29th May 2022

Hiking rates will damage economy, experts warn

  • 'If I raise interest rates today, it is not going to bring the price of energy down,' ECB president Christine Lagarde said (Photo: Council of the EU)
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With prices surging across Europe, the European Central Bank (ECB) has come under pressure to act more aggressively to contain inflation.

Speaking to Reuters on Monday (25 April), nine ECB policymakers broke rank and anonymously criticised the bank's management for underestimating inflation and not raising rates sooner.

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  • The International Monetary Fund estimated Greece will recover to its pre-crisis level of income per capita only in 2037. (Photo: IMF)

Energy and fuel costs have pushed inflation in Europe up to 7.5 percent, which has already slowed growth in Europe and has prompted people in some countries to spend less.

ECB president Christine Lagarde, for her part, had asked dissenters last Friday (22 April) to refrain from criticising the bank as it would diminish the effectiveness of the bank's policies.

But, seemingly relenting to the pressure Lagarde, in her clearest commitment to monetary tightening yet, the same day outlined the ECB will likely end its bond purchasing in the third quarter and increase interest rates before the end of the year.

It is, however, unlikely that higher interest rates will result in lower inflation.

Lagarde, in her monetary speeches, has consistently emphasised prices are pushed up by supply disruptions and high energy prices — things the bank has no control over; a message she repeated last week.

"If I raise interest rates today, it is not going to bring the price of energy down," Lagarde said.

Many economists also responded critically to the prospect of a tighter monetary regime.

"Raising rates doesn't make energy cheaper or unblock Shanghai's harbour. It doesn't create second-hand cars or lumber or arabica coffee," the philosopher and economist Jens van 't Klooster tweeted on Sunday.

The Bank of England and the Federal Reserve have already increased the cost of borrowing, but the ECB has so far tread more carefully.

The EU is "facing a different beast" Lagarde, appearing on CBS, said on Sunday.

Increasing interest rates and dialling-back asset purchases would have an uneven effect on EU countries, with commercial banks and investors that buy government bonds on financial markets likely charging southern European member states higher interest rates compared to wealthy nations in the north.

Since September, long-term interest rates on Greek government bonds have already quintupled to 2.61 percent.

This has led some to fear a repetition of the European debt crisis, which started in 2011 when former ECB president Jean Claude Trichet raised interest rates by a quarter of a point in the wake of the global financial crisis, causing interest rates on Southern European government bonds to explode to double-digit numbers.

In a July 2021 forecast, the International Monetary Fund estimated Greece will recover to its pre-crisis level of income per capita only in 2037.

"As bad, but far more sustained than America's Great Depression of the 1930s," financial historian Adam Tooze wrote in an April newsletter, detailing the effects the previous round of monetary tightening had on Greece. "One of the most devastating economic crises on record."

"Those who want to bring down (energy-price driven) inflation by [hiking] interest rates, argue for wrecking the [eurozone] economy," fellow economist and monetary expert Philipp Heimberger tweeted on Sunday, a decision which according to him would also lead to lower wage growth and higher unemployment.

"One can think this would be right (I don't), but we should at least be honest about the implications," he wrote.

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