Uncertainty is creating volatility, the war in Ukraine, the crazy Trussonomics scenario in September to October 2022 in the UK, China’s zero covid policy (up until recently) are just the tip of the iceberg. The world today seems, to me, absolutely bonkers and makes it very difficult to see a clear path ahead.
Whilst there is or was a need to increase interest rates to battle inflation my concern is whether central banks globally are overtightening in particular the ECB and the FED in their attempts to get to the holy grail of 2% target in such an aggressive manner, is causing economic damage. If truth were to be told neither the FED nor the ECB cannot control prices as this is a supply versus demand issue. The ECB’s and we could conclude, the US’s primary objectives are to maintain price stability, ultimately preserving the purchasing power of their currencies. In fairness price stability does create conditions for more stable economic growth and a more stable financial system but I would argue this would apply under more normalised conditions. But is 2% really the optimum for today’s environment, would 3% or 4% really be that detrimental, in my opinion it would not be as bad and certainly would be better than pushing a potential recession. Higher inflation rates would also allow for greater growth and allow Central Bankers more space to cut rates when needed.
The holy grail of 2% inflation which is the “so called optimum” for a balanced economy is not really possible in the current uncertain and volatile world we live in, the current thinking by central banks of fast and furious interest rate hikes is to crush demand, reducing employment which in turn should reduce inflation, but the downside may cause a recession. The medium to short-term goals should be more balanced, a levelling off, lower increases or a halt to increasing interest rates is paramount, we need to see if these hikes have already taken hold as further increases particularly high raises could unintentionally push the globe into a much more protracted recession than is required. If this were to happen then this would leave central banks with very little ammunition to rectify the situation, such as reducing interest rates and reverting to quantitative easing to counteract such a problem.
A protracted recession with depleted central bank arsenal leaves highly indebted countries open to the debt markets, that is government bonds start to become too expensive leaving governments to struggle to refinance their ongoing debt needs. On top of this we could also see a period of stagflation, “The danger of stagflation is considerable today,” the World Bank warned. “Several years of above-average inflation and below-average growth are now likely.” Economic slowdown, increased unemployment with consistent high inflation, this is all down to timing effects of monetary policy while so many other elements are outside of central banks control, such as the bottle necks of increased price of gas, ongoing supply shortages in construction, chip manufacturing, labour, etc driving up costs.
The tightrope central bankers are walking now is wobbly – let’s hope they can maintain their balance.
Colm McGrath, Managing Director of Surety Bonds
(This article originally appeared in the March 2023 edition of Civil & Construction Ireland Magazine )