The US Federal Reserve is taking vigorous action against inflation. This is unlikely to change in the foreseeable future. Some are wondering: is the Fed overdoing it? The interest rate policy of the central bankers could not only plunge the USA into a recession. It can be felt all over the world.
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. 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.
High dollar problematic for poor countries
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 borrowed 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.
Does history repeat itself?
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.