The Fed’s interest rate is over 4%, while it is 3% for the Bank of England and even lower for the ECB. Why is that?
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Central banks have a “dual mandate.” They exist both to promote economic growth as well as to mitigate and manage inflation.
Due to geopolitical tensions, Chinese zero-COVID policies, and some *very* loose money policies beginning in 2008, we’re experiencing very high inflation globally, historically speaking, in most countries. The “cure” for that is to lower the money supply. How?
The Federal Reserve has 2 ways that they’re doing it right now. The first is “quantitative tightening,” a process where they’re taking bonds that they own, and selling them to the open market. What does this do? It takes liquid cash out of circulation (replacing it with less-fungible bonds). This directly lessens the money supply, but at the rates they’re doing it, it isn’t extremely impactful.
The big moves they’re making are the interest rate hikes. Why does this work? In our current global economy, a single dollar can be used multiple times through borrowing, leverage, and other financial machinations. When interest rates are extremely low, the same dollar can be used 9 or 10 times because the number of people/institutions borrowing “cheap money” is very high. When interest rates become higher, people/institutions begin to lessen the amount of debt they carry; they “deleverage.” This makes the number of times that a single dollar is used much less.
Imagine the Fed pumped $9 trillion into the economy through quantitative easing over the last 13 years. (I mean… imagine, because that’s what they did.) Now pair that with a 10x multiplier because of the ultra-low interest rates. That’s $90 *trillion* in liquidity in the markets.
Then, they raise rates (as they have). Just for shits and giggles, let’s say that’s driven the multiplier effect down to 5x. That’s only $45 trillion; through rate hikes, they’ve removed $45 trillion in liquidity.
But here’s the thing: none of this happens in a vacuum. This is all 100% focused on the inflation side of things, what about that pesky economic growth mandate?
Long story short, they didn’t really care about until they broke inflation. There’s a number of reasons, but in the USA, one of those reasons is because the economy is absolutely *on-fire*. I know, the media would have you believe otherwise, but our unemployment is ridiculously low, our spending and consumption is still very high, and hell, we may have even had a rare bout of wage growth somewhere in there, all while many corporations are still reporting record profits. So, the Federal Reserve has had a very strong economic backdrop during this scenario, and they were able to be really, really aggressive with their rate hikes.
Not so much in other places (like England). I’m nowhere near the expert on all things Truss, but suffice it to say they didn’t have the same economic strength the US did at the outset. As such, they have be quite a bit more gentle with their rate hikes. As for the rest of Europe, a large part of their inflationary issues stem from the Russia/Ukraine invasion and sanctions. They’re a lot more tied to the Russian economy than the US is, and so they’re experiencing a bigger supply shortage than the US is (leading to higher prices in the supply/demand scale).
Hope this helps 🙂
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