Risk to World Economy: Drastic US Interest Rate Hikes

Although it is important to curb inflation by raising interest rates, the shrinking U.S. stock market means trouble. The U.S. Federal Reserve Board, which maintains domestic and foreign economies, needs to take control of fiscal policy.

On May 4, the Fed raised interest rates by 0.5% for the first time in 22 years after it lifted the de facto zero interest rate policy in March. The interest rate has increased to between 0.75 to 1% for the first time since 2000.

The Fed has continued its policy of quantitative easing that allows large amounts of money to flow into the market via national debt and spending, but the Fed has indicated that it will enact a policy to reduce assets in the future. This will decrease the amount of capital available in the market and result in a credit squeeze.

In March, the U.S. Consumer Price Index saw its highest growth rate in about 40 years. We can understand why the Fed is in a hurry to tighten monetary policy to curb inflation.

Fed Chair Jerome Powell told a press conference that “it’s absolutely essential to restore price stability,” and added that the Federal Reserve plans to continue raising rates.

The problem, however, is that a sudden credit squeeze could invite an economic downturn. Risks to the world economy are on the rise and the Fed needs to carefully scrutinize the impact of its decisions.

Russia’s invasion of Ukraine spurred a sudden jump in prices for resources and foodstuffs. This is a major blow to developing countries with low income levels. Rising U.S. interest rates could spark an outpouring of funds from emerging markets and developing countries, as investors look for bigger returns.

China is upholding a “zero-COVID policy” and Shanghai is under a city-wide lockdown. Stagnant production and consumption in China, which is said to be the “factory of the world” and has a vast market, are expected to seriously impact the world in the future.

In the U.S., the value of stock for industries like information technology, where there were high hopes of increasing prices, has recently plummeted. Powell indicated there will be further rate hikes after the 0.5% increase, but it is not yet clear when this will happen or what another increase would look like.

The Fed should pay close attention to the condition of the world economy and financial markets and adjust the pace of rate hikes carefully.

For Japan, it is worrisome that the U.S. interest rate hike could bring about further depreciation of the yen.

Last month, the Bank of Japan decided to continue quantitative easing in an effort to push long-term interest rates to around 0%. If the interest rate differential with the U.S. widens, it will be more profitable to manage funds there, resulting in the strengthening of the dollar while the yen depreciates.

Sudden market fluctuations have an immense impact on the economy, making it difficult for companies to make business plans. The government and the Bank of Japan must continue to monitor market trends.