More stories

  • in

    Economists Nervously Eye the Bank of England’s Market Rescue

    The Bank of England stepped in to save a critical market this week. Economists say it was necessary but also worry about the precedent.When the Bank of England announced last week that it would buy bonds in unlimited quantities in an effort to stabilize the market for U.K. government debt, economists agreed it was probably a necessary move to prevent a cataclysmic financial crisis.They also worried it could set a dangerous precedent.Central banks defend the financial stability of the nations in which they operate. In an era of highly leveraged and deeply interconnected markets, that means that they sometimes have to buy bonds or backstop lending to prevent a problem in one area from spiraling into a crisis that threatens the entire financial system.But that backstop role also means that if a government does something to generate a major shock, politicians can be fairly confident that the local central bank will step in to stem the fallout.Some economists say that is essentially what happened in the United Kingdom. Liz Truss, the new prime minister, proposed a huge package of tax cuts and spending during a period of already high inflation, when standard economic theory suggests governments should do the opposite. Markets reacted forcefully: Yields on long-term government debt shot up, and the value of the British pound fell sharply relative to the dollar and other major currencies.The Bank of England announced that it would buy long-term government debt “on whatever scale is necessary” to prevent a full-blown financial crisis. The move was particularly striking because the bank had been poised to begin selling its bond holdings — a plan that is now postponed — and has been raising interest rates in a bid to bring down inflation.Economists broadly agreed that the bank’s decision was the right one. The rapid rise in interest rates sent shock waves through financial markets and upended a typically sleepy corner of the pension fund industry, which, left unaddressed, could have carried severe consequences for millions of workers and retirees, destabilizing the country’s entire financial system.“You saw very substantial market dislocation,” said Lawrence H. Summers, a former U.S. Treasury Secretary who is now at Harvard. “It’s a recognized role of central banks to respond to that.”To some economists, that was exactly the problem: By shielding the U.K. government from the full consequences of its actions — both preventing citizens from feeling the painful aftereffects and keeping government borrowing costs from shooting higher — the policy demonstrated that central bankers stand ready to clean up messy fallout. That could make it easier for elected leaders around the world to take similar risks in the future.Those concerns eased somewhat on Monday when Ms. Truss partly backed down, reversing plans to abolish the top income tax rate of 45 percent on high earners.But she appears poised to go forward with the rest of her proposed tax cuts and spending programs, putting the Bank of England in a delicate spot.Rising Inflation in BritainInflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.Mortgage Market: The uptick in interest rates roiled Britain’s mortgage market, leaving many homeowners calculating their potential future mortgage payments with alarm.Investor Worries: The financial markets have been grumbling with unease about Britain’s economic outlook. The government plan to freeze energy bills and cut taxes is not easing concerns.The “partial U-turn” from Ms. Truss “still leaves the Bank of England with a set of near-impossible choices,” analysts at Evercore ISI wrote in a note to clients. “The only way to alleviate this is for the government to take much bigger steps to restore credibility — but there is little sign this is imminent.”There’s a reason that the interplay between monetary policy and politics in the United Kingdom is garnering so much attention. Central banks have for decades closely guarded their independence from politics. They set their policies to either stoke the economy or to slow it down based on what was necessary to achieve their goals — in most cases, low and stable inflation — free from the control of elected officials.The logic behind that insulation is simple. If central bankers had to listen to politicians, they might let price increases get out of control in exchange for faster short-term growth that would help the party in power.Now, that independence is being tested, and not just in the United Kingdom. Central banks around the world are raising interest rates to try to fight inflation, resulting in slower growth and making it harder for governments to borrow and spend. That is likely to lead to tension — if not outright conflict — between central bankers and elected leaders.It is already beginning. A United Nations agency on Monday warned that the Federal Reserve risked a global recession and significant harm in developing countries, for instance. But the United Kingdom’s example is stark because the elected government is carrying out policy that works against what the nation’s central bank is trying to achieve.“One always worries that actions like these can affect incentives going forward,” said Karen Dynan, a Harvard economist who served as a top official in the Treasury Department under President Obama. “It’s basic economics: People respond to incentives, and fiscal policymakers are people.”Part of the issue is that it is hard for central bankers to single-mindedly focus on controlling inflation in an era when financial markets are fragile and susceptible to disruption — including disruptions caused by elected governments.Before 2008, the Fed had never used mass long-term bond purchases to calm markets in its modern era. It has now used them twice in the span of 12 years. In addition to last week’s moves, the Bank of England also turned to mass bond purchases to calm markets in 2020.Bank of England officials have stressed that the policies they announced last week are a temporary response to an immediate crisis. The bank plans to buy long-dated bonds for less than two weeks and says it will not hold them longer than necessary. The Treasury, not the bank, will be responsible for any financial losses. The bank said it remained committed to fighting inflation, and some economists have speculated that it could raise rates even more aggressively in light of the government’s growth-stoking policies.If the bank is able to hold to that plan, it could mitigate economists’ concerns about the longer-run risks of the program. If interest rates rise again and it gets more expensive for the government to borrow, Ms. Truss will still need to grapple with the costs of her proposed programs, just without facing an imminent financial crisis.But some economists warn that the Bank of England may find the situation harder to extricate itself from than it hopes. It may turn out that the bank needs to keep buying bonds longer than expected, or that it cannot sell them without threatening another crisis. That could have the unintentional side effect of giving the British government a helping hand — and it could demonstrate that it is hard for a big central bank to remove support from its economy when the elected government wants to do the opposite.Liz Truss, Britain’s prime minister, will still need to grapple with the costs of her proposed programs, but she won’t be facing an imminent financial crisis because of the Bank of England’s actions.Alberto Pezzali/Associated PressMs. Truss’s policies — particularly before her partial reversal on Monday — would work directly against the bank’s efforts to cool growth, stoking demand through lower taxes and increased spending. The rapid rise in bond yields last week suggested that investors expected inflation to rise even further.Under ordinary circumstances, these conditions would lead the Bank of England to do even more to bring down the inflation it had already been fighting, raising interest rates more quickly or selling more of its bond holdings. Some analysts early last week expected the bank to announce an emergency rate increase. Instead, the brewing financial crisis forced the bank to do, in effect, the opposite, lowering borrowing costs by buying bonds.While lowering rates and stoking the economy was not the point — just a side effect — some economists warn that those actions risk setting a dangerous precedent in which central banks can only tighten policy to control inflation if their national governments cooperate and do not roil markets in a way that threatens financial stability. That situation puts politicians more in the driver’s seat when it comes to making economic policy.Guillaume Plantin, a French economist who has studied the interplay between central banks and governments, likened the dynamic to a game of chicken: To avoid a financial crisis, either Ms. Truss had to abandon her tax-cut plans, or the Bank of England had to set aside, at least temporarily, its efforts to raise borrowing costs. The result: “The Bank of England had to chicken out,” he said.Policymakers have known for decades that when the government steps in to rescue private companies or individuals, it can encourage them to repeat the same risky behavior in the future, a situation known as “moral hazard.” But in the private sector, there are steps governments can take to offset those risks — regulating banks to reduce the risk of collapse, for example, or wiping out shareholders if the government does need to step in to help.It is less clear what monetary policymakers can do to prevent the government itself from taking advantage of the safety net a central bank provides.“There is a moral hazard here: You are protecting some people from the full consequences of their actions,” said Donald Kohn, a former Fed vice chair and a former member of the Bank of England’s Financial Policy Committee, who agreed that it is necessary to intervene to prevent market dysfunction. “If you think about the entities that benefited from this, one was the chancellor of the Exchequer, the government.”Some forecasters have warned that other central banks might have to pull back on their own efforts to fight inflation to avoid destabilizing financial markets. Some investors are speculating that the Fed will have to end its policy of shrinking government bond holdings early or risk stirring market turmoil, for instance.Not all of those scenarios would necessarily raise the same concerns. In the United States, the Biden administration and the Fed are both focused on fighting inflation, so any reversal by the central bank would probably not look like bowing to pressure from the elected government.Still, the common thread is that financial stability issues could become a hurdle in the fight against inflation — especially where governments do not decide to go along with the push to rein in prices. And how worrying the British precedent proves will depend on whether the Bank of England is capable of backing away from bond buying quickly.“Is this just an exigent moment that they needed to respond to, or does it give the fiscal authority room to be irresponsible?” said Paul McCulley, an economist and the former managing director at the investment firm PIMCO. “The question is who blinks.”Joe Rennison More

  • in

    Strong Dollar Is Good for the US but Bad for the World

    The Federal Reserve may have no choice but to wage a relentless inflation fight, but countries rich and poor are feeling the pain of plunging currencies.The Federal Reserve’s determination to crush inflation at home by raising interest rates is inflicting profound pain in other countries — pushing up prices, ballooning the size of debt payments and increasing the risk of a deep recession.Those interest rate increases are pumping up the value of the dollar — the go-to currency for much of the world’s trade and transactions — and causing economic turmoil in both rich and poor nations. In Britain and across much of the European continent, the dollar’s acceleration is helping feed stinging inflation.On Monday, the British pound touched a record low against the dollar as investors balked at a government tax cut and spending plan. And China, which tightly controls its currency, fixed the renminbi at its lowest level in two years while taking steps to manage its decline.Weakening CurrenciesHow the values of global currencies have changed against the U.S. dollar from three months ago

    Data through 3 p.m. Eastern time MondaySource: FactSetBy The New York TimesIn Nigeria and Somalia, where the risk of starvation already lurks, the strong dollar is pushing up the price of imported food, fuel and medicine. The strong dollar is nudging debt-ridden Argentina, Egypt and Kenya closer to default and threatening to discourage foreign investment in emerging markets like India and South Korea.“For the rest of the world, it’s a no-win situation,” said Eswar Prasad, an economics professor at Cornell and author of several books on currencies. At the same time, he said, the Fed has no choice but to act aggressively to control inflation: “Any delay in action could make things potentially even worse.”Policy decisions made in Washington frequently reverberate widely. The United States is a superpower with the world’s largest economy and hefty reserves of oil and natural gas. When it comes to global finance and trade, though, its influence is outsize.That is because the dollar is the world’s reserve currency — the one that multinational corporations and financial institutions, no matter where they are, most often use to price goods and settle accounts. Energy and food tend to be priced in dollars when bought and sold on the world market. So is a lot of the debt owed by developing nations. Roughly 40 percent of the world’s transactions are done in dollars, whether the United States is involved or not, according to a study done by the International Monetary Fund.And now, the value of the dollar compared with other major currencies like the Japanese yen has reached a decades-long high. The euro, used by 19 nations across Europe, reached 1-to-1 parity with the dollar in June for the first time since 2002. The dollar is clobbering other currencies as well, including the Brazilian real, the South Korean won and the Tunisian dinar.One reason is the string of crises that have rocked the globe including the coronavirus pandemic, supply chain chokeholds, Russia’s invasion of Ukraine and the series of climate disasters that have imperiled the world’s food and energy supply. In an anxious world, the dollar has traditionally been a symbol of stability and security. The worse things get, the more people buy dollars. On top of that, the economic outlook in the United States, however cloudy, is still better than in most other regions.In Britain, the pound touched a record low against the dollar.Andrew Testa for The New York TimesMillions are at risk of famine in Somalia, which is facing extreme drought and a jump in food prices.Ed Ram/Getty ImagesChina set its currency at the lowest point in two years on Monday.Mark R Cristino/EPA, via ShutterstockRising interest rates make the dollar all the more alluring to investors by ensuring a better return. That, in turn, means they are investing less in emerging markets, which puts further strains on those economies.Inflation F.A.Q.Card 1 of 5What is inflation? More

  • in

    Central Banks Accept Pain Now, Fearing Worse Later

    Federal Reserve officials and their counterparts around the world are trying to defeat inflation by rapidly raising interest rates. They know it will come at a cost.A day after the Federal Reserve lifted interest rates sharply and signaled more to come, central banks across Asia and Europe followed suit on Thursday, waging their own campaigns to crush an outbreak of inflation that is bedeviling consumers and worrying policymakers around the globe.Central bankers typically move slowly. That’s because their policy tools are blunt and work with a lag. The interest rate increases taking place from Washington to Jakarta will need months to filter out across the global economy and take full effect. Jerome H. Powell, the Fed chair, once likened policymaking to walking through a furnished room with the lights off: You go slowly to avoid a painful outcome.Yet officials, learning from a history that has illustrated the perils of taking too long to stamp out price increases, have decided that they no longer have the luxury of patience.Inflation has been relentlessly rapid for a year and a half now. The longer that remains the case, the greater the risk that it is going to become a permanent feature of the economy. Employment contracts might begin to factor in cost-of-living increases, companies might begin to routinely raise prices and inflation might become part of the fabric of society. Many economists think that happened in the 1970s, when the Fed tolerated out-of-control price increases for years — allowing an “inflationary psychology” to take hold that later proved excruciating to crush.But the aggressiveness of the monetary policy action now underway also pushes central banks into new and risky territory. By tightening quickly and simultaneously when growth in China and Europe is already slowing and supply chain pressures are easing, global central banks risk overdoing it, some economists warn. They may plunge economies into recessions that are deeper than necessary to curb inflation, sending unemployment significantly higher.“The margin of error now is very thin,” said Robin Brooks, chief economist at the Institute of International Finance. “A lot of this comes down to judgment, and how much emphasis to put on the 1970s scenario.”In the 1970s, Fed policymakers did lift interest rates in a bid to control inflation, but they backed off when the economy began to slow. That allowed inflation to remain elevated for years, and when oil prices spiked in 1979, it reached untenable levels. The Fed, under Paul A. Volcker, ultimately raised rates to nearly 20 percent — and sent unemployment soaring to more than 10 percent — in an effort to wrestle the price increases down.That example weighs heavily on policymakers’ minds today.“We think that a failure to restore price stability would mean far greater pain later on,” Mr. Powell said at his news conference on Wednesday, after the Fed raised rates three-quarters of a percentage point for a third straight time. The Fed expects to raise borrowing costs to 4.4 percent next year in the fastest tightening campaign since the 1980s.The Bank of England raised interest rates half a point to 2.25 percent on Thursday, even as it said the United Kingdom might already be in a recession. The European Central Bank is similarly expected to continue raising rates at its meeting in October to combat high inflation, even as Russia’s war in Ukraine throws Europe’s economy into turmoil.As the major monetary authorities lift borrowing costs, their trading partners are following suit, in some cases to avoid big moves in their currencies that could push up local import prices or cause financial instability. On Thursday, Indonesia, Taiwan, the Philippines, South Africa and Norway lifted rates, and a large move by Switzerland’s central bank ended the era of below-zero interest rates in Europe. Japan has comparatively low inflation and is keeping rates low, but it intervened in currency markets for the first time in 24 years on Thursday to prop up the yen in light of all of the action by its counterparts.The wave of central bank action is expected to have consequences, working by design to sharply slow both interconnected commerce and national economies. The Fed, for instance, sees its moves pushing U.S. unemployment to 4.4 percent in 2023, up from the current 3.7 percent.A housing development in Phoenix. Climbing interest rates are already making it more expensive to borrow money to buy a car or purchase a house in many nations.Adriana Zehbrauskas for The New York TimesAlready, the moves are beginning to have an impact. Climbing interest rates are making it more expensive to borrow money to buy a car or a house in many nations. Mortgage rates in the United States are back above 6 percent for the first time since 2008, and the housing market is cooling down. Markets have swooned this year in response to the tough talk coming from central banks, reducing the amount of capital available to big companies and cutting into household wealth.Yet the full effect could take months or even years to be felt.Rates are rising from low levels, and the latest moves have not yet had time to fully play out. In continental Europe and Britain, the war in Ukraine rather than monetary tightening is pushing economies toward recession. And in the United States, where the fallout from the war is far less severe, hiring and the job market remain strong, at least for now. Consumer spending, while slowing, is not plummeting.That is why the Fed believes it has more work to do to slow the economy — even if that increases the risk of a downturn.“We have always understood that restoring price stability while achieving a relatively modest increase in unemployment, and a soft landing, would be very challenging,” Mr. Powell said on Wednesday. “No one knows whether this process will lead to a recession, or if so, how significant that recession would be.”Many global central bankers have painted today’s inflation burst as a situation in which their credibility is on the line.“For the first time in four decades, central banks need to prove how determined they are to protect price stability,” Isabel Schnabel, an executive board member of the European Central Bank, said at a Fed conference in Wyoming last month.A FedEx worker making deliveries in Miami Beach. Consumer spending in the United States, while slowing, is not plummeting.Scott McIntyre for The New York TimesBut that does not mean that the policy path the Fed and its counterparts are carving out is unanimously agreed upon — or unambiguously the correct one. This is not the 1970s, some economists have pointed out. Inflation has not been elevated for as long, supply chains appear to be healing and measures of inflation expectations remain under control.Mr. Brooks at the Institute of International Finance sees the pace of tightening in Europe as a mistake, and thinks that the Fed, too, could overdo it at a time when supply shocks are fading and the full effects of recent policy moves have yet to play out.Maurice Obstfeld, an economist at the Peterson Institute for International Economics and a former chief economist of the International Monetary Fund, wrote in a recent analysis that there is a risk that global central banks are not paying enough attention to one another.“Central banks clearly are scrambling to raise interest rates as inflation runs at levels not seen for nearly two generations,” he wrote. “But there can be too much of a good thing. Now is the time for monetary policymakers to put their heads up and look around.”Still, at many central banks around the world — and clearly at Mr. Powell’s Fed — policymakers are treating it as their duty to remain resolute in the fight against price increases. And that is translating into forceful action now, regardless of the imminent and uncertain costs.Mr. Powell may have once warned that moving quickly in a dark room could end painfully. But now, it’s as if the room is on fire: The threat of a stubbed toe still exists, but moving slowly and cautiously risks even greater peril. More

  • in

    The Fed Intensifies Its Battle Against Inflation

    Federal Reserve officials made another large rate increase and signaled more to come, pledging to quash inflation despite expected pain.The Federal Reserve raised interest rates by three-quarters of a percentage point in an attempt to lower inflation back to 2 percent.Drew Angerer/Getty ImagesFederal Reserve officials, struggling to contain the most rapid inflation in 40 years, delivered a third big rate increase on Wednesday and projected a more aggressive path ahead for monetary policy, one that would lift interest rates higher and keep them elevated longer.The Fed raised its policy interest rate by three-quarters of a percentage point, boosting it to a range of 3 to 3.25 percent. That’s a significant jump from as recently as March, when the federal funds rate was set at near-zero, and the increases since then have made for the Fed’s fastest policy adjustment since the 1980s.Even more notably, policymakers predicted on Wednesday that they would raise borrowing costs to 4.4 percent by the end of the year and forecast markedly higher interest rates in the years to come than they had previously expected. Jerome H. Powell, the Fed chair, warned that those moves would be painful for the U.S. economy — but said curbing growth to contain price increases was essential.“We have got to get inflation behind us,” Mr. Powell said during his post-meeting news conference. “I wish there were a painless way to do that; there isn’t.”Together, the Fed’s stark projections and the Fed chair’s comments amounted to a declaration: The central bank is determined to crush inflation, even if doing so comes at a cost to the economy in the near term. That message got through to markets, which slumped in reaction to the news, with the S&P 500 index closing down 1.7 percent.“We want to act aggressively now, and get this job done, and keep at it until its done,” Mr. Powell explained.His stern remarks reflect a challenging reality for the Fed. Inflation has been stubbornly rapid, and it is proving difficult to wrestle back under control.Prices continue to increase at more than three times the central bank’s target rate of 2 percent, making everyday life hard to afford as everything from rent to food to household goods continues to grow more expensive. The jump in inflation, which is being felt globally, stems partly from supply chain disruptions caused by the pandemic and war in Ukraine. But the price pressures also come from sustained consumer demand, which has allowed companies to charge more without losing customers.In fact, people have continued to buy cars, retail goods and dinners out even as the central bank has begun to sharply raise interest rates. Companies have continued to rake in big profits while hiring at a rapid clip, lifting wages as they compete for scarce workers — and sending prices relentlessly higher.The Fed is trying to change that, a statement the central bank delivered clearly on Wednesday.“It’s consistent with the message that inflation is public enemy No. 1: They have to keep going,” said Priya Misra, head of global rates research at T.D. Securities.What the Fed’s Rate Increases Mean for YouCard 1 of 4A toll on borrowers. More

  • in

    How to Read the Fed’s Projections Like a Pro

    Federal Reserve officials released both an interest-rate decision and a fresh set of economic projections on Wednesday, estimates that Wall Street was keenly awaiting as it tries to understand what the next phase of the central bank’s fight against rapid inflation will look like.Officials raised borrowing costs by three-quarters of a percentage point, their third-straight jumbo increase, taking their official interest rate to a range of 3 to 3.25 percent. But they also penciled in additional increases for the rest of this year and next, projecting that rates would reach 4.4 percent by the end of the year and climb to 4.6 percent by the end of 2023.Here’s how to read the numbers released on Wednesday.The dot plot, decodedWhen the central bank releases its Summary of Economic Projections each quarter, Fed watchers focus obsessively on one part in particular: the so-called dot plot.The dot plot shows the Fed’s 19 policymakers’ estimates for interest rates at the end of 2022, along with the next several years and over the longer run. The forecasts are represented by dots arranged along a vertical scale.What Federal Reserve officials think rates should be in the next two years. More

  • in

    How the Car Market Is Shedding Light on a Key Inflation Question

    How easily companies give up swollen profits could determine how easily the Federal Reserve can cool inflation. Dealerships offer clues.In a recent speech pointedly titled “Bringing Inflation Down,” Lael Brainard, the Federal Reserve’s vice chair, zoomed in on the automobile market as a real-world example of a major uncertainty looming over the outlook for price increases: What will happen next with corporate profits.Many companies have been able to raise prices beyond their own increasing costs over the past two years, swelling their profitability but also exacerbating inflation. That is especially true in the car market. While dealerships are paying manufacturers more for inventory, they have been charging customers even higher prices, sending their profits toward record highs.Dealers could pull that off because demand has been strong and, amid disruptions in the supply of parts, there are too few trucks and sedans to go around. But — in line with its desire for the economy as a whole — the Fed is hoping both sides of that equation could be on the cusp of changing.“With production now increasing, and interest-sensitive demand cooling, there may soon be pressures to reduce vehicle margins and prices in order to move the higher volume of cars being produced off dealer lots,” Ms. Brainard explained during her remarks.The Fed has been raising interest rates to make borrowing for big purchases — cars, houses, business expansions — more expensive. The goal is to cool demand and slow the fastest inflation in four decades. Whether it can pull that off without inflicting serious pain on the economy will hinge partly on how easily companies surrender their hefty profits.If companies begin to lower prices to compete for customers as demand abates, price increases might slow without costing a lot of jobs. But if they try to hold on to big profits, the transition could be bumpier as the Fed is forced to squeeze the economy more drastically and quash demand more severely.“There has been a giant shift in bargaining power between consumers and corporations,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities. “That’s where the next adjustment has to come — corporations have to see some pain.”The example of the auto industry offers reasons for hope but also caution. While there are signs that price increases for used cars are beginning to moderate as supply recovers, that process has been halting, and the new-car market illustrates why the path toward lower profits that help slow inflation could be a long one.That’s because three big forces that are playing out across the broader economy are on particularly clear display in the car market. Supply chains have not completely healed. Demand may be slowing down, but it still has momentum. And companies that have grown used to charging high prices and raking in big profits are proving hesitant to give up.The auto market split into two segments that are now diverging — new cars and used cars.New-car production was upended as the pandemic shut down factories making semiconductors and other parts, and it is only limping back. Freshly minted vehicles remain extraordinarily scarce, according to dealers and data, and several industry experts said they didn’t see a return to normal levels of output for years as supply problems continue. Prices are still increasing swiftly, and dealer profits remain sharply elevated with little sign of cracking.Inflation F.A.Q.Card 1 of 5What is inflation? More