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Central Banks May Stoke Risks by Raising Interest Rates Together


Central banks around the world raise their key interest rates in the most widespread monetary policy tightening ever. Some economists fear they are going too far if they do not consider their collective impact on global demand.

According to the World Bank, the number of rate hikes announced by central banks around the world in July was the highest since registration began in the early 1970s. On Wednesday, the Federal Reserve delivered the third increase of 0.75 percentage point in as many meetings. Over the past week, its counterparts in Indonesia, Norway, the Philippines, South Africa, Sweden, Switzerland, Taiwan and the UK have also increased rates.

Moreover, the magnitude of these rate increases is greater than usual. On September 20, the Swedish Riksbank raised its benchmark interest rate by a full percentage point. It had not raised or lowered rates by more than half a point since the adoption of the current framework in July 2002.

Those central banks respond to almost everything: high inflation. According to the Organization for Economic Co-operation and Development, inflation in the Group of 20 Leading Economies was 9.2% in July, double the year before. Higher tariffs cool the demand for goods and services and reassure households and businesses that inflation will decrease in the coming year.

Federal Reserve Chairman Jerome Powell said he expects rate hikes to continue as the Fed battles high inflation. Photo: Kevin Lamarque/Reuters

But some worry that central banks are actually pursuing national responses to what is a global problem of excessive demand and high prices. They warn that central banks as a group will go too far with that – pushing the global economy into a downturn that is deeper than it needs to be.

“The current danger … is not so much that current and planned measures will ultimately fail to contain inflation,” Maurice Obstfeld, former chief economist at the International Monetary Fund, wrote in a note to the Peterson Institute earlier this month. for International Economics, where he is a senior fellow. “It is that collectively they are going too far and driving the world economy into an unnecessarily hard contraction.”

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There are few signs that central banks are going to pause and inventory the impact of their rate increases to date. The Fed said on Wednesday it would likely raise interest rates by 1 percentage point to 1.25 percentage point in its next two meetings. Economists at JPMorgan expect central bankers from Canada, Mexico, Chile, Colombia, Peru, the eurozone, Hungary, Israel, Poland, Romania, Australia, New Zealand, South Korea, India, Malaysia and Thailand to raise interest rates during policy meetings that scheduled during the end of October.

That’s a range of firepower from the central bank with few precedents. But should they all be doing so much if they’re all doing the same thing?

Most economists accept that inflation in a particular country is not just due to forces in that country. Global demand also influences the prices of easily tradable goods and services. This has long been evident with commodities such as oil; a boom in China pushed prices up in 2008, even as the US slipped into recession. This has also been the case in recent years for manufactured goods, whose prices have been pushed up globally by supply chain disruptions, such as in Asian ports, and increased demand due to government stimulus. A Fed investigation found that US fiscal stimulus was driving inflation in Canada and the UK

Sweden’s Riksbank, led by Governor Stefan Ingves, raised its benchmark interest rate by a full percentage point this week.

Photo: Mikael Sjoberg/Bloomberg News

But an individual central bank’s focus on matching supply and demand at the national level could go too far, as other central banks are already dampening global demand, which is one of the drivers of national inflation. If every central bank does that, the over-tightening globally could be significant.

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The World Bank shares Mr Obstfeld’s concerns, warning in a report that “the cumulative effects of international spillovers from the highly synchronous tightening of monetary and fiscal policies could cause more damage to growth than would be expected on the basis of a simple summing up the effects of individual countries’ policy actions.”

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That risk could be mitigated through coordination between central banks, for example if they jointly lower key interest rates during the global financial crisis. Likewise, in 1985, when advanced economies acted together to bring down the dollar, and then again in 1987, when they acted together to support the dollar.

Fed Chair Jerome Powell noted on Wednesday that while central banks have coordinated interest rate action in the past, it was not appropriate now, as “we are in very different situations.” He added that the contact between global central banks is more or less ongoing. “And it’s not coordination, but there’s a lot of information exchange,” he said.

If coordination is not feasible, a more achievable goal, as the World Bank advised, may be for national policymakers to “consider the potential spill-over effects of globally synchronized domestic policies”.

Fed Chair Jerome Powell said it is not appropriate for central banks to coordinate interest rate campaigns at this time.

Photo: Drew Angerer/Getty Images

Mr Powell suggested: that’s already happening. The Fed’s forecasts always take into account “policy decisions – monetary policy and otherwise” [and] the economic developments taking place in major economies that could have an effect on the US economy,” he told reporters.

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Many central banks are concerned about not raising interest rates enough in light of high inflation. “In this environment, central banks must act strongly,” said Isabel Schnabel, a policymaker at the European Central Bank, in a speech at the end of August. “To regain and maintain confidence, we need to get inflation back on target quickly.”

“Informal coordination would be helpful,” said Philipp Heimberger, an economist at the Vienna Institute of International Economic Studies. “Systematic thinking about the impact of rate hikes should take into account what other central banks are doing at the same time. This would be a game changer.”

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Mr. Heimberger said the Fed has a key role as a driving force behind the rise in global interest rates and that it should “seriously consider the implications of its rate-raising cycle for other parts of the world.”

Gilles Moëc, chief economist at insurer AXA SA, doubts whether effective coordination is feasible and argues that, failing that, central banks should be more cautious when considering further rate hikes.

“Once monetary policy is in restrictive territory, I think it becomes dangerous to increase mechanically at every policy meeting without taking the time to assess how the economy is responding,” said Mr Moëc. “The amount of new info between two meetings can be too small and the risk of overreaction rises.”

Write to Paul Hannon at paul.hannon@wsj.com

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