What If The Rest Of The World Tightens And The U.S. Doesn’t

So the Fed, confronted with 6% official (~ 12% actual) inflation, steps right up and … promises a few quarter-point interest rate hikes not today, but at some indeterminate dates in 2022. Even if it follows through — a big if based on recent history — the U.S. will still find itself with negative real interest rates of at least 3%. Which is to say with monetary policy that remains wildly inflationary.

Contrast this insouciance with much of the rest of the world, where other central banks are already tightening aggressively. From last week’s Wall Street Journal:

Central Banks Around the World Raise Rates as Fed Prepares Move

Central banks across swaths of the globe are continuing to raise interest rates in an effort to tame inflation, largely dismissing for now the threat to economic growth posed by the spread of the highly infectious Omicron variant.

A rate rise announced by Russia’s central bank Friday was its seventh this year and brought the increase in its key interest rate to four-and-a-quarter percentage points since March. That is a reminder of how quickly and aggressively many poorer countries have responded to the acceleration in consumer prices, taking steps that are only now being contemplated or enacted in large rich countries. This is despite the new Covid-19 variant raising fresh questions about the pace of the global economic recovery.

While a lengthening list of central banks have or are poised to raise interest rates, central bank meetings this week underscored big differences in the perceived threat that inflation poses when set against the need to support fragile economic recoveries. Before Russia’s decision, rate rises were announced this week by Mexico, Chile, Costa Rica, Pakistan, Hungary and Armenia. Many of those indicated that further rate rises will come next year.

The Russian central bank said it was worried that initial price rises driven by turbulence in global energy and food markets, as well as blockages in supply chains, may be leading to a second round of price moves.

“The impact of one-off supply-side drivers of inflation is translating into growing prices for a wider range of goods and services as inflation expectations of households and businesses remain high and unanchored,” it said.

Those worries were at the forefront when the Bank of England raised its key interest rate Thursday, becoming the first major central bank to do so since the pandemic.

The major central banks have moved later than their counterparts in developing countries for two reasons. First, they counted on households showing faith in their track records of keeping inflation low, while monetary authorities in many developing economies aren’t sure that they have that credibility. Secondly, households in poorer countries spend a larger share of their incomes on essentials such as food and energy that have seen the largest price rises, so policy makers are quicker to tamp down on inflation.

To sum up, there’s a widening divergence between emerging economies that take inflation seriously and the rich debtor nations that think their citizens trust them enough to accept near-double-digit inflation for as long as they’re told to.

That’s quite a gamble. The Fed must find its other options scary enough to justify the risk.  

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