Could the interest rate hikes do more harm than good?
increasing with the overnight rate, fears of a recession are mounting. There are two big questions. First, are there alternatives to the blunt overnight rate for fighting inflation? Second, how bad will the recession need to be to bring inflation back down? Unfortunately, the answer to the first question is no, there aren’t any viable alternatives. However, the recession that could result might not be as bad as feared.
Is the trade-off of a possible recession worth it to bring inflation back down? Most economists subscribe to the idea that as unemployment falls, economic growth picks up until a level where demand starts to exceed supply, causing higher inflation . The thinking then goes that to tame inflation, we need to bring economic growth to heel, which causes unemployment to go up.
The problem with this analysis is that when the central bank is doing a good job of keeping inflation close to the 2 per cent target – as it has largely done since 1995 – future inflation is unrelated to current economic conditions. But when inflation is out of its ideal range, as was the case during the Great Recession, and is the case today, a more standard relationship between inflation and the state of the economy returns.
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