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FIXING A DISLOCATED SHOULDER

Harvest Global Markets :

The world’s largest central banks are on the census that to cage inflation, they will have to set their carriage on the bumpy ride of tightening monetary policy. However, the stretch of the path is still debatable.

Although many economists claim that central banks have surged the inter-bank rates more than required, a portion of analysts firmly believes that the rise in interest rates should be greater than the rise in the inflation rate (a concept called the Taylor Principle). Taylor’s Principle is based on the notion that aggregate demand will only decline if the inflation-adjusted borrowing costs (real interest rate) in the economy will increase. Presently, central banks seem to need to adopt Taylor’s Principle. The inflation of the U.S has elevated by 500 basis points since the start of the year, while its policy rate has increased by 375 basis points only. The general price level in the U.K has been uplifted by 800 basis points, while interest rates have been hiked by 290 basis points. Similarly, the excruciating inflation in Eurozone has mounted by 1000 basis points, and the European Central Bank has increased the rates by 200 basis points up till now.

As simple as the theory sounds in literature, it is as hard to implement. Real interest rates are effective if they are forward-looking. Analysts expect the inflation rate of the U.S to linger around 5.4%over the next year, and the Federal Reserve Bank projects its terminal rate to be 4.6%, i.e., still lower than the anticipated CPI. The elephant in the room is to determine the time frame for the rates, which is quite subjective.

Another school of thought denies Taylor’s principles and asserts that the multiplier impact of even the slightest interest rate hike takes time to reveal. By the time central banks are finished advancing their rates, it may be too late for the economy to recover.

No matter what policies are adopted, one fact is crystal clear inflation is like a dislocated shoulder that requires painful means to fix.

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