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Grace Blakeley is an economist, writer, and political commentator, focused on the international financial system and its distributional consequences. Blakeley is the author of Stolen: How to Save the World from Financialisation, and contributes regularly to The Guardian, The New Statesman, and The Independent.

For issue #28 of The Internationalist, Blakeley explains the recent controversy over central banks, interest rates, and the explosive consequences of US monetary policy for poor nations around the world.

There can no longer be any doubt that the era of extraordinarily loose monetary policy is over. Around the world, central banks have hiked interest rates in response to rising prices. The debate now centres on whether rates need to be increased significantly further, or whether they should remain at current levels. 

Higher interest rates mean higher borrowing costs for companies, households and states. This generally leads to less private and public investment, which equates to higher unemployment, lower productivity and lower wage increases over the long run. Meanwhile, consumers end up being squeezed between lower incomes on the one hand and higher borrowing costs on the other. This squeeze has become harsher in the world of permanently high consumer debt, which most rich countries have faced since the financial crisis. 

The consensus view on the relationship between interest rates and inflation suggests that policymakers have little choice other than to engineer a recession when prices begin to rise. If workers are not disciplined into accepting below-inflation wage rises then their greed will create a ‘wage-price spiral’ that could end up leading to growth-destroying hyperinflation.

But policymakers do have a choice. They simply consistently choose to wield their power in the interests of capital. In fact, the variation in interest rate policy among central banks is often less a reflection of divergent monetary conditions between states than differences in the balance of class power. In the US, for example, the Fed (US Federal Reserve System) has moved quickly to increase interest rates. In doing so, it hoped to create more unemployment in order to discipline workers into accepting lower wage increases, thereby taming the rate of inflation. As wage growth and job creation began to slow, many declared that the Fed had won its war against inflation. 

The Fed is portrayed as a neutral, technocratic institution, whose role is to keep prices stable and financial markets calm. But the decisions it is making have deep consequences for the balance of power not only within US society but also around the world. 

Most of the poorest states in the world are unable to borrow in their own currency, so when US interest rates rise and the dollar appreciates, their debt burden increases proportionately. As their currency depreciates relative to the dollar, much-needed imports also become more expensive, creating significant cost of living pressures for some of the poorest people in the world. Yet exports don’t tend to become more competitive as most of these poorer states export primary commodities, the demand for which doesn’t increase sharply when the price falls.

This often leads to economic turmoil, making investing in the country’s debt riskier. These states are then forced to increase domestic interest rates in a bid to avoid default. But this creates a catch-22 as interest rate rises reduce domestic investment, often leading to recessions. Yet failing to raise interest rates when prices are increasing leads to a loss of confidence, capital flight and often hyperinflation. Just look at Turkey. 

In other words, the world’s poorest states have been forced to cede control over their monetary policy to international financial markets. When the Fed chooses to raise interest rates in order to discipline domestic labour, it also pushes some of the poorest states in the world into deep debt distress. 

cant extent by the US Federal Reserve. Economists argue that raising interest rates is the only way to constrain inflation, which can be deeply damaging to growth and prosperity if allowed to increase unconstrained. This argument might be defensible in a world in which inflation was being driven by excessive demand. In the run up to the financial crisis, for example, there is a case to be made that low interest rates made borrowing artificially cheap, which encouraged an excessive build-up of debt. Of course, the Fed didn’t act to raise interest rates in time to curb the excess because US banks were making astonishing amounts of money from this accretion of debt. 

But today, it is very difficult to argue that inflation is being driven by excess demand. The price increases we’ve seen over the past few years emerged from the uneven recovery from the pandemic – most notable through supply chain blockages and rising fuel prices – as well as the war in Ukraine. The other less-noted factor pushing up prices is climate breakdown, which is making it harder for the world to feed itself, as well as leading to more extreme weather events that can lead to price shocks.  

Economists might argue that workers are making the problem worse by demanding wages even higher than inflation. But this story is totally implausible given how little bargaining power workers have in most advanced economies. As Isabelle Weber has forcefully argued, corporate profiteering is a far more likely culprit. Raising interest rates will not, it is safe to say, ease the recovery from the pandemic, end the war in Ukraine, or stop climate breakdown. In fact, higher rates are likely to make many of these problems worse. 

The cost of living crisis is being exacerbated by higher interest rates, which raise debt servicing costs and constrain workers’ incomes. Higher borrowing costs also make decarbonisation, necessarily funded in part by debt, more expensive. And a world that continues to rely on fossil fuels is a world that will continue to channel money directly into Putin’s war coffers. 

Inflation is high because we are entering a world of permanent crisis and low productivity. Put simply, it is becoming more difficult and more expensive to produce the goods upon which production and consumption depend. Tightening monetary policy is not a solution to this problem. The only way out is through a programme of public investment geared towards decarbonising economic activity. The world needs a Global Green New Deal.  

The Internationalist Archive