Raising interest rates is wrong solution to inflation problem, says analyst

One analyst said raising interest rates to reduce demand – and therefore inflation – is not the right solution, as higher prices have been driven primarily by supply chain shocks.

Global manufacturers and suppliers have been unable to efficiently produce and distribute goods to consumers during the COVID lockdown. And more recently, sanctions imposed on Russia have also mainly cut the supply of goods.

“Supply is very difficult to manage, we’re finding across a whole bunch of industries, a whole bunch of businesses, they have very different challenges,” said Paul Gambles, managing partner at advisory firm MBMG Group. told CNBCRoad signs” on Monday.

Referring to the energy crisis facing Europe as Russia’s threat to cut gas supplies, he said that “On American Independence Day, it is a co-dependence day where Europe is completely shooting itself in the foot.” Because a lot of it has come as a result of sanctions.”

“And the Fed is the first to put its hands on and say that monetary policy can’t do anything about supply shocks. And then they go and raise interest rates.”

The US Federal Reserve raised its benchmark interest rate by 75 basis points in June to a range of 1.5%-1.75% – the biggest increase since 1994. Fed Chairman Jerome Powell (above) hinted that another rate hike could happen in July.

Mary F. Calvert | Reuters

However, governments around the world have focused on cooling demand as a means to rein in inflation. The purpose of raising interest rates is to further increase demand with limited supply.

US Federal ReserveFor example, increased its benchmark interest rate By 75 basis points in June to a range of 1.5%-1.75% – the biggest increase since 1994 – with Chair Jerome Powell Another rate hike could be flagged off in July.

The Reserve Bank of Australia is set to raise rates again on Tuesday, and other Asia-Pacific economies such as the Philippines, Singapore and Malaysia have all jumped on the similar rate hike bandwagon.

The Fed said in a statement: It opted to raise rates as “overall economic activity” picked up in the first quarter of the year, with rising inflation reflecting a “supply and demand imbalance related to the pandemic, higher energy prices and wider price pressures”.

Monetary policy ‘the wrong solution’

Gambles said demand is still below the level it was before the pandemic began, but would have dwindled even without the constraints of Covid.

“If we look at where jobs would be in the states, if we didn’t have Covid, and we didn’t have lockdowns, we’re still about 10 million jobs short of where we would be. So there it is, there’s actually the labor market. There is a lot of potential slowdown. Somehow it is not translating to real slowdown,” he said.

“And, again, I don’t think it’s a monetary policy issue. I don’t think monetary policy will make much difference to that.”

Gambles said that as supply shocks raise their ugly heads from time to time, it will be difficult for central banks to maintain a constant grip on inflation.

Gambles argued that the United States should instead provide a fiscal boost to correct inflation.

“The U.S. federal budget for fiscal year 2022 is $3 trillion lighter on a gross basis than it is for 2021. So we’ve got, you know, we’ve got a big shortfall in the U.S. economy. And, you know, probably a lot. There is little that monetary policy can do about it,” he said.

Gambles says that adjusting monetary policies is “the wrong solution to the problem.”

Other “unorthodox economists” – cited by Gambles in the interview – such as HSBC senior economic adviser Stephen King have also analyzed the analysis, saying that it is not just a demand or supply shock that is responsible for inflation, but the workings of both sides of the equation. of.

Economists such as King have said pandemic lockdowns, supply chain turmoil and the Russo-Ukraine war as well as stimulus governments have contributed to their economies’ lax monetary policies.

“Economically, the COVID-19 crisis was primarily perceived as a demand challenge. Central banks responded by offering very low interest rates and continued quantitative easing, even as governments heavily Fiscal stimulus offered,” King said in a note earlier this year primarily referring to the pandemic,

“Indeed, COVID-19 had only a limited lockdown-related, demand-side effect in advanced economies.”

“The supply-side effects have proven to be both larger and far more permanent: markets now function less well, countries are economically disconnected, and workers are not able to cross borders and, in some cases, cross borders. are less readily available within. The loosening of policy terms when supply performance has become so poor is only likely to lead to inflation.”

Since supply is unable to fully respond to the increased currency passing through economies like the United States, prices will have to rise, he said.

still a popular antidote

Nevertheless, raising interest rates remains a popular antidote to inflation.

but economists now concerned that the use of interest rate hikes as a tool to solve the problem of inflation can cause recession,

An increase in interest rates makes it more expensive for firms to expand. This, in turn, can lead to investment cuts, ultimately damaging jobs and jobs.