Central banks 'have eggs in their faces' and risk causing a recession in their 'panic' to release them

The Bank of Canada’s (BoC) surprise decision to raise interest rates by 1 percentage point has shocked global markets and Canadian borrowers and raised expectations more central banks will follow with super-sized hikes.

Key points:

• The Bank of Canada has raised interest rates by a full percentage point, while monetary authorities in Singapore and the Philippines have also tightened them sharply
• Former IMF chief economist Maurice Obstfeld worries the central bank is catching up after delaying rate hikes for too long
• He warned that rising interest rates too quickly around the world could trigger a major economic downturn like that seen in the 1980s

The BoC raised its policy rate from 1.5 percent to 2.5 percent, the highest since 2008, in a bid to contain inflation.

It is far from alone in raising interest rates quickly. Today, the Philippine central bank raised interest rates by 0.75 percentage points to 3.25 percent in an unscheduled move, while the Singaporean authorities also tightened monetary policy surprisingly this morning.

Yesterday the Bank of Korea and the Reserve Bank of New Zealand both raised interest rates by half a percentage point, in the latest case for the third consecutive meeting.

The aggressive but uncoordinated action by the central bank worried former IMF chief economist Maurice Obstfeld, who said there was a real risk that they were taking interest rates too high while trying to fight inflation.

Maurice Obstfeld was chief economist at the International Monetary Fund between 2015 and 2018.(Provided: IMF)

“You get a real cocktail of a global monetary contraction that could go too far because each central bank only looks at its own domestic situation and doesn’t think about the global effects,” he warned.

Canada is the first G7 nation to undertake aggressive rate hikes in this economic cycle, but bets are mounting that the US Federal Reserve will follow suit after inflation came in much higher than anticipated, at 9.1 percent for the year to June.

A member of the Federal Reserve’s rate-setting committee, Raphael Bostic, further stoked fears of a bigger rate hike from the Fed by saying “everything is in the game” for a meeting later this month.

An unexpectedly large drop in Australia’s unemployment rate to 3.5 per cent means a local 75 basis point gain is now “not ruled out” when the RBA meets again next month, according to Shane Oliver of AMP Capital, while that of Deutsche Bank. basic estimate.

The Bank of England has so far only raised interest rates by 25 basis points to a 13-year high of 1.25 percent, but said it was prepared to act “by force” to stamp out inflation that’s headed north of 11 percent. penny.

Central banks take the risk of rerunning the 1980s

These measures have raised concerns that central banks risk accelerating the global economy’s path into a deep recession by not coordinating their gains.

“We saw something like that in the early 1980s when the Fed was battling inflation hard,” Professor Obstfeld, who teaches economics at the University of California Berkeley, told ABC’s The Business program.

“The dollar appreciates to the heights of the stratosphere [and] the depreciation experienced by US trading partners is hampering their efforts to disinflation, so they may raise interest rates more than they should.

“So we had a very deep global recession that spilled over into emerging markets in the form of the debt crisis of the 1980s and I think there are similar risks now.”

He believes the central bank waited too long to raise interest rates and is now panicking, trying to catch up.

“They have eggs on their faces because they’re behind the curve, and there’s a bit of panic in the air,” he said.

“A great example is your RBA: two back-to-back 50 basis point gains when inflation is between 5 and 6 percent.

“Now, governor [Philip] Lowe predicts that inflation, regardless of the rate hike, will hit the 7 percent level. [Federal Reserve chair] Jay Powell would love to have 7 per cent right now.”

Professor Obstfeld, a former economic adviser to then-US president Barack Obama who has contributed to a major economic paper prepared ahead of this year’s G20 meeting in Indonesia, believes that massive interest rate hikes in the West will seriously hurt developing and emerging economies. .

“They have higher debt to deal with COVID, and facing higher interest rates will put more fiscal pressure on them,” he warned.

“A lot of poor households can’t really deal with the energy and food prices we’re seeing without some sort of government support, which is going to put more strain on the budget.”

He believes the global community needs to think hard and act on reforms that might make debt restructuring for poor countries more orderly and less traumatic.

“If you’re in the UK, and you know that Europe is tightening and the US is tightening, and Canada and Australia are tightening, and developing countries are tightening, you can say, you could have done it a little easier because the spillover effect would be very strong, and maybe we no need to go that far.”

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