In July 1946, the Hungarian pengő became so worthless due to hyperinflation that the daily inflation rate was 207%. Prices doubled every 15 hours. The situation reached a point where banknotes were printed with denominations up to 100 quintillion pengő (100,000,000,000,000,000,000). To cope with this absurdity, people would spend their money as fast as possible, knowing that it would be worth significantly less the next day. Workers were paid multiple times a day, and prices in cafés and restaurants would increase by the hour.
The Hungarian government eventually had to introduce a new currency, the forint, to stabilise the economy, essentially resetting the nation’s monetary system. This dramatic episode serves as a stark reminder of how unchecked inflation can spiral out of control, leading to bizarre situations where money loses its meaning and function as a store of value and medium of exchange.
The importance of inflation targeting is underscored by historical episodes of hyperinflation, demonstrating its vital role in maintaining economic stability by preventing spiralling prices, preserving the purchasing power of currency to ensure it remains a reliable medium for transactions and savings, and fostering confidence among consumers and investors that their money will retain its value, encouraging economic activities that support growth.
It helps avoids economic distortions that high inflation can cause, such as discouraging savings and investment, misallocating resources, and creating financial planning uncertainties, thereby contributing to more efficient economic planning and resource allocation.
Due Covid-19 pandemic, the initial response of central banks to economic downturns was to lower interest rates and implement quantitative easing to stimulate economic activity. However, as the global economy started recovering and supply chain disruptions persisted, inflationary pressures began to mount, exceeding the typical inflation targets set by central banks. To counteract rising inflation and anchor inflation expectations, central banks, including the Federal Reserve and the European Central Bank, began to reverse their course and increase interest rates.
These interest rate hikes aimed to cool down the overheating economies by making borrowing more expensive, thereby reducing consumer spending and business investments. While this approach helped to control inflation, it also had significant implications for the economy.
Higher interest rates slowed down economic growth, impacted the housing market by making mortgages more expensive, and increased the cost of servicing debt for both consumers and businesses. This delicate balancing act highlighted the challenges central banks faced in navigating the post-pandemic economic landscape, where they had to carefully weigh the trade-offs between controlling inflation and supporting economic recovery.
Consistent pattern of raising rates
For instance, the United States has demonstrated a consistent pattern of raising rates as the economy has moved into a post-pandemic phase, mirroring actions by the United Kingdom and Canada. These adjustments suggest a shift in focus towards containing inflation and cooling down overheated economies. Meanwhile, nations like Brazil and Russia have also followed suit with frequent rate increases, possibly to counteract their specific economic challenges.
India has also engaged in a pattern of increasing rates, reflecting its economic rebound and the necessity to manage inflation, which often accompanies rapid growth. Contrastingly, Japan has maintained a more stable policy stance, with fewer rate changes, reflecting its unique economic situation and long-standing battle with deflation.
However, now the things have started to improve globally. Top central bankers in Europe and the US are showing optimism about overcoming the significant inflation surge experienced over the past years, as recent data boosts their confidence in the potential for interest rate reductions by the upcoming summer. The recent revisions in US job growth figures for the previous months have reinforced the market’s anticipation of an imminent rate cut by June.
Concurrently, the Eurozone has observed a deceleration in wage and profit growth, hinting at a reduced inflationary pressure from corporate sectors. This shift has prompted key figures such as the Federal Reserve Chair and the European Central Bank President to hint at a near-future easing of monetary policies, reflecting a significant stride towards their inflation targets.
The financial markets have reacted to these developments by adjusting their expectations for interest rate cuts in 2024, with predictions now leaning towards more aggressive monetary easing by the Federal Reserve and the European Central Bank within the year. The Bank of England is also anticipated to follow suit with a rate cut in the summer, buoyed by positive inflation indicators.
This change in stance is further supported by recent statements from several ECB officials, suggesting a potential rate cut as early as April. Despite this optimistic outlook, some remain cautious, noting the strength of the US economy and warning against premature excitement over an economic turnaround, indicating a complex balance between fostering growth and managing inflationary pressures.
In 2024, India stands as an exemplar of striking a balance between promoting economic growth and controlling inflation. With the GDP expected to grow at 7.6% in 2023-24 and further to at least 6.8% in 2024-25, the country has witnessed robust industrial production and service sector expansion.
The Reserve Bank of India’s vigilant monetary policy, involving a cumulative rate hike of 250 basis points, has been instrumental in mitigating inflation from its peak, evident from the reduction in the headline inflation rate to 4.8% in June 2023. These measures have helped cushion the economy against price instability, even amid the supply shock in food prices and the uncertainty of monsoons.
Countries can take cues from India’s fiscal and monetary policies. Regardless, the global economic future seems optimistic as central banks globally are poised to stabilise and foster growth. Much like the phoenix rising from the ashes, economies are rebounding, with central banks fine-tuning the delicate art of monetary balance. This optimism paves the way for progressive growth and the revitalisation of economies worldwide.
Aditya Sinha is Officer on Special Duty, Research, Economic Advisory Council to the Prime Minister of India.
Source: Gulf News
