Do not shoot Hue and Dia, this is the motto in matters of economic policy! When monetary policy tightens and enhances the cost of money, fiscal policy is supposed to go in the same direction by restricting expenditure. In the current context, deficit budgets are indeed exposed to the financial market cleaner, ready to fall even on its most fervent devotees, as evidenced by Liz Truss’s resignation in the United Kingdom. But will the increase in rates turn on inflation without causing an economic and financial crisis?
Central banks are counting on several channels for the rise in guiding rates to lower inflation. First of all, the anticipation channel: to convince the investors that they act can lead them to reduce their price increases. Then the bank credit canal which, by becoming more expensive, should contract. That also of market interest rates, very directly for short -term rates, more indirectly for those of longer term, which should reduce the emissions of new titles on the primary markets and accentuate sales of old titles on secondary markets. That of the exchange rate, which goes back as the interest rate rises, reducing the increase in the price of imported products. And finally that of the prices of financial assets (the obligations in particular), which fall as the rates go up, reducing the value of the financial heritage: feeling less rich, their holders will consume less.
All this will actually reduce economic activity. But the risk is great for the contraction of the activity to be faster and stronger than that of inflation. Indeed, it is only if inflation is due to an overheating that it joins, as the activity contracts, the target of 2 % targeted by most central banks. But if the causes of inflation are elsewhere, then it will not drop, at least much less than activity.
finance the energy transition
And that’s precisely what we can fear! Current inflation, largely taken by the prices of energy and raw materials (food in particular), draws its roots from more structural than economic factors, linked to the absence of energy and ecological transition.
The best that monetary policy can do under these conditions is to “green”. By making depending on the rise in guiding rates of the contribution of banks to the financing of the ecological transition, central banks could make a rise in more gradual rates: these would remain more accommodating for banks which finance the transition to fossil activities , and would go up for others. This would expose less savings at the risk of recession, and contribute to their transformation.
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