With its third unusually sharp rate hike in a row, the US Federal Reserve is continuing its aggressive fight against inflation. The strict monetary policy should finally noticeably reduce the rate of inflation in the USA.
The Fed raised its key interest rate again by 0.75 percentage points on Wednesday – and Fed Chairman Jerome Powell made it clear that the big rate hikes are far from over. “Without price stability, the economy doesn’t work for anyone,” he said. But the central banker’s decision not only has an impact on the world’s largest economy, but also on economically weaker countries. And Germany is also feeling the effects of the US interest rate policy.
The head of the International Monetary Fund (IMF), Kristalina Georgiewa, has been warning of a debt crisis for middle- and low-income countries for months. “We have to recognize that there is a tectonic shift,” she said around July. The world has become more vulnerable to shock. Currently, the effects of the supply chain disruptions caused by the corona pandemic and the “horror of another war in Europe” have led to runaway inflation. The head of the IMF emphasized that the central banks are rightly concentrating on combating this with interest rate hikes. But as central banks hiked interest rates, global financial conditions tightened more than previously thought.
Interest rates drive the US dollar higher
The main problem: The high interest rates are driving the US dollar higher – to the detriment of other countries. Because not only imports are becoming more expensive, but also the servicing of loans. The tight monetary policy of the US Federal Reserve is therefore particularly felt in lower-income countries that have borrowed heavily during the pandemic and took out their loans in US dollars – but do not earn any dollars themselves. The higher interest rates make these loans more expensive.
This comes at a time when inflation is already wreaking havoc on many countries in Central Asia, Latin America and sub-Saharan Africa. Rising interest rates are making the situation worse. In addition, when interest rates are high in the USA, capital can flow out of developing and emerging countries. If interest rates rise in the USA, investments there become more attractive. Investors currently investing in lower-income countries may choose to switch to the now more attractive US market instead. This has serious consequences for the countries affected, as they are likely to have even more difficulty recovering from the catastrophic effects of the pandemic.
US interest rate policy can trigger a serious economic crisis in low-income countries – as history has shown. The consequences of the so-called Volcker shock are particularly memorable. Legendary Fed Chairman Paul Volcker raised interest rates drastically in the 1980s to fight inflation. Economic growth in the USA slowed down. However, this also dragged other economies down with it. Countries like Mexico and Chile slid into a severe debt crisis from which they did not recover for years. In Latin America there was even talk of a lost decade. Interest rate hikes by the Fed also repeatedly had economic consequences for developing and emerging countries in later years.
Economists are now warning that these scenarios could repeat themselves – with devastating consequences for the people in these countries. “High inflation, rising interest rates and slowing growth have set the stage for the financial crises that plagued a number of developing countries in the early 1980s,” wrote the World Bank’s Sebastian Essl and Marcello Estevão in June.
US interest rate policy puts pressure on the euro
As an exporting nation, Germany is also likely to feel the effects of such a debt crisis. Because German exports could be jeopardized if the economic situation in other countries deteriorated drastically.
The Fed’s interest rate policy is also putting massive pressure on the euro. The common currency fell back below the US dollar in late US currency trading on Wednesday and even fell to its lowest level since the end of 2002. In the summer, a euro was worth less than a dollar for the first time in around two decades. The European Central Bank started raising interest rates much later than the Fed.
When asked whether the Fed was also keeping an eye on developments in the rest of the world and thus also on a possible global recession, Fed Chair Powell said: “We are very aware of what is going on in other economies around the world and what that means for us – and vice versa.” Of course you try to coordinate, but that is difficult with the different interest rates. His summary: “We are all in very different situations.”
