The feared rise in interest rates It should not take longer than necessary. That is the reassuring message of the International Monetary Fund (IMF) which provides for the return to pre-pandemic interest rates after controlling for inflation. The forecast can calm the alarm situation in the real estate market, which fears a deep crisis of activity in Spain, and enhances the discussion on the economic policies to be faced in the current moments of financial uncertainty. Specifically, the IMF considers that real interest rates, discounting inflation from the nominal rate, will return to the pre-pandemic level once inflation has been brought under control. The unknown that is impossible to decipher is the period in which this price control will be achieved.
The institution considers it probable that the recent increases in real interest rates “are temporary” and anticipates that, when inflation is no longer a threat, the central banks of advanced economies “will ease the monetary politics” and bring real interest rates to pre-pandemic levels. Markus Brunnermeier, Edward S. Sanford Professor of Economics, at Princeton University, points out on the IMF website that given the current situation of the economy banks must adapt their strategies and “change their approach” and “maintain their independence only if they promise not to give in to any desire of governments to monetize excess debt, which would then force authorities to cut spending or raise taxes, or both, that is to say, to apply fiscal consolidation measures”.
In the case of the large emerging economies, conservative projections of future demographic and productivity trends suggest a gradual convergence towards real interest rates in advanced economies. In this sense, the IMF warns that the adjustment towards pre-pandemic levels will depend on whether alternative scenarios that imply persistently higher debt and public deficit or financial fragmentation materialize. For the Fund this means that the problems associated with the “effective lower bound” of interest rates and “long low (interest rates)” are likely to reappear. “Unconventional policies through active management of central bank balance sheets and forward orientation can become standard stabilization tools, even in emerging markets,” the IMF notes. An international risk is that the current global economic situation also points to an increasing fragmentation of foreign direct investment. Capital flows are increasingly concentrated in geopolitically strategic countries. As a result, several emerging market and developing countries are highly vulnerable to relocation and the differences between countries may increase in the coming years.
Towards the natural rate of interest
The natural interest rate—the real interest rate that neither stimulates nor contracts the economy—is important for both monetary and fiscal policy; it is the reference level for gauging the stance of monetary policy and a key determinant of public debt sustainability. IMF analysis indicates that once the current inflation episode has passed, interest rates are likely to return to pre-pandemic levels in advanced economies. How close interest rates get to those levels will depend on whether the alternative scenarios, with persistently higher public debt and deficits or financial fragmentation, materialize.
For the financial organization debates on the “appropriate level of inflation targeting” they may also resurface among economists as countries weigh the social cost of higher inflation against the constraints of ineffective stabilization by the effective lower bound. On the other hand, permanently lower real interest rates also increase fiscal space and allow fiscal authorities to take a more active role in stabilizing the economy, provided fiscal sustainability is ensured. In this case, it is crucial for the institution to clarify the scope and responsibilities of the fiscal and monetary authorities to avoid long-term damage to the credibility of central banks. On this issue, the IMF pointed out last week that the design of fiscal policy by governments can help central banks in their fight against inflation and, therefore, limit the need to raise interest rates, while the most vulnerable groups are better protected. “When central banks act alone, without the support of fiscal policy, they need to substantially increase interest rates to combat inflation,” the director of the IMF’s Fiscal Affairs Department, Vitor Gaspar, pointed out in an article, pointing out that the adjustment tax “allows interest rates to be increased less to contain inflation,” reports Europa Press.
The IMF argues that while monetary policy “is in the driver’s seat in the battle against inflation,” fiscal policy can help design a well-targeted fiscal adjustment to support the central bank in its pursuit of stability. of prices, while protecting the vulnerable from the crisis due to the increase in the cost of living.