Central banks are scrambling to raise interest rates as inflation soars to the highest levels in almost two generations. They risk acting too forcefully, however. By simultaneously raising interest rates, they amplify each other’s policy impact and, if this feedback loop isn’t taken into account, could drive the global economy into recession.
Emerging-market economies implemented a slew of rate hikes in 2021 and have extended this trend in 2022 (panel a). Advanced economies generally were slower to act but, except for Japan, have also moved to raise rates in 2022 (panel b). Among the world’s biggest economies, only China has cut rates, reflecting unique factors in the Chinese economy.
The decisive response by central banks to inflation is generally welcome, but monetary policymakers must consider other central banks’ actions when setting their own rates. Global trade integration means foreign labor market conditions can more easily dampen domestic prices, limiting inflation. Global financial integration accelerates the spread of tighter financial conditions across the world. If other central banks are also raising rates, that could reinforce the effects of a rate hike on domestic economic output.
Globalization raises the stakes of doing too much. To avoid an economic slowdown beyond what is needed to bring inflation under control, central banks should coordinate a gentler collective tightening of monetary policy and clearly communicate their intentions. They coordinated monetary policy responses effectively during the global financial crisis, and the current inflationary dilemma merits an equally collaborative approach.
This PIIE Chart is based on Maurice Obstfeld’s blog, Uncoordinated monetary policies risk a historic global slowdown. Produced and designed by Nia Kitchin and Oliver Ward.