When the world faced the financial crisis in the fall of 2008, which lasted most of 2009, monetary policymakers in major central banks were the stars of this phase due to the monetary policies they adopted to overcome the crisis and revive economies. When the world was hit by the COVID-19 pandemic since late 2019, policymakers in central banks once again took center stage thanks to highly flexible policies and massive monetary stimulus packages. However, the current economic crisis facing the world seems to require more than just the actions of central banks.
Economic analyst Marcus Ashworth stated in an analysis published by Bloomberg that recent interest rate hikes, which are both delayed and minimal, along with budget cuts, will not prevent inflation rates from exceeding 10 percent. At the same time, adopting monetary policies that push the economy towards recession after years of ultra-flexible monetary policies will not be anything more than a new failure with a different flavor. According to Ashworth, who has spent over three decades in the banking sector, financial policies need to bear a larger part of the burden of reviving the economy.
After a brief period of joint thinking between central banks and governments when government spending increased in coordination with innovative stimulus programs from central banks, we have returned to a situation where central banks are the only stronghold against recession. The current separation between the levels of fiscal policy set by governments and the monetary policy set by central banks puts monetary policymakers and officials responsible for financial stability and their independence from government in a vulnerable position.
Ashworth warns that walking a tightrope between the desire to combat high inflation and the economy slipping into recession poses a dilemma for the European Central Bank. While hawks on the bank’s Governing Council are calling for a quick withdrawal of stimulus programs and the abandonment of negative interest rates, the risks of Eurozone economies entering a slowdown are increasing next year with the acceleration of stimulus withdrawal.
Nevertheless, there remains a glimmer of hope to avoid this nightmarish scenario: the declining likelihood of continued wage growth, which limits the pace of inflation rise. Here, governments can help by mitigating the impact of rising energy prices on consumers to lessen the effects of the second inflation wave. The European Union achieved significant success when it established the "Next Generation Fund" worth €800 billion to help member states cope with the economic fallout from the COVID-19 pandemic. However, the EU's financial response to the consequences of the Russian invasion of Ukraine has been underwhelming.
The EU’s resilience in facing difficulties is one of its greatest strengths, so it must develop a package of measures to sustain economic growth and limit the repercussions of rising prices due to the Russian war, alongside its current coordination of military movements and sanctions against Russia.
Outside the EU, the task of the Bank of England in dealing with the current crisis is tougher, given British Treasury Secretary Rishi Sunak's insistence on raising taxes instead of reducing them. Clearly, it will not bode well for the Bank of England when it decides to raise interest rates for the fourth consecutive time while warning of growing risks of an economic recession. Relying solely on interest rate increases could exacerbate the rising cost of living, which has led to increasing divisions among Monetary Policy Committee members, with some prioritizing the need to curb inflation, while others see the risks of government financial contraction.
The British government is turning a deaf ear to calls from financial experts for easing the coming decline in living standards. With signs of the Bank of England's declining willingness to address the consumer price increase crisis and the expected recession, market participants and investors are understandably growing anxious about pound-denominated assets, according to Ashworth, who recently served as the market planning director at Haitong Securities in London.
On the other side of the Atlantic, the U.S. Federal Reserve does not see obstacles to tightening monetary policy at an accelerated pace. This will increase the divergence in interest rates between the U.S. dollar and other major currencies, pushing the dollar higher and causing chaos in the currency market, particularly in emerging economies. However, the U.S. central bank has few options beyond eliminating massive government stimulus packages. The United States is also facing the specter of political paralysis after the midterm congressional elections, with the expected Republican opposition taking control of a majority, complicating the management of Democratic President Joe Biden.
The Federal Reserve and the Bank of England are looking to cool down economic activity and curb consumer demand by tightening monetary policy. However, this not only risks wasting trillions of dollars spent on economic recovery efforts following the COVID-19 pandemic but also threatens to spiral out of control. In this case, the remedy that the two central banks resort to may be worse than the disease itself, with trust already eroding in central banks' ability to fulfill their duties.
Ashworth believes that no one desires a return of politicians' authority over monetary policy and interest rate setting. Therefore, there must be an understanding of the limits of what monetary policy can achieve alone, especially when the world underwent complete lockdown measures, then reopened under the disruption of global supply chains and an energy crisis caused by the Russian war in Ukraine.
Central banks have little control over the supply side of the economy but can certainly stifle demand, which they have sought to encourage and stimulate abundantly over previous years. In contrast, governments can encourage the supply and production side, but only when it is commercially justified. Infrastructure projects and large-scale projects take a long time to yield results, but there is much that fiscal policy can achieve in this regard, especially through tax reductions and investment incentives.
Ashworth concluded his analysis by stating that it is now time for authorities around the world to replicate the creative impulse they demonstrated during the pandemic. These authorities must act without delay.
