Impact of higher US interest rates could implicate smaller economies as well
ALBAWABA – A study by the United States (US) Federal Reserve Bank of San Francisco found that the hikes in US interest rates reduced potential economic output for at least 12 years, Bloomberg reported Wednesday.
Contrary to traditional theories of national economics, the study found that monetary policy may actually not be neutral on the long run.
“We find that these long-run effects develop primarily through investment decisions that ultimately result in lower productivity and lower capital stock than would be available without policy intervention,” the study said.
San Francisco Fed researchers Òscar Jordà and Sanjay R. Singh, and University of California Davis professor Alan M. Taylor published the research note Tuesday on the Fed’s website.
“These productivity effects persist for at least 12 years following a period of monetary policy tightening,” the researchers said.
The economists used historical data for smaller economies that pegged their exchange rate to the currency of a bigger economy to study the impact of externally driven interest-rate changes. The study addressed how components of output — labor, capital and total factor productivity — respond to such changes, including those resulting from higher US interest rates.
Monetary policy shocks “can slow the pace of economic activity much more persistently than is commonly believed, all other economic factors being equal,” Jordà, Singh and Taylor said.
Runaway inflation has driven the Fed to hike US interest rates - Shutterstock
For example, in response to a 1 percent interest-rate increase, real gross domestic product would be about 5 percent lower after 12 years than it would otherwise be, the researchers found.
The researchers also looked at whether central banks can boost an economy’s capacity in the long term with lower interest rates after the policy tightening cycle is over. They found that “there is no free lunch.”
In other words, it is likely that no lower interest rates in the aftermath could compensate for the impact of an externally driven rate hike.
“A central bank might not be able to undo the long-run effects on the economy’s potential by running the economy hot,” they said.
Higher US interest rates make oil and energy more expensive for countries settling payments in other currencies. And it forces countries whose currencies are pegged to the US dollar to raise interest rates as well, costing their economies an untold amount in borrowing, for example, which would otherwise finance domestic demand and businesses alike.
With that in mind, central banks around the world, including most of those in the Middle East, have embarked on the most aggressive cycle of rate hikes in decades, according to Bloomberg.
All in an attempt to cool inflation that was in part driven by outsize demand as economies emerged from the Covid-19 pandemic. Not to mention higher energy and food prices, partly also driven by the Russian-Ukranian war.
