Cost of war: A gas station burns after Russia attacked Kharkiv, Ukraine. Russia has reduced gas supplies to Europe. Photo: Fadel Senna/AFP
With the world economy reeling from a cost-of-living crisis, after two waves of supply-side shocks, central banks are dispensing the wrong medicine that could make the patient worse.
Rising interest rates reduce demand and GDP growth and can tip economies into recessions. But they cannot fix a broken supply chain or reduce the price of oil.
With supply chain issues on the wane, the immediate priority should be to reduce geo-political tensions. The West must realise that it cannot achieve regime change in Moscow. The sanctions against Russia are counterproductive and have caused too much pain in the rest of the world. There must be a negotiated end to the war in Ukraine.
The first shock saw a sudden and unexpected rise in world inflation rates during 2021 to multi-decade highs with production unable to keep up with a strong economic recovery as Covid-19 restrictions were relaxed.
The Brent crude oil price, which had fallen to $14 a barrel in April 2020, increased to $78 by the end of 2021. Russia’s unjust invasion of Ukraine on 24 February 2022 provided a second inflationary shock to consumer prices, which were already high. The oil price soared to a high of $133 in March 2022 on fears that the war would reduce supplies from Russia, the world’s third largest producer after the United States and Saudi Arabia with 12.1% of production in 2020.
Russia is also the world’s second largest producer of natural gas after the US with 16.6% of production. It has an infrastructure of pipelines that supplies 40% of European natural gas. Russia has reduced natural gas supplies to Europe to conduct maintenance, according to the official line. But the fear is that the shutdown — a dangerous game of Russian Roulette — could last much longer. As higher world oil prices have inflicted pain on 1.4 billion car owners in the world, Russia has been a major beneficiary of sanctions.
It has shrugged off the West freezing $300-billion of its foreign exchange reserves and reported a 249% increase in its current account surplus for the first six months of 2022 to $138.5-billion. The Russian rouble is the world’s strongest currency this year. It has soared from a low of 143 roubles against the US dollar in March to 58 roubles. The Russian central bank has tried to weaken the currency and reduced interest rates to 9.5% from a high of 20% earlier this year.
Inflation has shot up in most major economies, members of the G20 group of 19 countries and the European Union, except a few in Asia. China, Japan, Indonesia, Saudi Arabia and Switzerland have inflation rates of less than 5%. But elsewhere — the US (9.1%), the Eurozone (8.6%), the United Kingdom (9.1%) — consumer prices have risen to their highest levels for four decades.
Many Central Banks, led by the US Federal Reserve, have increased interest rates sharply. The Fed increased rates by 25 basis points in March, 50 basis points in May and 0.75 basis points in June. It is expected to announce an increase of up to 100 basis points at its next meeting on 26 to 27 July. The rate increases stoked fears of a recession, resulting in a collapse of prices of shares and cryptocurrencies. World oil prices fell to below $100 this week. But the fears abated after a recent jobs report, which showed that the US unemployment rate had remained at 3.6%.
The European Central Bank, which has yet to raise its policy rate from minus 0.5%, is expected to announce a hike of 0.25 basis points at its next meeting on 21 July. It is taking a more cautious approach because the Eurozone economy is more exposed to the war in Ukraine and will enter a recession this year. With interest rates in the US expected to increase much faster than those in the Eurozone, the dollar has soared against the euro and most other currencies.
But central banks do not have the policy tools to address supply-side inflation. The textbook response is to accommodate (or ignore) the first-round effects of a supply-side shock and wait and see if there will be second-round effects. But in the US and other countries, including South Africa, there is no sign of wage-price spirals or rising expectations of future inflation.
During Fed chairperson Jerome Powell’s recent testimony to congress, senator Elizabeth Warren said: “Inflation is like an illness and the medicine needs to be tailored to the specific problem, otherwise you could make things a lot worse. Right now, the Fed has no control over the main drivers of rising prices but the Fed can slow demand by getting a lot of people fired and making families poorer.”
In South Africa, it is monetary policy masochism to hike interest rates and shoot blanks at world oil prices in an economy where Eskom does a more effective job of decimating demand. Adding the misery of interest rate increases to austerity measures, stage six power blackouts and unpaid social relief of distress grants is creating the conditions for another uprising.
The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian.
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