December-2021.pdf">its playbook</a> to dictate how players in the Treasurys market will communicate in case of a default. </p>
<p>And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans <a href="https://theconversation.com/a-brief-history-of-debt-ceiling-crises-and-the-political-chaos-theyve-unleashed-205178">demanded the elimination</a> of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash. </p>
<p>One of the biggest concerns Fed officials had at the time, according to a <a href="https://www.federalreserve.gov/monetarypolicy/files/FOMC20131016confcall.pdf">meeting transcript recently made public</a>, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government <a href="https://home.treasury.gov/news/press-releases/jy1460">issued just under $100 billion</a> in notes and bonds to replace maturing debt and raise cash. </p>
<p>The risk is that there would be too few buyers at one of the <a href="https://www.treasurydirect.gov/auctions/upcoming/">government’s daily debt auctions</a> – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt. </p>
<p>That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the <a href="https://fiscaldata.treasury.gov/americas-finance-guide/#">government spent over $6 trillion on</a> in 2022. This would be nothing short of apocalyptic if the Fed could not save the day. </p>
<p>To mitigate that risk, the Fed said it could could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.</p>
<h2>A self-imposed catastrophe</h2>
<p>Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit. </p>
<p>These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to <a href="https://www.nytimes.com/2023/01/19/us/politics/republicans-democrats-debt-ceiling.html">rein in government spending</a>. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, <a href="https://www.bakerinstitute.org/research/reflecting-budget-control-act-2011-and-its-relevance-now">history shows they fail</a>, as energy analyst Autumn Engebretson and I recently explained in a review of that episode. </p>
<p>That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.</p>
<p>Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.</p><img src="https://counter.theconversation.com/content/205537/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John W. Diamond 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>Major players in the financial system are pondering the unthinkable as the US inches closer to an unprecedented default.John W. Diamond, Director of the Center for Public Finance at the Baker Institute, Rice UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2053372023-05-11T13:28:34Z2023-05-11T13:28:34ZBank of England interest rate rise: why this could be the last increase for a while<figure><img src="https://images.theconversation.com/files/525457/original/file-20230510-12317-w8ujoi.jpg?ixlib=rb-1.1.0&rect=0%2C92%2C3861%2C2323&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Bank of England, London.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/bank-england-london-46410508">cristapper/Shutterstock</a></span></figcaption></figure><p>The <a href="https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2023/may-2023">Bank of England</a> has increased its benchmark interest rate to 4.5% – the <a href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">seventh</a> rise since May 2022, when the base rate was just 1%. It is now at the highest level since 2008. </p>
<p>The European Central Bank (<a href="https://www.ecb.europa.eu">ECB</a>) also increased its <a href="https://www.ft.com/content/bd3c28cc-3407-45a9-9c72-9c89c9aa9740">benchmark rate to 3.25%</a> at its latest meeting in early May and is now nearing a high not seen <a href="https://money.cnn.com/2001/10/25/international/ecb/">since 2001</a>. A few days before, the <a href="https://www.federalreserve.gov">US Federal Reserve</a> increased its rate from 5% to 5.25%, the highest level since mid-2007 and its <a href="https://www.nytimes.com/2023/05/07/business/federal-reserve-interest-rates.html">10th consecutive increase</a> in just over a year. </p>
<p>Both central banks are nearing the end of their <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2023/february/financial-market-conditions-during-monetary-tightening/#:%7E:text=A%20tightening%20cycle%20ends%20when,months%20after%20and%20is%201.5">rate-tightening cycles</a> as price pressures fall from a peak and the world anticipates a looming credit crisis.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/small-businesses-seek-to-avoid-possible-credit-crunch-as-federal-reserve-raises-rates-once-more-204256">Small businesses seek to avoid possible credit crunch as Federal Reserve raises rates once more</a>
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</em>
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<p>But plans could change depending on how the economy fares. And whether we can expect the same from the Bank of England could depend more on the fragility of the banking system than the need to continue to tame inflation.</p>
<p>The UK’s new <a href="https://www.ft.com/content/aa09b5b9-f88a-4ffc-8a1c-826970dfbc73">4.5% base rate may seem high</a>, but it’s actually quite low compared to the <a href="https://www.ft.com/content/a92ead2e-5a5e-4861-b7b0-ad5e787646d1">1980s</a> and <a href="https://www.bloomberg.com/news/articles/2022-02-19/1990s-lesson-recession-is-the-price-of-curbing-u-k-inflation">1990s</a>. During these decades, the rate peaked at 16% and 13.88% respectively, but was always higher than 5%. These high rates reflected a similar <a href="https://www.historyandpolicy.org/policy-papers/papers/reforming-the-bank-of-england-to-tame-inflation-and-boost-financial-stability-lessons-from-two-centuries-of-british-financial-history">battle with high inflation</a> by the bank as it is dealing with today. </p>
<p><strong>Low base rate today versus 1980s and 1990s:</strong></p>
<figure class="align-center ">
<img alt="A line chart showing high base rates in the 1970s, 1980s and 1990s, followed by a drop in the last decade." src="https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=371&fit=crop&dpr=1 600w, https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=371&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=371&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=466&fit=crop&dpr=1 754w, https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=466&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/525588/original/file-20230511-9582-saii54.png?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>
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<span class="attribution"><a class="source" href="https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp">Bank of England</a></span>
</figcaption>
</figure>
<p>So why are today’s interest rates at such (relatively) low levels? This is because of the toolkit central banks use to tackle rising prices, in particular base rate adjustments.</p>
<p>Like the Fed and the ECB, the Bank of England is trying to hit an inflation <a href="https://www.cnbc.com/video/2023/02/20/why-the-federal-reserve-aims-for-2percent-inflation.html">target of 2%</a>. The latest <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/d7g7/mm23">official UK data</a> shows inflation is at 10.1%, considerably above this target. </p>
<p>Inflation is measured by tracking the yearly change in the prices of <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationbasketofgoodsandservices/2023">a “basket” of goods and services</a> that includes items like food, petrol and leisure activities. <a href="https://www.theguardian.com/business/2023/feb/21/energy-crisis-ukraine-war-uk-cost-gas">Surging energy prices</a> following <a href="https://www.bbc.co.uk/news/world-60525350">Russia’s invasion of Ukraine</a> last February caused inflation to spike but have now been priced in to the annual measure. </p>
<p>Now food prices are keeping it elevated with a 19% rise over the year to March – the <a href="https://news.sky.com/story/uk-inflation-why-are-food-prices-rising-so-much-12860884">fastest increase in over 45 years</a>.</p>
<p>Interest rate changes are <a href="https://www.chicagobooth.edu/review/what-makes-it-hard-control-inflation">a blunt tool</a> to control such price rises without severely denting economic activity. A good example of this is when the US suffered painful <a href="https://www.nber.org/system/files/chapters/c11462/c11462.pdf">inflation during the 1970s</a>. </p>
<p>It took a crackdown by cigar-chomping Fed chairman <a href="https://en.wikipedia.org/wiki/Paul_Volcker">Paul Volcker</a> to break the cycle of rising prices and wages. He <a href="https://www.bu.edu/econ/files/2011/01/GKcr2005.pdf">slammed the brakes on the economy</a> by raising interest rates to 20%. Volcker’s actions worked: inflation retreated from 14.8% in 1980 to just over 3% by 1983. But <a href="https://www.npr.org/2022/09/29/1125462240/inflation-1970s-volcker-nixon-carter-interest-rates-fed">4 million people lost their jobs</a> in recessions in the early 1980s. </p>
<figure class="align-center ">
<img alt="Paul Volcker, glasses, suit & tie, cigar; in front of microphone, seated at a desk, people and paintings in the background." src="https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=403&fit=crop&dpr=1 600w, https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=403&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=403&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=507&fit=crop&dpr=1 754w, https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=507&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/525455/original/file-20230510-16071-jmyca.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=507&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">Paul Volcker smokes a cigar while testifying before the House Banking Committee in 1986 during his time as US Federal Reserve Chair.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/washington-dc-usa-february-19-1986-2185750041">mark reinstein/Shutterstock</a></span>
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</figure>
<h2>Three effects of central bank decisions</h2>
<p>Even without such drastic rate changes, such monetary policy decisions affect the wider economy and inflation in three main ways. Economists call these transmission channels.</p>
<p>The most obvious of the three is the <a href="https://www.jstor.org/stable/40722514">interest rate channel</a> because the changes in a central bank’s rates affect other interest rates such as mortgages. Higher rates will translate into higher repayments and less cash to spend on other things. Less spending means that businesses will be reluctant to increase their prices, which should lower inflation.</p>
<p>Interest rates also affect the real economy and inflation through the <a href="https://www.sciencedirect.com/science/article/abs/pii/S0164070406000905">credit channel</a>. It covers lending to both businesses and people. This can be seen through the availability of bank loans, as well as business balance sheets and risk taking. </p>
<p>When interest rates rise, the risk that some borrowers cannot safely repay their debts may increase so much that a bank <a href="https://www.sciencedirect.com/science/article/pii/S2212567112000652">will not lend any more money to them</a>. These borrowers are then forced to stop spending or investing. This helps reduce inflation because less demand for products or services encourages companies to cut prices. </p>
<p>Changes in interest rates also affect <a href="https://www.jstor.org/stable/40268893">firms’ balance sheets</a>. An increase in interest rates lowers the value of things a company owns <a href="https://www.economist.com/briefing/2022/12/08/rising-interest-rates-and-inflation-have-upended-investing">such as a building</a>. In a higher rate environment, the property will be worth less, which matters if a business wants to use it as collateral on a loan for further investment in the business. </p>
<p>The effects of rate decisions on <a href="https://onlinelibrary.wiley.com/doi/10.1111/fima.12256">risk taking</a> is thought to operate in two ways. First, low interest rates boost asset (and collateral) values. This, along with the belief that an increase in asset values will last for a long time, leads both borrowers and banks to accept higher risks. Second, low interest rates make riskier assets more attractive because investors must search for higher yields to make returns. </p>
<p>So, when interest rates are low, banks relax their lending rules, which can lead to an excessive increase in loan supply. This pumps more money into the financial system. Rate increases have the opposite effect.</p>
<h2>Banking crisis fears</h2>
<p>These effects can be seen recently via banking failures, most notably <a href="https://www.theguardian.com/business/2023/mar/17/why-silicon-valley-bank-collapsed-svb-fail">Silicon Valley Bank</a> and <a href="https://www.cnbc.com/2023/04/28/swiss-national-bank-to-face-credit-suisse-and-climate-protests-at-fraught-agm.html">Credit Suisse</a>. While they happened for different reasons, both collapses exposed regulatory failures and poor risk management. Both were also triggered by tightening credit conditions, and by the increase in interest rates related to central bank rate hikes.</p>
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<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>
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<p>Such <a href="https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath">financial fragility</a> should be expected in any parts of the banking system that are badly managed, poorly regulated and more exposed to tight credit conditions. This means another banking crisis could happen, especially if central banks continue to tighten monetary policy. </p>
<p>The Bank of England takes all of this into account when deciding on the next move for interest rates. And so, if it has stopped raising rates for now, it’s not because inflation has been tamed but because the risk to the banking industry is too great at the moment.</p><img src="https://counter.theconversation.com/content/205337/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 Bank of England is factoring more than sky-high inflation into its base rate decisions right now.Edward Thomas Jones, Lecturer in Economics / Director of the Institute of European Finance, Bangor UniversityYener Altunbas, Professor of Banking, Bangor UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2036392023-05-03T18:30:37Z2023-05-03T18:30:37ZFed rate hikes, recession fears and political backlash leave ESG investors at a crossroads<figure><img src="https://images.theconversation.com/files/523943/original/file-20230502-26-p3xlrc.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C5464%2C3631&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">ESG investing looks for companies that do well on environmental, social and governance benchmarks. </span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/directly-above-the-downtown-district-royalty-free-image/1328074262">Zhengshun Tang/Moment via Getty Images</a></span></figcaption></figure><p>The Federal Reserve <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230503a.htm">raised interest rates</a> again on May 3, 2023, by a quarter point, making it the <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm">Fed’s 10th rate hike</a> since March 2022 in an ongoing fight to tame inflation. These rate hikes have been reverberating through the economy, raising prospects of a recession amid heightened <a href="https://www.nber.org/papers/w31048">concerns about the fragile state of banks</a>. </p>
<p>The rate hikes are also rattling sustainability-focused investing, better known as ESG investing.</p>
<p>The trend toward ESG investing, which puts pressure on companies to meet environmental, social and governance benchmarks, has almost redefined asset management over the past decade. ESG funds today are a <a href="https://www.ussif.org//Files/Trends/2022/Overview%20infographic.pdf">multitrillion-dollar market</a>.</p>
<p>However, the high uncertainty around interest rates today, along with the prospects of a looming recession and a <a href="https://www.yahoo.com/now/larry-fink-face-esg-says-213102226.html">political backlash</a>, has put the future of ESG investors at a crossroads.</p>
<p>I <a href="https://warrington.ufl.edu/directory/person/7627/">specialize in sustainable finance</a>, and my recent work has documented the <a href="https://doi.org/10.1017/S0022109022001296">impact that tough economic times</a> can have on ESG investing demand. Investments into U.S. sustainable mutual funds have <a href="https://www.morningstar.com/articles/1133418/us-sustainable-funds-suffer-a-worse-quarter-than-conventional-peers">visibly slowed</a> since 2022, suffering their worst net flows in five years. Here are how three critical factors can affect investors’ zeal for socially conscious investing going forward.</p>
<p><iframe id="KYfr3" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/KYfr3/3/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<h2>Interest rate uncertainty</h2>
<p>One of the primary arguments that big institutional investors like BlackRock make for ESG investing is that it <a href="https://www.blackrock.com/ch/individual/en/themes/sustainable-investing">creates long-term value for shareholders</a>. Companies that pay careful attention to environmental, social and governance issues are believed to be better prepared for distant future risks, including regulatory risks and physical risks from climate change.</p>
<p>However, heightened uncertainty about interest rates poses a challenge today. That’s because higher rates can disproportionately affect the present value that investors assign to long-term investment outcomes. Let me explain.</p>
<p>Within the past year, the Federal Reserve has raised its benchmark lending rate from almost zero to a target <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20230503a.htm">range of 5% to 5.25%</a> to combat inflation. In financial markets, higher interest rates lead to higher discount rates. That means that future cash generated by long-term investments is considered to be worth considerably less at today’s higher interest rates.</p>
<p>The more distant an asset’s value lies in the future, the more heavily it will be discounted in value when rates are high. So, long-duration investments – like most ESG investments – are especially sensitive to changes in interest rates.</p>
<p>This economic mechanism was also part of the backdrop of the recent rout in tech stocks and the <a href="https://theconversation.com/why-svb-and-signature-bank-failed-so-fast-and-the-us-banking-crisis-isnt-over-yet-201737">series of bank failures</a> that started with the <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">collapse of Silicon Valley Bank</a>. </p>
<h2>Looming recession</h2>
<p>Another factor that could affect ESG investing is the potential for an economic downturn.</p>
<p>As <a href="https://doi.org/10.1111/jofi.12547">research shows</a>, investors do not necessarily make ESG investments for greater long-term returns, but often for altruistic reasons or due to personal preferences to hold greener assets. For these ESG investors, a looming recession could change their perspective on these “luxuries.”</p>
<p>In an early warning about this possibility, <a href="https://doi.org/10.1017/S0022109022001296">a recent study</a> I conducted with an economist at the Rotterdam School of Management found that retail investors showed signs of shying away from investing in sustainable mutual funds during the early months of the COVID-19 shock in 2020. This was a period when many households experienced layoffs and furloughs, which likely pushed them to set aside luxuries to prioritize protecting the values of their 401(k)s, IRAs and other investment portfolios.</p>
<p>In other words, investors may be all for ESG, <a href="https://www.wsj.com/articles/investors-are-all-for-esg-except-that-is-when-times-are-tough-11675527842">except when times are tough</a>.</p>
<p><iframe id="Yun0K" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/Yun0K/5/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Prominent economists, such as former Treasury Secretary Larry Summers, have warned of a <a href="https://www.bloomberg.com/news/articles/2023-04-07/larry-summers-sees-higher-chance-of-recession-fed-nearing-the-end#xj4y7vzkg">likely recession</a> as inflation and the Fed’s battle against it persist. The International Monetary Fund also <a href="https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023">lowered its global economic growth outlook</a> from 3.4% in 2022 to 2.8% in 2023. </p>
<h2>Political backlash</h2>
<p>Finally, recent political friction and anti-ESG policies across states have started to create headwinds for pension funds and large institutions that serve them.</p>
<p>For example, <a href="https://www.reuters.com/business/sustainable-business/desantis-signs-sweeping-anti-esg-legislation-florida-2023-05-02/">Florida</a> and <a href="https://apnews.com/article/esg-woke-investing-kansas-culture-war-vetoes-20842bdda84432add49f267adb897df3">Kansas</a> passed laws in recent weeks and <a href="https://corpgov.law.harvard.edu/2023/03/11/esg-battlegrounds-how-the-states-are-shaping-the-regulatory-landscape-in-the-u-s/">several other states</a> including <a href="https://www.texastribune.org/2022/08/24/texas-boycott-companies-fossil-fuels/">Texas</a> and <a href="https://www.nytimes.com/2023/02/24/your-money/anti-esg-investing-kentucky.html">Kentucky</a> have taken actions to restrict the ability of state public pension funds to invest in companies based on their ESG performance, citing concerns about fraudulent greenwashing and potential fiduciary duty violations, referring to the obligation institutional investors have to seek the highest returns for the lowest risk possible.</p>
<p>These restrictions can severely limit the capacity for ESG investing by institutional investors, which have played a significant role in driving the growth of ESG investing.</p>
<figure class="align-center ">
<img alt="Lark Fink, in business attire and glasses, sits in a news studio being interviewed." src="https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/523942/original/file-20230502-321-8ju3yp.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">Blackrock CEO Larry Fink, shown during an earlier interview, told Bloomberg in 2023: ‘For the first time in my professional career, attacks are now personal. They’re trying to demonize the issues.’</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/blackrock-chairman-ceo-laurence-d-fink-appears-on-opening-news-photo/470074732">Taylor Hill/Getty Images</a></span>
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<p>While <a href="https://dx.doi.org/10.2139/ssrn.3837706">concerns about greenwashing</a> and <a href="https://dx.doi.org/10.2139/ssrn.3887716">high fees</a> in ESG investing are not totally unwarranted, these political interventions can also have unintended consequences.</p>
<p>A <a href="https://dx.doi.org/10.2139/ssrn.4123366">recent study</a> from economists at Wharton and the Federal Reserve Bank of Chicago found that a Texas law enacted in 2021 prohibiting municipalities from contracting with banks with ESG policies had a distorting side effect on those municipalities’ borrowing costs. The policy ended up raising the cost of public finance, meaning the law ultimately cost taxpayers.</p>
<h2>Navigating the crossroads</h2>
<p>As companies hold their 2023 annual meetings, the discussions among corporate officials, investors and stakeholders will serve as an important barometer for the current state and future of ESG investing.</p>
<p>Due to high interest rate uncertainty, prospects of a recession and political upheaval, ESG is under pressure. Perceived in recent years as a paradigm shift in how market mechanisms can address harms to society, stakeholders are now <a href="https://www.eenews.net/articles/they-helped-create-esg-two-decades-later-some-see-a-mess/">scrutinizing ESG investing</a> with a critical lens regarding how strongly it can persist and how much impact it can have.</p>
<p>The next few years will be its most important stress test yet.</p><img src="https://counter.theconversation.com/content/203639/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sehoon Kim 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>Three forces are pulling down ESG’s once-rapid rise in the investment world.Sehoon Kim, Assistant Professor of Finance, University of FloridaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2042562023-05-03T04:56:45Z2023-05-03T04:56:45ZSmall businesses seek to avoid possible credit crunch as Federal Reserve raises rates once more<figure><img src="https://images.theconversation.com/files/523980/original/file-20230503-16-ymdytm.jpg?ixlib=rb-1.1.0&rect=214%2C74%2C6015%2C4072&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Most small businesses rely on loans to finance at least some of their operations. </span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/license/1327235816">Westend61/Getty Images</a></span></figcaption></figure><p>Small businesses – the heartbeat of the U.S. economy – are beginning to feel the pinch of tighter credit conditions as the Federal Reserve continues to increase borrowing costs. </p>
<p>A <a href="https://www.bloomberg.com/news/articles/2023-04-29/signs-are-mounting-that-a-debt-crunch-is-looming-credit-weekly?sref=Hjm5biAW">flurry of headlines</a> in <a href="https://apnews.com/article/small-business-credit-crunch-lending-f09741c39bd0e5e9a8ea51c272143365">recent weeks</a> <a href="https://www.forbes.com/sites/rohitarora/2023/04/25/loss-of-confidence-and-resulting-withdrawals-from-banks-lead-to-a-small-business-credit-crunch/?sh=40efdb143a86">has suggested</a> a <a href="https://www.inc.com/ali-donaldson/a-credit-crunch-comes-for-small-businesses-cue-alternative-lenders.html">credit crunch</a> – meaning the availability of lending gets scarcer – <a href="https://markets.businessinsider.com/news/stocks/credit-crunch-us-bank-crisis-stock-corporate-earnings-recession-svb-2023-4">is already happening</a>. </p>
<p>That’s in large part brought on by the actions of the Federal Reserve, which has been raising borrowing costs for companies and consumers for over a year in an effort to tame inflation and <a href="https://www.bloomberg.com/news/live-blog/2023-05-03/fomc-rate-decision-and-fed-chair-news-conference?srnd=premium&sref=Hjm5biAW">lifted rates</a> by another quarter point on May 3, 2023. Concerns about the availability of credit have also risen as a result of a spate of bank failures, including that of <a href="https://apnews.com/article/first-republic-seized-deposits-bank-cd830cfa7390e315889a259981f2e79b">First Republic on May 1</a>. </p>
<p>A decline in the availability of loans and other financing poses problems for all types of companies. But this can be particularly detrimental to small businesses, which have <a href="https://www.consumerfinance.gov/about-us/small-business-lending/">limited resources</a> to sustain their growth and rely heavily on regional bank financing, currently the <a href="https://www.reuters.com/markets/us/feds-jefferson-still-learning-impact-tighter-monetary-policy-2023-03-27/">most stressed pocket of lending</a>. </p>
<h2>Small but mighty</h2>
<p>Despite their size, small businesses – typically defined as companies with under 500 employees – are a very important part of the U.S. economy. </p>
<p>Almost all of them, however, employ fewer than 20. And yet collectively <a href="https://www.federalreserve.gov/publications/2019-november-consumer-community-context.htm">they account for half of all private-sector workers</a> and 44% of private-sector output. </p>
<p>And virtually all for-profit companies <a href="https://www.federalreserve.gov/publications/2019-november-consumer-community-context.htm">are considered small businesses</a>. </p>
<p>Small businesses don’t borrow a lot of money, with the average size of their debt just US$195,000. Altogether, though, it really adds up. At the end of 2022, small businesses owed nearly $18 trillion in debt. </p>
<p>About 70% of small businesses have at least some outstanding debt, which they use to <a href="https://www.fedsmallbusiness.org/survey/2022/report-on-employer-firms">help cover basic operating expenses</a> like wages, rent and inventory, as well as to invest in new equipment and the like. After individual savings, the second-<a href="https://advocacy.sba.gov/wp-content/uploads/2020/11/Small-Business-FAQ-2020.pdf">most common source of capital</a> to start a business is loans from a bank, so the ability to access capital is crucial for businesses – <a href="https://www.investopedia.com/articles/personal-finance/120815/4-most-common-reasons-small-business-fails.asp">a lack of financing is often cited as the primary reason for failure</a>. </p>
<p>While large companies <a href="https://www.reuters.com/markets/rates-bonds/some-highly-rated-us-companies-take-unusual-funding-route-rates-rise-2023-02-27/">have a range of financing options</a> at their disposal, such as raising capital by selling stock or issuing convertible bonds, small businesses generally rely on <a href="https://ilsr.org/rule/financing-local-businesses">bank loans</a> for over 90% of their financing. </p>
<p>Consequently, if bank lending becomes harder to come by, they may need to cut spending or seek alternative sources of more expensive capital to continue investing and expanding. This could have implications for employment and commercial real estate, leading to further slowdowns in growth. </p>
<p>The last time small businesses faced similar financing challenges was during the 2008 financial crisis, when <a href="https://www.investopedia.com/small-business/10-years-after-financial-crisis-impact-small-business">1.8 million small businesses failed</a>.</p>
<h2>Signs of credit tightening</h2>
<p>Whether or not the current banking turmoil is creating a serious credit crunch for small businesses remains an open question. </p>
<p>The stories warning of a crunch point to a variety of statistics. For example, the <a href="https://fred.stlouisfed.org/series/WM2NS">money supply is shrinking</a> at the <a href="https://www.bloomberg.com/news/articles/2023-04-29/signs-are-mounting-that-a-debt-crunch-is-looming-credit-weekly?sref=Hjm5biAW">fastest pace since 1960</a>. Bank lending <a href="https://www.bloomberg.com/news/articles/2023-04-07/us-bank-lending-declines-sharply-for-a-second-straight-week?sref=Hjm5biAW">fell in March by the most</a> since the Fed began compiling the data in 1975. And the share of U.S. banks that say they’re tightening credit standards versus loosening them is at a level that <a href="https://fred.stlouisfed.org/graph/?g=qw94">has preceded the past few recessions</a>. </p>
<p>But the money supply was already very elevated, commercial bank lending <a href="https://fred.stlouisfed.org/series/TOTLL">has recovered somewhat</a> since March, and this is the first time in decades that credit has tightened as a result of rate increases, which is different from other recent recessions. In those cases, credit tightening may very well have been the consequence of the downturn, as opposed to the cause. </p>
<p>In addition, a monthly survey on small business economic trends conducted by the National Federation of Independent Business, a lobbying group, <a href="https://www.nfib.com/surveys/small-business-economic-trends/">found that overall optimism</a> remained high in March, the latest data available.</p>
<p>Yet the survey did find that more business owners reported that it was harder to get a loan than in the past. Banks continue to <a href="https://fredblog.stlouisfed.org/2020/03/bank-lending-standards-and-loan-growth/">tighten their lending standards</a> to levels approaching those seen during the pandemic as <a href="https://www.axios.com/2023/04/28/fed-report-bank-failure-svb-stock-signature">policymakers consider stricter regulations</a> to prevent the bank crisis from spreading. </p>
<p>This tightening of credit could lead to decreased capital expenditures and slower payroll growth in the future. These challenges for small businesses may ultimately end up <a href="https://theconversation.com/the-federal-reserve-and-the-art-of-navigating-a-soft-landing-when-economic-data-sends-mixed-signals-204707">causing the economy to decelerate further</a> after a sluggish first quarter. </p>
<p>When companies have limited cash during a potential downturn, bankruptcy and company failures can occur, which is almost what happened in March, when Silicon Valley Bank was on the brink of causing many companies to <a href="https://www.techtarget.com/searchhrsoftware/news/365532574/How-the-SVB-collapse-upended-payroll-for-thousands">lose the deposits</a> they needed to make payroll. </p>
<h2>Room for optimism</h2>
<p>On the bright side, companies <a href="https://www.cnbc.com/2022/12/23/why-everyone-thinks-a-recession-is-coming-in-2023.html">have been bracing</a> for reduced access to credit since at least March 2022, when the Fed began raising rates.</p>
<p>What’s more, they’ve been anticipating that higher rates could drive the U.S. into recession. That means they should have had plenty of time to prepare to weather most potential storms.</p>
<p>In addition, <a href="https://www.cnn.com/2023/03/06/economy/consumers-keep-spending/index.html">strong consumer spending</a>, <a href="https://fredblog.stlouisfed.org/2018/11/the-lowdown-on-loan-delinquencies/">overall healthy bank balance sheets</a>, <a href="https://www.census.gov/econ/bfs/current/index.html">steady growth in new business creation</a> and a <a href="https://www.reuters.com/business/finance/regulators-urged-find-silicon-valley-bank-buyer-industry-frets-about-fallout-2023-03-12/">regulatory response that aims to ensure credit doesn’t dry up</a> too much could help avert a credit crisis for small businesses. </p>
<p>But with a fourth bank failing and lingering uncertainty as to whether the quarter-point hike on May 3 will be the Fed’s last, we believe small businesses – and the U.S. economy – aren’t out of the woods quite yet.</p>
<p>Still, with the number of new business applications growing, we anticipate more businesses next year than the U.S. has today, and that may be welcome news for an economy trudging through a challenging environment.</p>
<p><em>This article was updated to include details of Fed rate hike.</em></p><img src="https://counter.theconversation.com/content/204256/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>Concerns about a decline in lending to small businesses are growing as the Fed raised rates for the 10th time in a little over a year.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityBrandy Hadley, Associate Professor of Finance and the David A. Thompson Distinguished Scholar in Applied Investments, Appalachian 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/2042552023-04-28T17:29:12Z2023-04-28T17:29:12ZRecent banking crises are rooted in a system that rewards excessive risk-taking – as First Republic’s failure shows<figure><img src="https://images.theconversation.com/files/523616/original/file-20230501-991-zod71e.jpg?ixlib=rb-1.1.0&rect=114%2C198%2C4916%2C3198&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Another U.S. bank bit the dust.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/general-view-of-first-republic-bank-in-century-city-on-news-photo/1248481248">AaronP/Bauer-Griffin/GC Images via Getty Images</a></span></figcaption></figure><p>First Republic Bank <a href="https://www.marketwatch.com/story/jpmorgan-to-take-over-first-republic-after-regional-bank-was-closed-2ccd8069">became the second-biggest bank failure</a> in U.S. history after the lender was seized by the Federal Deposit Insurance Corp. and sold to JPMorgan Chase on May 1, 2023. First Republic is the latest victim of the panic that has roiled small and midsize banks since the <a href="https://theconversation.com/silicon-valley-bank-biggest-us-lender-to-fail-since-2008-financial-crisis-a-finance-expert-explains-the-impact-201626">failure of Silicon Valley Bank in March 2023</a>.</p>
<p>The collapse of SVB and now First Republic underscores how the impact of risky decisions at one bank can quickly spread into the broader financial system. It should also provide the impetus for policymakers and regulators to address a systemic problem that has plagued the banking industry from the <a href="https://www.federalreservehistory.org/essays/savings-and-loan-crisis">savings and loan crisis of the 1980s</a> to the <a href="https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath">financial crisis of 2008</a> to the <a href="https://theconversation.com/why-svb-and-signature-bank-failed-so-fast-and-the-us-banking-crisis-isnt-over-yet-201737">recent turmoil following SVB’s demise</a>: incentive structures that encourage excessive risk-taking.</p>
<p>The Federal Reserve’s top regulator seems to agree. On April 28, the central bank’s vice chair for supervision <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230428a.htm">delivered a stinging report</a> on the collapse of Silicon Valley Bank, blaming its failures on its weak risk management, as well as supervisory missteps.</p>
<p><a href="https://www.sas.rochester.edu/eco/people/faculty/digby_alexandra/index.html">We are professors</a> <a href="https://www.minerva.edu/about/faculty/">of economics</a> who study and teach the history of financial crises. In each of the financial upheavals since the 1980s, the common denominator was risk. Banks provided incentives that encouraged executives to take big risks to boost profits, with few consequences if their bets turned bad. In other words, all carrot and no stick.</p>
<p>One question we are grappling with now is what can be done to keep history from repeating itself and threatening the banking system, economy and jobs of everyday people.</p>
<h2>S&L crisis sets the stage</h2>
<p>The precursor to the banking crises of the 21st century was the savings and loan crisis of the 1980s.</p>
<p>The so-called S&L crisis, like the collapse of SVB, <a href="https://www.federalreservehistory.org/essays/savings-and-loan-crisis">began in a rapidly changing interest rate environment</a>. Savings and loan banks, also known as thrifts, provided home loans at attractive interest rates. When the Federal Reserve under Chairman Paul Volcker aggressively raised rates in the late 1970s to fight raging inflation, S&Ls were suddenly earning less on fixed-rate mortgages while having to pay higher interest to attract depositors. At one point, their <a href="https://www.heraldtribune.com/story/opinion/columns/2019/11/28/rescue-by-unelected/2194940007/">losses topped US$100 billion</a>.</p>
<p>To help the teetering banks, the federal government <a href="https://www.federalreservehistory.org/essays/savings-and-loan-crisis">deregulated the thrift industry</a>, allowing S&Ls to expand beyond home loans to commercial real estate. S&L executives were often paid <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2315600">based on the size of their institutions’ assets</a>, and they aggressively lent to commercial real estate projects, taking on riskier loans to grow their loan portfolios quickly.</p>
<p>In the late 1980s, the commercial real estate boom turned bust. S&Ls, burdened by bad loans, failed in droves, requiring the federal government take over banks and delinquent commercial properties and sell the assets to recover money paid to insured depositors. Ultimately, the <a href="https://www.fdic.gov/bank/historical/history/167_188.pdf">bailout cost taxpayers more than $100 billion</a>.</p>
<h2>Short-term incentives</h2>
<p>The 2008 crisis is another obvious example of incentive structures that encourage risky strategies.</p>
<p>At all levels of mortgage financing – from Main Street lenders to Wall Street investment firms – executives prospered by taking excessive risks and passing them to someone else. Lenders passed mortgages <a href="https://irle.berkeley.edu/files/2012/The-Transformation-of-Mortgage-Finance-and-the-Industrial-Roots-of-the-Mortgage-Meltdown.pdf">made to people who could not afford them</a> onto Wall Street firms, which in turn bundled those into securities to sell to investors. It all came crashing down when the housing bubble burst, followed by a wave of foreclosures.</p>
<p>Incentives rewarded short-term performance, and executives responded by <a href="https://www.sciencedirect.com/science/article/abs/pii/S0929119914000042">taking bigger risks for immediate gains</a>. At the Wall Street investment banks Bear Stearns and Lehman Brothers, profits grew as the firms bundled increasingly risky loans into mortgage-backed securities to sell, buy and hold.</p>
<p>As foreclosures spread, the value of these securities plummeted, and Bear Stearns collapsed in early 2008, providing the spark of the financial crisis. Lehman failed in September of that year, paralyzing the global financial system and plunging the U.S. economy into the <a href="https://www.epi.org/publication/snapshot_20100127/">worst recession since the Great Depression</a>.</p>
<p>Executives at the banks, however, had already cashed in, and <a href="https://features.marketplace.org/why-no-ceo-went-jail-after-financial-crisis/">none were held accountable</a>. Researchers at Harvard University estimated that top executive teams at Bear Stearns and Lehman <a href="http://www.law.harvard.edu/faculty/bebchuk/pdfs/BCS-Wages-of-Failure-Nov09.pdf">pocketed a combined $2.4 billion in cash bonuses</a> and stock sales from 2000 to 2008.</p>
<h2>A familiar ring</h2>
<p>That brings us back to Silicon Valley Bank. </p>
<p>Executives tied up the bank’s assets in long-term Treasury and mortgage-backed securities, failing to protect against rising interest rates that <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">would undermine the value of these assets</a>. The interest rate risk was particularly acute for SVB, since a <a href="https://www.cnbc.com/2023/03/28/svb-customers-tried-to-pull-nearly-all-deposits-in-two-days-barr-says.html">large share of depositors were startups</a>, whose finances depend on investors’ access to cheap money.</p>
<p>When the Fed <a href="https://theconversation.com/us/topics/us-federal-reserve-256">began raising interest rates last year</a>, SVB was doubly exposed. As startups’ fundraising slowed, they withdrew money, which <a href="https://theconversation.com/silicon-valley-bank-how-interest-rates-helped-trigger-its-collapse-and-what-central-bankers-should-do-next-201697">required SVB to sell long-term holdings</a> at a loss to cover the withdrawals. When the extent of SVB’s losses became known, depositors lost trust, spurring a run that ended with SVB’s collapse.</p>
<p>For executives, however, there was <a href="https://www.ft.com/content/02ff2860-2d5b-4e21-96af-cef596bff58e">little downside in discounting or even ignoring</a> the risk of rising rates. The cash bonus of SVB CEO Greg Becker <a href="https://news.bloomberglaw.com/esg/failed-bank-execs-dodge-pay-clawbacks-as-tougher-remedies-sought">more than doubled to $3 million</a> in 2021 from $1.4 million in 2017, lifting his total earnings to $10 million, up 60% from four years earlier. Becker also sold <a href="https://www.cnbc.com/2023/03/14/svb-execs-sold-84-million-of-the-banks-stock-over-the-past-2-years.html">nearly $30 million in stock</a> over the past two years, including some $3.6 million in the days leading up to his bank’s failure.</p>
<p>The impact of the failure was not contained to SVB. Share prices of many <a href="https://www.forbes.com/sites/brianbushard/2023/03/17/these-regional-banks-stocks-are-falling-as-contagion-fears-loom-following-svb-collapse/?sh=3929d3423814">midsize banks tumbled</a>. Another American bank, Signature, <a href="https://www.reuters.com/business/finance/new-york-state-regulators-close-signature-bank-2023-03-12/">collapsed days after SVB did</a>. </p>
<p>First Republic survived the initial panic in March after it <a href="https://nypost.com/2023/03/16/jpm-morgan-stanley-in-deal-talks-with-first-republic-report/">was rescued by a consortium</a> of major banks led by JPMorgan Chase, but the damage was already done. First Republic recently reported that <a href="https://apnews.com/article/first-republic-deposits-withdrawal-silicon-valley-11f9503216c49559ff8cf645963c8bfd">depositors withdrew more than $100 billion</a> in the six weeks following SVB’s collapse, and on May 1, the FDIC <a href="https://www.nytimes.com/2023/05/01/business/first-republic-bank-jpmorgan.html">seized control of the bank</a> and engineered a sale to JPMorgan Chase. </p>
<p>The crisis isn’t over yet. Banks <a href="https://www.fdic.gov/news/speeches/2023/spmar2723.html">had over $620 billion</a> in unrealized losses at the end of 2022, largely due to rapidly rising interest rates.</p>
<h2>The big picture</h2>
<p>So, what’s to be done? </p>
<p>We believe the bipartisan bill recently filed in Congress, the Failed Bank Executives Clawback, would be a good start. In the event of a bank failure, the legislation <a href="https://www.warren.senate.gov/newsroom/press-releases/warren-hawley-cortez-masto-braun-introduce-bipartisan-bill-to-claw-back-compensation-from-failed-bank-executives">would empower regulators to claw back</a> compensation received by bank executives in the five-year period preceding the failure.</p>
<p>Clawbacks, however, kick in only after the fact. To prevent risky behavior, regulators could require executive compensation to <a href="https://openyls.law.yale.edu/handle/20.500.13051/8112">prioritize long-term performance</a> over short-term gains. And new rules could restrict the ability of bank executives to take the money and run, including requiring executives to hold substantial portions of their stock and options until they retire. </p>
<p>The Fed’s new report on what led to SVB’s failure points in this direction. The 102-page report recommends new limits on executive compensation, saying leaders “were not compensated to manage the bank’s risk,” as well as stronger stress-testing and higher liquidity requirements. </p>
<p>We believe these are also good steps, but probably not enough.</p>
<p>It comes down to this: Financial crises are less likely to happen if banks and bank executives consider the interest of the entire banking system, not just themselves, their institutions and shareholders.</p>
<p><em>This article was updated on May 1, 2023, with details of the FDIC’s seizure of First Republic Bank and its sale to JPMorgan Chase.</em></p><img src="https://counter.theconversation.com/content/204255/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>The cause of banking crises since the debacle in the 1980s remains unchanged. Incentives encourage executives to take excessive risks, with few consequences if bets turn bad. It’s happening again.Alexandra Digby, Adjunct Assistant professor of Economics, University of RochesterDollie Davis, Associate Dean of Faculty, Minerva UniversityRobson Hiroshi Hatsukami Morgan, Assistant Professor of Social Sciences, Minerva UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2042072023-04-24T16:14:02Z2023-04-24T16:14:02ZChatGPT: how to use AI as a virtual financial adviser<figure><img src="https://images.theconversation.com/files/522314/original/file-20230421-20-89ix5g.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C5991%2C2559&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Tech support for investors.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/ai-robot-analysis-future-financial-expert-2264241731">Darunrat Wongsuvan/Shutterstock</a></span></figcaption></figure><p>From chatbots and virtual assistants to <a href="https://www.ft.com/content/aae4f11a-aa7b-47ce-b9a7-eb39f345dab3">fraud detection</a> and <a href="https://www.elibrary.imf.org/view/journals/087/2021/024/article-A001-en.xml">risk management</a>, artificial intelligence (AI) is now being used in many <a href="https://www.forbes.com/sites/qai/2023/02/24/artificial-intelligence-applications-in-investing/?sh=30aff5c5e216">areas of finance</a>. But what could an AI system like ChatGPT do for your bank balance?</p>
<p>AI tools might seem overly complex or expensive to non-experts, but advances in <a href="https://oxsci.org/chatgpt-natural-language-processing/">natural language processing and machine learning</a> could turn ChatGPT and similar products into virtual personal finance assistants. This would mean having an expert on hand to help you make sense of the latest financial news and data. </p>
<p>Staying on top of business news and financial market trends is important for making informed investment decisions and gaining an edge in the markets. Companies already use these tools to perform what finance professionals call “<a href="https://dl.acm.org/doi/10.3115/1118693.1118704">sentiment analysis</a>”. </p>
<p>This involves analysing financial news and statements to generate insights and predictions for investors about shares and other investments. For example, <a href="https://www.cnbc.com/2019/08/02/this-etf-run-by-a-robot-is-beating-the-marketheres-how-it-works.html">Morgan Stanley’s AI models</a> analyse a wide range of data – including news articles, social media posts and financial statements – to identify patterns and predict stock prices. </p>
<p>Researchers have started to explore the potential of AI tools like ChatGPT, but given how new this technology is, much of the academic research remains in the early stages. A recent preprint <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4412788">study</a>, the results of which have not been reviewed by other academics, tested ChatGPT’s predictions about stock market performance based on sentiment analysis of news headlines. </p>
<p>ChatGPT determines if a headline is good, bad or irrelevant for a firm’s stock prices and computes a score. This research found a high correlation between ChatGPT’s responses and stock market movements, showing some ability to predict the direction of returns.</p>
<p>AI tools may also be able to help investors decipher monetary policy announcements, providing insights into their potential effects on financial markets. <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4399406">Another recent preprint</a> evaluated ChatGPT’s ability to understand what announcements from the US central bank, the Federal Reserve, might mean for financial markets. </p>
<p>It compared this to professional investors’ efforts to do the same. The study found that, particularly when ChatGPT models are fine tuned, they are more accurate than other machine learning models used by professionals to analyse and understand “Fedspeak”.</p>
<p>Monetary policy decisions, such as interest rates or asset purchase programmes, can have a <a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1997.tb04816.x?casa_token=nI99tv3YOYQAAAAA%3AAgJsU9RILIeswy6aUdZT38P1ibqjdIXdsKwbtjwxuWEtOcR-U59N-YFSeFCu8MeXCexnE5OugDTsDLvHxQ">big effect on financial markets</a>. So AI’s ability to assess what <a href="https://www.federalreserve.gov/newsevents/pressreleases.htm">central bank announcements on policy changes</a> will mean for financial markets could provide valuable insights into the effects of these actions. This could help you make more informed investment decisions.</p>
<figure class="align-center ">
<img alt="The flag of the US Federal Reserve Board waving in front of the US flag and a blue sky with clouds." src="https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=316&fit=crop&dpr=1 600w, https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=316&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=316&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=398&fit=crop&dpr=1 754w, https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=398&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/522317/original/file-20230421-16-kpu52u.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=398&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">AI tools can help decipher central bank announcements.</span>
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</figure>
<h2>Tailored financial guidance</h2>
<p>The ability to <a href="https://www.forbes.com/sites/qai/2023/02/10/can-i-invest-with-openai-can-and-should-openai-pick-my-stock-portfolio/?sh=27cd020e4a82">identify trends in specific market sectors</a> could also be helpful for people seeking more tailored financial guidance.</p>
<p>For example, an AI tool could be used to analyse financial data, such as balance sheets and income statements, from technology companies. It could identify patterns that might indicate opportunities or problems. An investor could then adjust their portfolio, potentially increasing returns or even just helping to reduce exposure to certain risks.</p>
<p>In addition to analysing market trends, AI could also be used to build an investment portfolio tailored to an <a href="https://www.businessinsider.com/ai-in-finance-fintech-chatgpt-generative-tools-credit-suisse-2023-3?r=US&IR=T">individual’s specific investment goals and risk tolerance</a>. Using information on your preferences such as your current financial situation and risk attitude, for example, the AI could generate a customised portfolio that accounts for the level of return you’d like to make, but also the kinds of risks you’d like to avoid.</p>
<h2>Your assistant, but not your only guide</h2>
<p>AI tools show tremendous potential as personal financial assistants, but also <a href="https://www.forbes.com/sites/bernardmarr/2023/03/03/the-top-10-limitations-of-chatgpt/?sh=407872268f35">present some challenges</a>. </p>
<p>There are several factors that AI tools may not be able to account for, such as unexpected events or changes in market conditions, as well as human behaviour. A tool like ChatGPT cannot fully comprehend the intricacies of human language and conversation, which can lead to responses that lack depth and insight. </p>
<p>There is also a <a href="https://www.sciencedirect.com/science/article/pii/S0306452223000799">need for greater transparency</a> about how these tools make decisions. For an investor to leave their portfolio in the hands of one of these “robots”, they would need to be able to understand how, for example, it reaches its conclusions and what data it uses. Some financial planning companies already offer <a href="https://www.investopedia.com/terms/r/roboadvisor-roboadviser.asp">robo-advisors</a> – services that use algorithms to design individual investment plans – that can also do this, but, of course, you pay a fee to the financial advisers for this.</p>
<p>The <a href="https://hbswk.hbs.edu/item/chatgpt-did-big-tech-set-up-the-world-for-ai-bias-disaster">potential for bias</a> in the recommendations of these tools must also be considered. ChatGPT’s training data may have underlying biases that could affect its predictions. The <a href="https://www.theguardian.com/commentisfree/2023/mar/03/fake-news-chatgpt-truth-journalism-disinformation">accuracy and reliability</a> of ChatGPT’s predictions need careful evaluation given recent reports that it has repeated disinformation. </p>
<figure class="align-center ">
<img alt="Woman looking and pointing at financial charts, screen and laptop, window in the background." src="https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/522315/original/file-20230421-20-2qcpbo.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">shutterstock.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/business-woman-study-financial-market-calculate-1204727542">GaudiLab/Shutterstock</a></span>
</figcaption>
</figure>
<p>No single model or algorithm can predict financial market movements with complete accuracy. So AI tools like ChatGPT should only be used to <a href="https://ifamagazine.com/article/supplement-or-substitute-how-do-advisers-view-chatgpt-potential-impact-on-financial-services/">supplement your own judgment, not as a replacement</a>.</p>
<p>While AI could be an excellent aid for investing, it is important to do your homework thoroughly about potential investments, understand and accept the right level of risk for you, and diversify your portfolio when deciding where to invest.</p><img src="https://counter.theconversation.com/content/204207/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Eun Young (EY) Oh 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>AI tools could help you to learn more about investing in shares and other financial markets – but it’s not a perfect solution.Eun Young (EY) Oh, Senior Lecturer in Economics and Finance, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2034852023-04-07T16:06:54Z2023-04-07T16:06:54ZJobs report hints that Fed policy is paying off – and that a ‘growth recession’ awaits<figure><img src="https://images.theconversation.com/files/519950/original/file-20230407-440-nik1hr.jpg?ixlib=rb-1.1.0&rect=30%2C218%2C5002%2C3214&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Inching toward a recession .. but what kind?</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/close-up-of-paper-currency-tied-with-measuring-tape-royalty-free-image/1134683297?phrase=measuring%20tape%20money&adppopup=true">Eskay Lim/EyeEm via Getty Images</a></span></figcaption></figure><p>The latest jobs report is in, and the good news is Federal Reserve policy on inflation appears to be working. The bad news is Fed policy on inflation appears to be working.</p>
<p>The March 2023 <a href="https://www.bls.gov/news.release/empsit.nr0.htm">jobs report reveals</a> that the U.S. economy added 236,000 jobs during the month – roughly <a href="https://www.cnn.com/2023/04/06/economy/march-jobs-report-preview/index.html">in line with expectations</a>. A trend does appear to be emerging as the U.S. central bank’s efforts to slow the economy down and tame inflation appear to finally be working on the labor market, with some companies feeling the effect of increased business costs.</p>
<p>While that will calm the nerves of monetary policymakers, it does raise the prospect of some economic pain ahead – not least for those who will indeed lose their jobs. And for the wider economy, it could also signal another slightly unwelcome phenomenon: the “growth recession.”</p>
<h2>What is a growth recession?</h2>
<p>Growth recessions <a href="https://www.forbes.com/sites/qai/2022/10/06/what-is-a-growth-recession-exactly/?sh=302deaac7678">occur when an economy enters</a> a prolonged period of low growth – of say 0.5% to 1.5% – while also experiencing the other telltale signs of a recession, such as higher unemployment and lower consumer spending. The economy is still expanding, but it may feel just like a recession to regular people. Some economists <a href="https://www.investopedia.com/terms/g/growth_recession.asp">consider the 2002 to 2003 period</a> to have been a growth recession.</p>
<p>For now, the job market is still relatively robust. In March, the unemployment rate even edged downward very slightly to 3.5% from 3.6% the previous month.</p>
<p>Effectively, in terms of job additions, this still-healthy increase nevertheless does suggest a slowdown in hiring. The 236,000 jobs added in March is down from the 326,000 and 472,000 added in February and January, respectively.</p>
<p>A slowdown has been anticipated and suggested by other data for some time now. Eye-grabbing headlines about <a href="https://www.bankrate.com/banking/federal-reserve/economic-indicator-survey-recession-risks-april-2023/">bank failures</a> and <a href="https://www.cnbc.com/2023/04/06/layoffs-are-up-nearly-fivefold-so-far-this-year-with-tech-companies-leading-the-way.html">layoffs in the tech sector</a> also signal a slowdown.</p>
<p>Other data hint at more employment pain to come. The February <a href="https://www.bls.gov/news.release/jolts.nr0.htm">Job Openings and Labor Turnover</a> report from the Bureau of Labor Statistics posted a job openings number below 10 million for the first time since May 2021 – a downward trend that has been in place since December 2021, when openings peaked at 11.8 million.</p>
<p>Meanwhile, the U.S. Census Bureau recently reported that new manufacturing orders fell by 0.7% in February 2023. Indeed new orders declined in three of the last four reported months, and prior to that, orders growth had been <a href="https://www.census.gov/manufacturing/m3/current/index.html">sluggish at best</a>.</p>
<p>In terms of sectors, job declines in construction – down by 9,000 – and manufacturing – down by 1,000 – are as expected, as both sectors are sensitive to interest rate increases.</p>
<p>It is quite likely that such declines will continue in coming months.</p>
<p>Other sectors posted substantial gains. Health services were up 50,800, and leisure gained 72,000. However, these gains are still smaller than in previous months.</p>
<h2>What this means for Fed policy</h2>
<p>This report seems to suggest that Fed actions to slow the economy are working, even though inflation still remains well <a href="https://www.cnbc.com/2023/02/20/the-federal-reserves-2percent-inflation-targeting-policy-explained.html">ahead of its 2% target</a>.</p>
<p>I believe this probably won’t significantly alter Fed policy. Indeed, it suggests that the year-old campaign of using aggressive interest rate hikes to tame inflation appears to be paying dividends. The slow drip of data proving this allows monetary policymakers to manage the economy as they try to provide a so-called “soft landing.”</p>
<p>If the April jobs report is similar to March’s, and barring any unusual events between now and its release in May, I expect the Fed to inch rates up very slowly, likely by another quarter basis point. </p>
<p>Where this leaves the economy as the year progresses, only time – and more data – will tell. But from where I stand, the economy looks to be heading toward a downturn by the fall. The question is whether it will take the form of a mild recession – which will include periods of economic shrinkage – or whether, as I suspect, it will be a low-growth recession. Either way, it will involve some pain.</p><img src="https://counter.theconversation.com/content/203485/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 Fed’s campaign of rate hikes is showing more signs of having the intended effect of slowing the economy – but that may be bad news for those who lose their jobs or have a harder time finding one.Christopher Decker, Professor of Economics, University of Nebraska OmahaLicensed as Creative Commons – attribution, no derivatives.