NOTDon’t shoot at all costs, that’s the motto in economic policy! When monetary policy tightens and raises the cost of money, fiscal policy is supposed to go in the same direction by restraining spending. In the current context, deficit budgets are indeed exposed to the ax of the financial market, ready to strike down even its most fervent devotees, as evidenced by the resignation of Liz Truss in the United Kingdom. But will the rate hike curb inflation without causing an economic and financial crisis?
Central banks are counting on several channels for the rise in key rates to bring down inflation. First, the expectations channel: convincing investors that they are taking action could lead them to reduce their expectations of price increases. Then the bank credit channel which, by becoming more expensive, should contract. That of market interest rates too, very directly for short-term rates, more indirectly for longer-term ones, which should reduce issues of new securities on the primary markets and increase sales of old securities on secondary markets. That of the exchange rate, which rises as the interest rate rises, reducing the rise in the price of imported products. And finally that of the prices of financial assets (bonds in particular), which fall as interest rates rise, reducing the value of financial assets: feeling less rich, their holders will consume less.
All of this will effectively reduce economic activity. But the risk is great that the contraction in activity will be faster and stronger than that of inflation. Indeed, it is only if inflation is due to overheating that it will reach, as activity contracts, the 2% target targeted by most central banks. But if the causes of inflation are elsewhere, then it will not fall, in any case much less than activity.
Financing the energy transition
And that is precisely what we can fear! Current inflation, driven largely by the prices of energy and raw materials (food in particular), has its roots in factors that are more structural than cyclical, linked to the lack of energy and ecological transition.
The best that monetary policy can do under these conditions is to “green”. By making the rise in key rates dependent on the banks’ contribution to financing the ecological transition, central banks could raise rates more gradually: these would remain more accommodating for banks that finance the transition instead of fossil fuel activities. , and would go up for the others. This would expose economies to less risk of recession, and contribute to their transformation.
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