Why the US is inflicting an economic slowdown on itself and what is the biggest risk

It may sound strange that the world’s largest economy is inflicting an economic slowdown on itself, right?

The Federal Reserve of the United States (the Fed) -equivalent to the central bank of other countries- has embarked on a historic rise in interest rates with the aim of lowering an inflationary spiral that in June reached 9.1%, the highest high in 40 years in that country, and which is currently at 8.3%.

The bet is as follows: if the cost of credit rises, there is less demand to buy products and prices begin to fall.

It lowers inflation, but the problem is that it also lowers growth, and that is why it is said to be a self-inflicted slowdown.

The big risk is that if growth falls too low, it could turn into a recession, experts argue.

A “real danger” of recession

The current debate in the United States revolves around the dilemma of how far to raise interest rates without going too far.

In the end, if the price to pay for controlled inflation is economic recession, the outlook for this year and next does not look very promising in the US and the rest of the countries that are also raising the cost of credit at a speed that had not happened in decades.

There is a “real danger” of global economic contraction by 2023World Bank President David Malpass said on Monday, warning that a strong dollar is weakening the currencies of developing nations.

This increases its debts to “onerous” levels, he said at an event that kicked off the annual meetings of the World Bank and the International Monetary Fund (IMF) in Washington this week.

The IMF estimates that about a third of the global economy will experience two straight quarters of contraction this year and in 2023, and that the level of lost output by 2026 will reach $4 trillion.

However, the managing director of the IMF, Kristalina Georgieva, argued that the authorities cannot let inflation become “a train without brakes.

Both organizations argue that there are greater risks of a global recession, as faster inflation leads central banks to raise interest rates, which weighs on growth.

That alert comes as the Fed, the European Central Bank and most of their peers have signaled that they will continue to raise the cost of borrowing in the coming weeks and months.

A global crossroads

Economic historian Adam Tooze, director of the European Institute at Columbia University, explains that as soon as the Fed takes action and the dollar strengthens, other countries also raise their interest rates or face a sharp devaluationwhich further fuels inflation.

The difference between what is happening now and previous experiences, he says, is that this pattern has never been replicated by so many countries at the same time.

“We are in the center of the most extensive contractionary fiscal policy the world has ever seen,” argues the economist.

“There are moments when you discover that you live in a historical period. This is one of those moments”.

Will we be able to lower inflation? Very likely, says Tooze.

But, he adds, we could also fall into the risk of a global recession that, in the worst case, would hit the housing market, drive several companies and nations out of business, and leave hundreds of millions of people around the world unemployed and in dire straits.

Not controlling inflation would be “more painful”

“Nobody knows if this process will lead to a recession or, if so, how significant that recession would be,” said Fed Chairman Jerome Powell, after announcing the third consecutive increase in interest rates (leaving it in a range of 3%-3.25%) on September 21.

“It is likely that the chances of a soft landing decrease to the extent that the policy needs to be more restrictive or restrictive longer. However, we are committed to bringing inflation down to 2% again,” he stated.

Those statements are added to the warnings that Powell had already made at the end of August at the central bankers’ meeting in Jackson Hole, Wyoming, in relation to the fact that the path to lower inflation would not be easy.

“Reducing inflation is likely to require a sustained period of below-trend growth,” Powell said, in cryptic language that analysts took as a sign that a recessionary scenario was not out of the question.

“While higher interest rates, slower growth and softer labor market conditions will reduce inflation, they will also bring some trouble to households and businesses,” he continued.

“These are the unfortunate costs of reducing inflation. But failing to restore price stability would mean much more pain.“.

Despite fears of a possible recession, the US economy is still showing some mixed signs: Businesses are still hiring workers, wages are up, consumers are still spending and manufacturing remains strong, experts say.

That is why some analyzes suggest that if the US fell into a recession it would be “like never before” in the history of the country.

For many, those mixed signals have become something of a puzzle.

The effects of a strong dollar

Strong currencies such as the euro or the pound sterling have depreciated against the dollar, as is also happening to countries with lower incomes, including several Latin American countries, such as Argentina, Colombia or Chile.

The strength of the dollar is a concern outside the United States.

And it is that when a central bank increases interest rates, one of the effects it takes advantage of to reduce inflation is that the currency appreciates.

Higher rates in the United States have attracted big investors looking for higher yields, pushing up the exchange rate.

Thus, a stronger dollar makes imports cheaper and reduces inflation, but leaves other countries at a disadvantage.

Given this scenario, the other central banks also raise their own rates.

In Latin America, the cost of credit in Argentina is at 69.5%; in Brazil, 13.75%; in Chile, 10.75%; in Colombia, 10%; Mexico, 9.25%, and Peru, 7%.

Such high rates put debtors between a rock and a hard place, be they individuals, companies or countries, but increasing the cost of credit in the current international situation has become the most used tool by central banks to stem the wave of inflation.

The great risk for the United States and the rest of the world, experts say, is that the control of inflation leaves behind a recession whose effects can last for years.

We’ll see.