The rise in policy interest rates in the US also boosts the dollar

 

After the start of the pandemic, the world economy has been in a crisis of high inflation. Due to the huge financial incentives given by the developed countries to turn around the economy from the corona problem, the demand index went up a lot. This is the primary cause of ongoing inflation. There was also a supply shortage.

However, the world economy was turning around, but then the Russia-Ukraine war started. As a result, inflation has risen to record highs in the country. In this reality, central banks have a weapon in hand—increasing policy interest rates. Almost all the world's major central banks have raised policy rates in the past few months. But the rise in policy interest rates in developed countries has a negative impact on developing countries.

 

Central banks try to curb inflation by reducing the money supply. An increase in the policy interest rate will make money more expensive; That is, interest rates on loans will rise, demand in the market will tighten and economic recovery will suffer. The US Federal Reserve, the world's most influential central bank, is leading interest rate hikes. They are the first policy interest during the pandemic

increases Investors expect the Fed to raise policy rates by 1.25 percent each quarter this year. In all, the Fed could raise interest rates by 1.5 percent in 2022. The Economist predicts that interest rates will rise in 58 countries over the next 3 years. Apart from this, the interest rate of the US five-year treasury bond has also increased.

However, there is less evidence that the central bank has gone to control inflation and the economy has not been in recession. The last time such a thing happened was 70 years ago when US inflation fell below 5 percent.

 

. In other words, if inflation is to be controlled, the economy loses momentum. This situation has now arisen in the European Union including the United States, United Kingdom. On the one hand, people have reduced spending to cope with inflationary pressures, while on the other hand, the flow of money is decreasing. As a result, in the last quarter of this year, there is a risk of recession around the world.

Inflation targeting

Traditionally, one of the main tasks of the central bank is to keep inflation under control. However, it was only in 1990 that the Reserve Bank of New Zealand set the first inflation target. Next is the Bank of Japan's global inflation target

The rate is set at 2 percent, though it is 5 percent in developing countries like Bangladesh. But there is debate over whether central banks should have such an inflation target.

In an essay published in the Financial Times, economic writer Edward Chancellor said, 'If the central bank's inflation target is set in this way, its activities are limited. It becomes difficult for him to think critically.

They can then say, "We're on target." However, the fact that the target is artificial is understood by the behavior of the central banks of different countries. The point is, policy interest rates are not rising at the same rate as inflation. US inflation passed 9 percent in June, but the Federal Reserve remains cautious on raising policy rates, although the Fed is the most aggressive of the world's central banks. They increased the policy rate by 1.5 percent till June this year.

Nobel laureate American economist Joseph Stiglitz wrote in an article of Project Syndicate, now if the central banks of different countries increase the interest rate at the mass rate, it will be like an overdose. It does not make sense to disrupt the supply chain by reducing demand or allowing the unemployment rate to rise. It is true that this policy will bring inflation under control for a while, but it will disrupt people's lives, especially the low-income people.

For that, according to Stiglitz, the adoption of specific structural and fiscal policies to increase the efficiency of the supply system. Providing food assistance to the poor as well as subsidizing fuel and reducing taxes by adjusting for inflation. And to finance subsidies by raising taxes on sectors that have taken a heavy hit from the pandemic.

Impact of policy rate hikes in the US

Meanwhile, another consequence of the increase in the policy interest rate in the United States is the increase in the interest rate on Treasury bonds in that country. As a result, investors are no longer interested in investing in developing countries during turbulent times. They think that it is better to invest in US treasury bonds, they can easily eat the interest. And they are as big as India

Withdrawal of investment from the country has created a crisis of the dollar as a hard currency around the world. As a result, the exchange rate of the dollar is increasing, the local currency is depreciating in each country. A rise in the exchange rate makes imports more expensive, which in turn inevitably increases the rate of inflation. And companies whose net liabilities are determined in terms of dollars, their profits will decrease. In other words, due to the steps that the United States is taking to fight inflation in its own country, inflation is increasing in many countries.

 

Meanwhile, increasing policy interest rates is not working overall. Because, this inflation is mainly not due to demand, but due to the crisis of the supply system. For that reason, the rate of inflation is not decreasing, but on the contrary, the discomfort of the economy is increasing. In this situation, the analysts believe that taking the initiative to stop the Russia-Ukraine war is the main task. Even if the war does not stop, it is necessary to take the initiative to keep the supply system running through negotiations.

But not this year, the IMF thinks that in 2023 many countries, including the United States, could start a recession.