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The US Federal Reserve has raised interest rates drastically – by three-quarters of a percentage point – and further rate hikes are imminent. Whether that will be enough to get inflation under control is questionable. Because not only the previous policy of cheap money is to blame for the upward trend in prices.
A key driver in recent months has been the rise in raw material prices – for example for oil and gas from Russia. This additional surge in inflation is primarily a consequence of the Russian attack on Ukraine. This has nothing directly to do with monetary policy. And higher interest rates do little to counteract the war-related price shock.
Rising risk of recession
Nevertheless, the leading Western central banks have to put up with the accusation that they waited too long. With their late, but all the more violent reaction to the horrendously high inflation, they are now risking stalling the economy.
The US Federal Reserve is stepping on the brakes; the European Central Bank (ECB) also announced an interest rate hike for July. This restrictive policy could cost jobs. That would also plague consumers who are already suffering from rising prices – and who may also have to worry about their jobs in the future.
In addition, it weakens a central bank’s credibility if it acts under pressure – with a considerable delay – after procrastinating for a long time and watching everything becoming more and more expensive for the population.
Price stability has priority
When trust dwindles, when people get the impression that the FED, ECB & Co. are not up to their task, that is doubly dangerous. Then – in addition to the prices – the price expectations will also rise.
This further fuels inflation and is bad from a monetary policy point of view. Then even higher interest rates are needed to make it clear: ensuring stable prices is the most important task of every central bank, and not just in theory. Price stability is also a priority in practice.
US Federal Reserve Chairman Jay Powell left no doubt about it this week: he is taking up the fight against inflation. He even runs the risk of an economic downturn.
In Europe, the ECB and the Swiss National Bank SNB now have the opportunity to show at least roughly the same determination. Better late than never.