A case for ‘good inflation’

A case for ‘good inflation’

The almost overnight collapse of Silicon Valley Bank is feared to be a curtain raiser of worse things to happen if the Fed keeps on raising rates

Everyone is apprehensive that the US central bank, the Federal Reserve (Fed) will hit the interest rate hike pedal a bit too hard, send the USeconomy toppling over a cliff, and with it trigger a global recession. They are pointing to the almost overnight collapse of Silicon Valley Bank (SVB) as a curtain raiser of worse things to happen if the Fed keeps on raising rates. Not surprisingly though, the Fed Chairman,Jerome Powell, was unfazed. A Financial Times poll of leading academic economists showed that the Fed will keep raising its benchmark policy rate, holding it above 5.5 per cent for the rest of the year, despite turmoil across the US banking sector, to achieve their 2% inflation goal.

A case for ‘good inflation’

While traditional view is that tightening money supply is the best way to combat inflation, quite a few researchers are going against the tide to argue that ‘good inflation’ helps economic growth.A certain amount of inflation is precursor to growth because when individuals/businesses borrow money for incremental capacity creation then certain amount of liquidity is created in the economy and there is a time lag in the creation of incremental (new) goods and services from money being pumped into the economy. The debate can be over what is that ‘certain amount? Powell and his team feels that 2% is ideal percentage of inflation which helps the economy to chug along smoothly.

Cascading global impact

There is of course a strong global sentiment gathering against the Fed’s move to continuously raise interest rates. They started to increase rates in early 2022, taking and the total interest rate up by 450 basis points pushing the current rate to 4.75%. This is having a cascading effect around the world, with most central banks, with the exception of Japan, being forced to raise rates to stop their respective currencies from collapsing, as the US dollar then becomes an attractive destination.

Earlier economic theory used to preach that neighbouring countries used to proactively engage in “Beggar thy NeighbourPolicy” by aggressively depreciating their currency to make similar export products cheaper compared to their neighbours!  Now we see an opposite kind of policy being implemented by FED – which is appreciate your currency (since Fed is increasing interest rates continuously).

Neo Colonialism

So, economies like India are forced to compete on currency appreciation with FED to avoid becoming beggars when they are import dependent on energy (oil) so that their currency does not aggressively depreciate resulting in energy prices going up with implications on downstream industries. Fed induced interest rate hardening in India is hurting growth of the domestic economy in India.  Perhaps, an example of spread of neo-colonialism through contagion impact of interest rate mechanism!

It’s hurting the US too

But the US is not unscathed. Generally speaking, output and jobs will be derailed in USA because of relentless interest rate hikes!  To take a few specific examples.  Energy sector will find it expensive to finance capital investments and exploration.  With cost of borrowings going up consumers will stop borrowing hurting retailers and jobs in retail industry. The global tech boom reached a crescendo when the pandemic has ended. As consumers dialled down their app-based consumption and interest rates went up to fight inflation, investors tightened their belts. Around the world, start-ups and major tech companies are scrambling to adjust. Waves of layoffs that have hit more than 280,000 tech workers from Silicon Valley to Bengaluru. Venture funding, fell from $329.5 billion in 2021 to $191.5 billion in 2022 in the US. In Asia total venture deal value dropped from about $227.2 billion in 2021 to $136.8 billion to 2022. Funds are continuing to be scarce.

Real estate to be hit next

Real estate will slow down with mortgages coming down which will again impact output and jobs.  Within the past few weeks, an office landlord controlled by Pacific Investment Management Co. defaulted on about $1.7 billion of mortgage notes on seven buildings in places such as San Francisco, Boston and New York. Before that, a Brookfield Corp. business defaulted on loans tied to two Los Angeles office towers. A $1.2 billion mortgage on a San Francisco complex co-owned by former President Donald Trump and Vornado Realty Trust has showed up on a watchlist of loans that may be in jeopardy.

With dollar appreciating, US exports become more expensive and less competitive globally hurting sectors like manufacturing and agriculture.Sector-wise speaking, this story keeps on repeating. Is this phenomenon desirable in the name of control being exercised by policy makers!

It must be understood that growth by definition is inflationary because of the time lag (pumping of new money and resultant generation of incremental output).Policy makers need to be cautious when attempting to assassinate the economy in their over-enthusiasm to control inflation!

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