Is Interest Rate Hiking a Recipe for Missing Several Goals of Monetary Policy—Beating Inflation, Preserving Financial Stability, and Keeping up Output Growth?

Abstract

levelsof all goods in the US and Europe rose surprisingly quickly and persistently. TheFED began in March 2022 and the ECB in July 2022 with historically unique interestrate increases to combat the wage-price spiral that had not yet begun. In this article weshow that energy, commodities and food were the main drivers of inflation. For this reason,central banks’ goal of weakening demand for labor through historically large interestrate hikes seems unwise. We argue that the current measures cannot achieve all of theirobjectives: slowing inflation, stabilizing financial markets and sustaining growth. If interestrates remain high, but external forces emerge with a lasting effect and keep inflationrates high, especially in smaller emerging countries, it will be difficult to counteract thison a country or regional basis through high interest rate policy and national control ofthe price- and wage-Phillips curve. Significant negative side effects of interest rate hikesincrease the risk of not making the necessary investments and, in particular, weaken thebargaining power of particularly vulnerable employment groups. Other tools are neededto curb inflation and keep it under control, for example more investment in sectors withsupply disruptions and a massive expansion of investment in renewable energy.