Victims of inflation: how the rejection of a long-term policy of cheap money can threaten the economies of the United States and Europe

On Thursday, February 2, the Board of Governors of the European Central Bank (ECB) raised the base interest rate for the fifth time in a row - up to 3% per annum.

The level reached was the highest since December 2008.

In addition, the ECB leadership approved an increase in rates on deposits (up to 2.5% per annum) and on short-term loans (up to 3.25% per annum).

The monetary authorities of the eurozone explained their actions by the need to restrain the growth of consumer prices in the region.

To achieve this goal, the regulator is going to further tighten its monetary policy (MP).

“Due to continued inflationary pressures, the board of governors intends to raise rates by another 50 basis points at its meeting in March, after which it will assess the future direction of monetary policy.

Keeping rates at restrictive levels will eventually reduce inflation,” the ECB said in a press release.

It is noteworthy that on the eve of a similar decision was made by the US Federal Reserve.

So, on the evening of February 1, the Fed's Open Market Committee raised the interest rate for the eighth time in a row - to a range of 4.5-4.75% per annum.

The previous time similar values ​​could be observed in autumn 2007.

Like the European regulator, the Fed motivated its decision by the desire to curb inflation.

Moreover, the increase in rates in the United States is also planned to continue.

“We are going to raise the rate a couple more times and bring it to the level that, in our opinion, will allow us to properly limit (rising prices. -

).

Why do we think it's necessary?

Because, in our opinion, inflation is still very high,” said Fed Chairman Jerome Powell.

• US Federal Reserve Chairman Jerome Powell

• Gettyimages.ru

• © Kevin Dietsch

Inflation in the US and Europe began to grow steadily back in 2021 amid the effects of the coronavirus pandemic.

At that time, quarantine restrictions led to interruptions in the supply of components, components, raw materials and materials, which ultimately resulted in an increase in the cost of products.

At the same time, to support their economies, the Fed and the ECB began to actively print money, which was not sufficiently backed by goods.

In 2022, the situation was aggravated by the sanctions of Washington and Brussels against Moscow.

In particular, the rejection of Russian oil led to a shortage of energy resources in the Western countries and, as a result, an exorbitant rise in fuel prices at American and European gas stations in the first half of the year.

The rise in the cost of fuel turned into an even more tangible increase in the prices of goods and services.

Against this background, at some point, inflation in the United States rose to a record high of 9.1% for 41 years, and in the eurozone the figure reached 10.6% - the highest value in history.

Under the circumstances, the Fed and the European Central Bank decided for the first time in a long time to return to tightening monetary policy.

Although both regulators had previously kept their interest rates near zero for a long period, in 2022 they began to rise sharply.

back side

According to the latest estimates from the US Department of Labor and the EU Statistical Service, inflation in the United States has slowed to 6.5%, and in the euro area to 8.5%.

However, the figures are still several times higher than the Fed and ECB target of 2%.

“The emerging slowdown in inflation is due to several factors.

These include easing supply chain problems, lowering oil prices from their 2022 peaks and tightening financial conditions.

However, we believe that the effect of raising rates will be more tangible in 2023, since this mechanism works with a lag of 12-18 months,” Mikhail Stepanyan, Freedom Finance Global strategist, explained to RT.

Traditionally, tightening monetary policy is considered one of the main tools in the fight against rising prices.

Due to the increase in interest rates, borrowed money becomes more expensive for citizens and businesses, consumer and business activity weakens, which puts pressure on inflation.

However, now such actions of regulators may pose a threat to the American and European economies, experts do not exclude.

“In the fight against inflation, central banks are forced to raise rates in order to increase the overall value of money in the economy.

However, the reverse side of such tightening of the monetary policy is to discourage economic growth.

Indeed, as a result of a sharp rise in the cost of loans, investments are complicated, business profitability decreases and effective demand is limited, ”Mark Goykhman, chief analyst at TeleTrade, said in a conversation with RT.

• Headquarters of the European Central Bank

• Gettyimages.ru

• © Arne Dedert/picture alliance

It should be noted that in 2022, the growth of the American economy slowed down almost three times compared to 2021 (from 5.9 to 2%), and the European one - by about one and a half times, from 5.3 to 3.5%.

Such figures are given in the January study of the International Monetary Fund (IMF).

According to the organization’s forecast, in 2023 the economic slowdown will continue: the volume of US GDP may increase by only 1.4%, and the eurozone – by only 0.7%.

Meanwhile, World Bank (WB) experts are even more pessimistic.

“In the US, growth will be about 0.5%, which is a very weak indicator for the US economy.

In the euro area, growth will be zero, that is, absent, which, of course, cannot be called a good result either.

There are discussions about whether the US or the Eurozone is facing a recession.

In fact, regardless of whether there is an economic recession there or not, it will be felt exactly like a recession, ”said Ayhan Kose, director of the WB Economic Prospects Group.

According to him, it is the tight monetary policy that now remains one of the main economic risks.

Moreover, if headline inflation continues to decline in 2023, then the base indicator (excluding energy and food prices) may still remain at a high level and central banks will have to raise rates even more, the economist added.

• Symbols of the US Federal Reserve

• Gettyimages.ru

• © Brooks Kraft

Nevertheless, today the governments of the United States and the eurozone countries are ready to sacrifice economic growth for the sake of fighting inflation, Mark Goykhman believes.

According to him, Western authorities are trying to choose the lesser of two evils, although they understand that a record increase in rates will hit ordinary citizens and businesses.

A similar point of view is shared by a member of the Supervisory Board of the Guild of Financial Analysts and Risk Managers Alexander Razuvaev.

As the specialist noted, Americans and Europeans are already accustomed to living in debt, so the rejection of such dependence can be painful.

“Further rate hikes could increase corporate bankruptcies, social tensions and unemployment.

Since borrowed money has become more expensive, production will gradually decrease and, as a result, the taxable base.

Investment projects will also have to be put on hold, which will negatively affect business activity.

At the same time, an increase in rates leads to an increase in the cost of servicing the public debt, which is fraught with additional problems, ”the source explained to RT.

Previously, experts from the United Nations Conference on Trade and Development (UNCTAD) warned about similar threats of tightening the monetary policy.

According to experts, keeping interest rates “at an ultra-low level” over the past ten years has not helped developed countries achieve high-quality growth in their economies.

And the current policy of regulators may lead to a new global crisis, analysts fear.

“Changes in the monetary and fiscal policies of advanced economies could push the world into a global recession and prolonged stagnation, causing more serious damage than the financial crisis of 2008 and COVID-19 in 2020,” UNCTAD did not rule out.