Everything that should be up is down and everything that should be down is going up. The sentiment effectively sums up the state of the global economy. It depicts the red alert flashing across financial markets. It captures the mood of consumers and savers. It also brings into stark focus the question of the credibility of monetary policy emanating from central banks on Mint Street in Mumbai or Liberty Street in New York.
The flow of high-frequency indicators riveted with references of record highs and new lows is triggering tremors in living rooms. On Friday consumer price inflation for the month of May recorded a 40-year high demolishing the thesis that inflation had peaked. On Thursday the European Central Bank announced its decision to raise interest rates in the Euro-zone — a first in the Euro-zone infamous for negative interest rates. On Wednesday the Reserve Bank of India raised its estimate for inflation and lowered its forecast of growth.
Predictably rising costs are impacting consumption and investment and therefore projections of growth. Multilateral institutions are racing to correct their estimations of what global GDP growth would be. On Tuesday the World Bank trimmed its 2022 forecast for global growth to 2.9 per cent from 4.1 per cent predicted in January. On Thursday the 38-nation Organisation for Economic Cooperation and Development trimmed its growth forecast to 3 per cent from 4.5 per cent it had predicted in December 2021. The IMF which has already trimmed its growth forecast to 3.6 per cent has warned of yet another cut.
Inflation, the nine-letter phantom, is haunting economies across the world. The pandemic saw countries subscribe to Keynesian stimulus pouring trillions into the economies. Violation of the principles of money presented in 1910 by Irving Fisher has consequences. Countries which adopted Keynesian policies ironically are now faced with the challenge posed by Paul Samuelson. Stagflation – stagnation with inflation – a 1970 coinage of British Conservative politico Iain Macleod is at the door. Worse, the dreaded R word, recession, is hovering on the horizon.
Almost every country in the world has raised interest rates. Globally yields on government bonds have spiked to new highs — yields on the US 10-year treasury have spiked from around 1.6 per cent to over 3 per cent in five months and that in India from 6.4 per cent to 7.5 per cent. Predictably stock indices have plunged — in the US the S&P 500 has plunged from 4,766 to 3,900 since January. This aggravated the flight to safety of portfolio flows from emerging economies — in India the Nifty 50 has slid from 17,600 levels to 16,200. The rise in interest rates though has not detained the rise of commodity prices — the Bloomberg commodities index is up nearly 40 per cent and the benchmark Brent crude has stayed above the $100 per barrel mark since March.
Yes, Keynesian stimulus was necessary to protect economies. Where central banks failed is in flagging the risks posed by both the quantum and the duration of the stimulus programmes. It is true that not all of the inflation is caused by excesses which flowed following the pandemic. Some of it came via China’s Zero Covid policy. Russia’s invasion of Ukraine and the sanctions worsened with rising food and fuel prices. That said it is not just food and energy prices which are fuelling inflation and this is manifest in the data.
There is circumstance and then there is the fact that central banks have been sanguine and clearly behind the curve. The US Federal Reserve has been roundly criticised and its credibility questioned repeatedly. In India the RBI, as this column has pointed out, was out of sync with not just the curve in the domestic economy but also what was emerging across the world. It has had to recast its inflation estimates for 2022-23 thrice — from 4.5 per cent to 5.7 per cent to 6.7 percent.
It is a fact that central banks have to work with backward looking data to construct forward looking policies. What is worrisome is the subscription of wishful thinking as strategy — the assumption of crude oil prices at $105 per barrel by the RBI is one instance. Sure the end of the war in Ukraine may theoretically, ceteris paribus, bring down prices. But it is also a reality that the emergence of China post the Zero Covid policy will ramp up demand.
It has been argued that much of this falls in the domain of “unprecedented”. There is no denying uncertainty but uncertainty is the base case scenario for monetary policy. The spectre of simultaneous supply side and demand side shocks is unravelling — beyond interest rate risk is liquidity risk and credit risk. Rising cost of capital will impair investment and shrinking trade affect currencies. The shock to equity and real estate markets has implications for the real economy — just as the phenomenon of rising wealth effect catalysed consumption loss of wealth can and will hurt demand.
The perception gaining ground, thanks to reactive responses in fits and starts followed by ifs and buts justifications, is that central banks are flying blind. As the thought process evolves for policy to be re-shaped one can only hope for the best. And yes, brace for impact!
Shankkar Aiyar is author of The Gated Republic, Aadhaar: A Biometric History of India’s 12 Digit Revolution, and Accidental India. He can be reached at shankkar.aiyar@gmail.com.