Inflation and rising interest rates: a false solution?

The Federal Open Market Committee of the U.S. Federal Reserve decided, at its first meeting of the year, to increase the benchmark interest rate for the U.S. financial market by 25 basis points, in order to make credit more expensive and thus curb consumption and, consequently, inflation. The upward interest rate cycle began in March 2022, and subsequently, a continuous and drastic increase was agreed upon, which included four 75 basis point moves. The Board of Governors of the Federal Reserve System assures that the execution of this monetary policy is the only means to contain inflation.

The consumer price index (CPI) in the United States closed in the year 2022 with an increase of 6.5% over the previous year. However, this is the sixth consecutive month in which a reduction in that indicator has been observed. According to different estimates, it is possible to state that the increase in the CPI has peaked and, as the International Monetary Fund (IMF) asserts in the January 2023 update of the world economic outlook, there are signs that the tightening of monetary policy is beginning to reduce demand and inflation. However, the figures achieved are far short of the 2% target and there is no indication that such a target will be achieved before 2024.

Recently, the Federal Reserve System (FED) noted that the latest indicators point to moderate growth in spending and output. But, on the other hand, job creation has been solid and the unemployment rate remains low. Building on previous meetings, the FED marked that rising unemployment and a weaker labor market were necessary to consider that tight monetary policy was having a significant effect. Therefore, it would be imperative to continue implementing the restrictive monetary policy, and with hikes from now on, taking into account the cumulative effect of the implemented monetary policy, the economic and financial evolution, and the behavior of the labor market.

The application of these decisions involves systematic action by the Open Market Desk at the Reserve Bank of New York through overnight repurchase operations. It is this direct action that allows interest rates to change. By their own means and on the basis of instruments defined by each of them, the European Central Bank, the Bank of England, and the Swiss National Bank have been raising their rates with a view to the need for a restrictive monetary policy to control inflation. In fact, there has been relative synchrony in interest rate increases in this group of countries since the FED’s decision. And in other developed economies such as Canada, Denmark, Sweden, Norway, Australia, New Zealand, and Iceland there are similar processes.

In Latin America, the central banks of the main economies have also decided to hike rates, even at a faster pace. FED’s decision has an impact on the larger economies as a whole and on a large part of the emerging market and developing economies. An even more important aspect is the establishment of the conditions under which the financial markets of this group of countries and, therefore, of the international financial system as a whole, operate.

Among the major economies, there are two relevant exceptions: Japan and China. Japan’s central bank has not changed its monetary policy and maintains reference rates close to zero. In China, there have been no changes in this area either, and in a context in which prices and economic growth are behaving differently from the rest of the major economies.

The conditions under which financial markets operate on a global scale are defined by FED’s decisions. The increase in benchmark interest rates does not imply negative results for everyone. In addition to the data from different reports on the increase in wealth among the world’s millionaires, such as that of Oxfam or Credit Suisse, there are others related to the increase in the profits of a small group of large companies. 

The largest profits, with respect to the immediately preceding period, are in the large oil, food, and beverage companies, including those involved in the intermediation of grains and fertilizers, activities that stand out for the notable increase in their prices. Banks and other financial firms also reported substantial gains.

The fact is so remarkable that several governments of developed countries (e.g., the United States) are proposing specific taxes for large companies. An additional problem, relevant in the case of Latin American countries, is the rising cost of debt and the increased instability of their financial markets. The profits of some large financiers incorporate the higher yields paid on the debt of Latin American countries, especially public debt, even if it is denominated in local currency.

The high profits for some groups show that under inflationary conditions not everyone loses. There are companies that enjoy the ability to influence or set prices and therefore increase profits in this context. There are also firms that can move significant amounts of resources and place them in the financial markets, thus earning high returns from rising interest rates.

Some of these firms have acted since the beginning of the recent inflationary process, and have been able to increase the prices of the goods they produce or trade in order to maintain their profits. This, on the other hand, is not due to an increase in demand and, even less so, to an excess of cheap credit that leads to purchases in excess of production capacities. But it does present one of the defining characteristics of inflation: the notable difference in price increases between different activities, which accounts for the redistribution of profits between companies and the differentiated reduction in spending capacity between sectors of workers and families.

Inflation today, as in the past, is not a monetary problem. Moreover, over the course of the last few months, the rise in the U.S. benchmark interest rate has been a means to maintain the strength of the dollar, just as economic and geopolitical tensions have increased, particularly vis-à-vis China’s economy. Interest rate hikes by central banks lead to higher profits for a small group of large corporations and are a means to maintain the strength of the dollar.

*Translated from Spanish by Janaína Ruviaro da Silva

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