Is interest rate hiking a recipe for missing several goals of monetary policy—beating inflation, preserving financial stability, and keeping up output growth?

Dorothea Schäfer and Willi Semmler
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Willi Semmler: The New School for Social Research (NSSR)

Eurasian Economic Review, 2024, vol. 14, issue 2, No 1, 235-254

Abstract: Abstract After the corona crisis, and even more so when the war in Ukraine struck, the price levels of all goods in the US and Europe rose surprisingly quickly and persistently. The FED began in March 2022 and the ECB in July 2022 with historically unique interest rate increases to combat the wage-price spiral that had not yet begun. In this article we show that energy, commodities and food were the main drivers of inflation. For this reason, central banks' goal of weakening demand for labor through historically large interest rate hikes seems unwise. We argue that the current measures cannot achieve all of their objectives: slowing inflation, stabilizing financial markets and sustaining growth. If interest rates remain high, but external forces emerge with a lasting effect and keep inflation rates high, especially in smaller emerging countries, it will be difficult to counteract this on a country or regional basis through high interest rate policy and national control of the price- and wage-Phillips curve. Significant negative side effects of interest rate hikes increase the risk of not making the necessary investments and, in particular, weaken the bargaining power of particularly vulnerable employment groups. Other tools are needed to curb inflation and keep it under control, for example more investment in sectors with supply disruptions and a massive expansion of investment in renewable energy.

Keywords: Interest rate hike; Inflation; Banking crisis; Labor market; Central banks; Energy crisis; Corona crisis (search for similar items in EconPapers)
JEL-codes: E00 E42 E43 E44 E50 E51 E52 G01 H00 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s40822-023-00256-6

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