A cure for inflation worse than the disease? Criticism mounts against central banks

In the United States, the United Kingdom, in the euro zone, but also in most emerging economies, key rate hikes follow one another at a frantic pace in order to slow inflation. But critics point to the risk of stifling growth in this way.

“It reminds me of what happened with bloodletting,” said Nobel laureate in economics Joseph Stiglitz in an interview with AFP, referring to the practice since ancient times of making a patient bleed to cure him.

“When a patient was bled, generally he did not recover, except by miracle. So they bled him even more, and his health worsened all the more. I fear that the central bankers are doing the same thing at the moment”, criticized the economist.

This week again, the American, British and European central banks should unsurprisingly continue their tightening. The Fed could thus raise its rates on Wednesday by 0.75 or even a full percentage point, after already four increases since March.

Those in South Africa, Brazil and Sweden should also show a resolute tone to tackle inflation.

The objective is to increase the cost of credit granted to households and companies, to slow down the job market, wage increases, and ultimately the rise in prices.

“Consumer brake”

But after six months of war in Ukraine and the devastating consequences for parts of the world, some worry about the consequences of such restrictive and synchronized policies.

“Did the economy really need this to slow down?” asks Éric Dor, director of economic studies at the IESEG business school.

According to him, “inflation has itself created the decline in activity, households are losing purchasing power, the increase in wages is lower than inflation, and represents a brake on consumption”, particularly for Europe where rate hikes risk further weakening the economy.

“Will it cause a little loss of growth? It is possible, “recognized the boss of the European Central Bank Christine Lagarde on Friday during a conference in Paris. But for her, “it’s a risk that we must take by having measured it well”.

The priority is to curb rising prices, also said Joe Biden’s Minister of Economy and Finance Janet Yellen, while acknowledging “a risk” of recession in the United States. The specter of inflation in the 1970s and 1980s is never far from people’s minds, when prices had soared for almost ten years.

The World Bank, for its part, estimated on Thursday that the simultaneous rise in interest rates increased the risk of a global recession next year, and especially in emerging and developing countries, while calling on central banks to continue their efforts to reduce inflation.

Rental prices

In addition to the potency of the remedy adopted and its side effects, the debate also focuses on the causes of the disease.

According to Joseph Stiglitz, the inflationary surge is less caused by excess demand than by energy and food price hikes and persistent blockages in supply chains. Phenomena against which central bankers have a much smaller field of action.

They “use a remedy resulting from a bad diagnosis”, insists the economist, warning that we could see in the United States the prices of rents continue to soar under the effect of the rise in rates, and therefore inflation persist.

“The risk is that without having any real impact on inflation, this policy worsens the cost in terms of activity and employment”, adds Éric Dor concerning Europe.

“Stricter monetary policy will inevitably have economic costs,” acknowledged for his part in July the chief economist of the International Monetary Fund Pierre-Olivier Gourinchas, specifying that “any delay will only exacerbate them”.

Faced with the limits of monetary policies, the latter had advocated “targeted budgetary support” from governments, a solution on which a consensus is emerging across the world despite its high cost on public finances already severely degraded.

A cure for inflation worse than the disease? Criticism mounts against central banks