There is a lot of global upheaval about the anticipation of the rate hike by the US Fed due to spiral inflationary worries. However, in the last two years, most of the inflation is not on account of the excessive money supply – which remains in the economy because of dovish monetary stance and undue fiscal stimulus. But it is due to supply shortages and logistic gaps after easing Covid-19 restrictions. The US consumer-price index climbed 7.5 percent from a year earlier, following a 7 percent annual gain in Dec 2021, and this burst was more than expected to a forty-year high, which has recalled urgency for the Fed to react quickly.
The United Kingdom, South Korea, New Zealand, Brazil, and many Latin American countries have raised the interest rate in the wake of inflation in 2021. The US, European Union, and Japan are scaling down their emergency fiscal supports. The Fed has announced to be aggressively hawkish in its policy stand soon.
Notwithstanding anything discussed so far, leading economists believe any sudden jerks in money supply in the form of reduction in liquidity or any kind of overreaction in tightening monetary policy may derail economic recovery processes.
The US Fed had been abrupt in infusing money recklessly to emerge from the pandemic-induced recession and health-related fears of repeated waves. G-20 member countries’ fiscal stimulus package varied from 1.9 – 53.69 percent of GDP as of May 2021. These packages supported V-shape recovery growth and simultaneously contributed to increased consumer-price inflation.
Many research firms believe that the primary source of inflation is global. The main reasons are – the higher crude prices due to oil producers’ vicious cartels, other energy prices owing to curtailed production of gas and coal, automotive costs following chip shortage, or metal prices under added fiscal stimulus in infra projects. Recently, the Russia-Ukraine war has led to unprecedented economic sanctions announced on Russia. These sanctions have economic effects on the Russian economy and people and have spillover effects globally.
While the situation remains highly fluid and the outlook is subject to phenomenal uncertainty, the economic consequences are already terrible. Energy and commodity prices—including metals, wheat, and other grains—have increased, adding to inflationary pressures from supply chain disruptions and the rebound from the Covid‑19 pandemic. As per an IMF report, the ‘Price shocks will have an impact worldwide, especially on poor households for whom food and fuel are a higher proportion of expenses.’
According to Joseph Stiglitz, a Nobel prize winner, US-based economist-It would be a mistake to attribute all the parts of inflation to excessive money supply than recognising global issues and supply shortages. He also believes any sharp increase in interest rates by the US Fed would jeopardise nascent economic recovery and hit most of those at the bottom of society.
Globe – including the US – is feeling the heat of inflation is now in a hurry to raise rates to mend its past mistakes of being a spender of easy money in trillions of dollars in the last one and a half years. The size of the US Fed’s balance sheet increased from about $4.2 trillion at the end of Feb 2020 to nearly $8.9 trillion as of Jan 2022. The liquidity ease-up support was immense to help the business grow and recover.
Although I believe there is a situation that warrants a hawkish policy, it would not be justified to terrorise financial markets by repeatedly hammering them with a warning. Nevertheless, suppose the Fed goes all along to raise rates by 1.75-2 percent, as has been anticipated. In that case, it may not necessarily be translated into a lower inflation regime in the coming months. Nevertheless, such a policy stand will only create a fearful environment for businesses and households, consequently, hamper economic growth in the longer run.
How is India performing in this regard? If one analyses the path of transition of the monetary policy in India during Covid-19, whose MPC is just 5-6 years old, one will find it smooth and responsive. Sashikant Das, the governor of RBI, signals the economy with clarity and strategically to win and to boost the business’s confidence. No part of industries seems dissatisfied by his policy stance, even with its last month’s policy outcomes.
It is not that RBI is unresponsive to the money supply regulations; it has tapered Open Market Operations in the last six months, which helped regulate money supply maintaining its dovish policy stance. Last week, the RBI announced to increase in VRR (Voluntary Retention Route) and VRRR (Variable Rate Reverse Repo) auctions to impart flexibility to its reverse repo rate; however, keeping it unchanged in policy declarations.
The macroeconomic parameters speak differently for India and the US. In comparison, the US has shown better demand recovery and better unemployment data. But it is facing a conspicuous heating up of the economy. Its inflation has crossed 40 yrs’ high with a nascent stage of ‘asset bubble’ in tech equity, cryptocurrency, and real estate. On the other hand, India is more study and consistent as far as policy transmission, though subdued, and its impacts are concerned; the inflation is within the 4 ± 2 percent range, and a spread between inflation and interest rates is within 2 percent as opposed to 7 percent in the USA.
Recognising the global context acknowledging misplaced understanding of global consumer-price inflation, our central banks must balance price stability and economic growth. The world’s debt has reached 355 percent of GDP, making firms and households sensitive and governments vulnerable to the policy rates.
The Fed has its MPC meeting on 15-16th of this month, where it might go for a hawkish monetary policy with a 50 bps rate cut. Frightening the households, businesses, and global financial markets may not help reduce consumer-price inflation. However, the Fed may hike 0.75-1.25 % in the fed rates this year with a 25 bps cut in the coming meet to check worries and set expectations right for growth.
To my understanding, in emerging economies like us, the rate hikes should be smooth. We may like to remain in a lower interest rate regime for a longer duration to harness the advantages of cheap financing to foster growth and keep the debt burden in check. However, coordinated global efforts are required for unlocking the supply disruptions to arrest global inflation in manageable limits.
