Language : English 简体 繁體

Inflation Risks in Monetary Policy

Aug 08, 2022
  • Zhang Monan

    Deputy Director of Institute of American and European Studies, CCIEE

As inflation rates soar around the world, central banks are raising interest rates on a scale not seen in more than 20 years. Over the past three months, the world’s central banking systems have hiked interest rates 70 times altogether. Nonetheless, because of variations in inflation levels and differences in domestic political and economic situations, the United States, Japan and Europe are adopting various approaches to battling inflation. These may further exacerbate the complexity of the global economic landscape and give rise to additional risks.

For the U.S. economy, inflation has become a principal danger and one with unexpected obstinacy. Former U.S. Treasury Secretary Lawrence Summers, a professor of economics at Harvard, warned in February that additional government stimulus efforts to combat the pandemic slowdown raised the risk of inflation.

The Biden administration and the Federal Reserve have said the surge in U.S. inflation is “temporary,” as they play down the risk. But the temporary inflation talk reflects a severe misjudgment. The U.S. inflation rate has exceeded 5 percent for 13 months in a row and 8 percent for four consecutive months. In June, it jumped a staggering 9.1 percent, the biggest 12-month leap in four decades.

To contain surging consumer prices, the Federal Reserve in June made a historic move, raising its benchmark interest rates by 75 basis points, the largest increase in 28 years, and vowed to continue the sprint to tamp down inflation. Recently, the Fed enacted its second consecutive 0.75 percentage point rate hike.

Under the pressure of inflation, central banks around the world are also hiking their rates. The Bank of England, the Bank of Canada, the Swiss National Bank and the Bank of Korea have followed the Federal Reserve and adopted tighter monetary policies. But not all developed markets stay in sync with the Fed. The U.S., Japan and Europe have shown obvious divergences in their monetary policies.

In June, inflation in the eurozone’s 19 countries hit 8.6 percent, the highest level since the introduction of the euro currency in 1999. It was not until late July that the European Central Bank pushed its interest rates by 50 basis points, ending an eight-year run of negative rates. It was the first rate increase in 11 years.

At the same time, however, the ECB also approved the Transmission Protection Instrument, in addition to a new plan to buy the debt of Europe’s most vulnerable economies. It seeks to “protect the currency union as it navigates the twin threats of skyrocketing inflation and slowing economic growth.” But the political and economic quagmire in which Europe is now entrenched makes it difficult for the ECB to impose another aggressive rate hike.

On one hand, a heavy reliance on foreign energy is Europe’s Achilles’ heel. Because of rising energy prices, Germany recorded its first monthly trade deficit since 1991, so raising interest rates to fight inflation seems inevitable.

On the other hand, the ECB has refrained from hiking interest rates too fast out of fear of undermining economic growth. The energy crisis in the wake of the Russia-Ukraine conflict gives rise to the risk of recession. Because of the policy differences of the ECB and the Fed, the interest margin between the dollar and the euro has expanded. As a result, the euro shed more than 8 percent against the dollar and even fell to parity with the dollar this year. And once Russia cuts off its gas supply, Europe will be bogged down in a severe recession and the euro will drop further.

At a time when the central banks of major economies tighten the policies, the Bank of Japan continues to maintain its ultra-loose monetary policy. It will maintain its -0.1 percent target for short-term rates and zero for long-term rates under its yield curve control policy. As part of its stimulus plan, the BOJ offered to buy 10-year Japanese government bonds at 0.25 percent, to keep short- and long-term policy interest rates at current or lower levels. And it will not hesitate to adopt more easing measures.

At the end of June, the BOJ held a record 528.23 trillion yen in long-term Japanese government bonds, accounting for some 50 percent of the debt. The unusual move by the BOJ might boil down to the fact that Japan is blighted more by stagnation than by inflation, compared with the U.S. and major European economies. Moreover, its inflation is imported, triggered by surging energy prices. According to BOJ Governor Haruhiko Kuroda, it’s necessary to continue with aggressive monetary easing to achieve a price stability target of 2 percent. It’s expected that in this way a benign cycle in which companies profit, employment and wages rise, and inflation remains mild will take shape.

This might be another misjudgment. Global inflation ripples out quickly. In May, Japan’s inflation rate was at 2.5 percent, higher than that during the 2008 financial crisis, but its producer prices soared 9.2 percent in June, to their highest level in 20 years. As inflation worsens, the BOJ may have to slam on the brakes at some point, as the BOJ’s ever-expanding balance sheet, combined with a drastically depreciated yen and a national debt market disassembled under the yield curve control policy, will bring new risks to Japan and the world economy. 

You might also like
Back to Top