By Nigel Green
The Federal Reserve’s latest indication of prolonged higher borrowing costs in the US underscores the ongoing struggle to curb inflation in the world’s largest economy.
As the Federal Open Market Committee acknowledges the lack of progress toward its 2% inflation target, I believe that it’s becoming increasingly apparent that high-interest rates alone may not suffice in bringing down inflationary pressures.
High-interest rates have traditionally been a go-to tool for central banks in combating inflation by curbing borrowing, spending, and investment.
However, the efficacy of this approach is now being challenged.
One significant limitation lies in the changing nature of inflation drivers. While conventional models primarily focused on demand-side factors, such as consumer spending and wage growth, contemporary inflationary pressures are influenced by an interplay of supply chain disruptions, geopolitical tensions, and structural shifts in the global economy.
These non-monetary factors operate independently of interest rate adjustments, limiting the effectiveness of monetary policy in reining in inflation.
In addition, the transmission mechanism of monetary policy has become increasingly intricate, posing challenges to the impact of high-interest rates on inflation.
In today’s complex global economy, domestic interest rate changes may have limited influence when confronted with external pressures.
Global capital flows, exchange rate dynamics, and the interconnectedness of financial markets all contribute to the complexities of transmitting monetary policy impulses.
Therefore, the Fed’s ability to control inflation solely through interest rate adjustments is constrained by broader economic forces beyond its control.
Additionally, high levels of debt in the US economy present a significant obstacle to the effectiveness of high-interest rates in curbing inflation.
Both government and household debt burdens weigh heavily, making any increase in borrowing costs potentially detrimental to economic stability. Higher interest rates can lead to increased debt servicing costs, reducing disposable income and dampening consumer spending.
This, in turn, could prompt businesses to scale back investment plans, further suppressing economic activity. Consequently, policymakers face a delicate balance when considering interest rate adjustments to avoid exacerbating existing debt vulnerabilities.
In light of these constraints, it’s imperative to explore alternative strategies beyond high-interest rates to effectively manage inflation in the US.
Fiscal measures, such as targeted spending programs and tax policies, can directly influence aggregate demand and inflationary pressures.
By strategically allocating resources towards infrastructure projects, education, and healthcare, policymakers can stimulate economic growth while addressing supply-side constraints that contribute to inflation.
Plus, structural reforms aimed at enhancing productivity and reducing bottlenecks in key sectors of the economy can play a crucial role in containing inflationary pressures.
Investing in innovation, upgrading infrastructure, and streamlining regulatory processes can improve efficiency and mitigate cost-push inflation. Additionally, policies focused on promoting competition and reducing market concentration can foster greater price competition, exerting downward pressure on prices.
Targeted interventions, such as addressing supply chain disruptions and investing in renewable energy sources, can also help alleviate inflationary pressures in specific industries. By addressing these supply-side constraints and promoting sustainable production practices, policymakers can mitigate inflationary risks while promoting long-term economic resilience.
High-interest rates have traditionally been a primary tool for central banks in combating inflation.
But the Federal Reserve – and its major central bank peers – now needs to be realistic with the limitations of high rates in the current economic landscape.
(Author is deVere Group CEO and Founder)