Japan's Deputy Prime Minister and Finance Minister Taro Aso, left, Britain's Chancellor of the Exchequer Philip Hammond, Zambia's Minister of Finance Margaret Mwanakatwe and Brazil's Finance Minister Eduardo Guardia participate in the International Monetary Fund Governors family photo during the IMF/World Bank spring meeting in Washington, U.S., April 21, 2018.Yuri Gripas/Reuters
Todd Hirsch was the Calgary-based chief economist of ATB Financial and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.
It seemed inevitable. The fifty basis point rate hike today by the Bank of Canada might have surprised those who expected a larger increase. Still, it has a lot of people perplexed. Some are even angry.
The reason why Canada’s central bank is so keen to raise rates has been talked about for months. The increases this year have been a strident effort to cool the economy and tame inflation. There’s nothing new to say about that.
There’s also been a lot of chatter about whether the Bank of Canada’s decisions will push the economy into a mild recession. And the answer to that question is: probably. It’s a risk that the Bank is prepared to take.
What hasn’t been talked about as much, however, is what impact the unco-ordinated and simultaneous rate hikes by central banks around the world could have on global financial and currency markets.
The rate increase announced today by the Bank of Canada was intended to cool the Canadian economy. In the same way, rate announcements by the U.S. Federal Reserve targets the American economy, the Bank of England targets the British economy, and so on.
Yet, in a tightly knit global financial system, what might be the impact of all of these central banks slamming on their monetary brakes at the same time? Could there be a negative feedback loop at work, with well-intended monetary policy actions having unintended impacts on a larger scale?
The World Bank is one group sounding the alarm.
“The simultaneous tightening of monetary and fiscal policies across the world will likely prove complementary in reducing inflation. However, since they are highly synchronous across countries, they could be mutually compounding, and produce cumulative effects that are larger than envisioned – both in tightening financial conditions and in steepening the global growth slowdown,” writes the authors in the conclusion of a September, 2022, report titled Is a Global Recession Imminent?
Think of global financial markets like a container of water. If you were asked to carry a half-full pail of water across a room, you’d easily do so without spilling a drop.
But pour that pail of water onto a cookie sheet, and now carrying the water across the room becomes nearly impossible. It’s because of the shallowness of the water. Once it starts to move and shift, it picks up momentum and there is very little to keep it from sloshing over the sides.
The global financial markets can act like a cookie sheet full of water. Currency crises in the 1980s and 1990s, throughout Latin America and Asian economies particularly, were triggered when borrowing costs rose steeply and forced a rapid outflow of capital from developing economies and into the U.S. dollar. Currencies were battered and bruised, setting back growth and wreaking havoc on financial markets around the world.
Financial crises, like the mortgage-induced one in 2008, are unpredictable. If we were able to predict them, they wouldn’t happen. Looking back on it, all of the ingredients of a crisis were present: an over-leveraged market, reckless lending and questionable practices within the shadow banking system. And when the trigger was pulled, the entire global economy was flung into panic.
In the wake of every financial crisis, the refrain rings out: we should have seen this coming!
The Bank of Canada did the right thing today. It’s unpleasant, like ripping off the bandage all at once. Forceful efforts to douse an overheated economy are already having an effect. Inflation will be brought to its knees eventually.
But are the ingredients of the next global financial crisis right before our eyes? Will we once again be surprised that we didn’t see it coming? When all central banks are taking such aggressive actions simultaneously, what triggers might we be pulling?
The thought of these cumulative and concurrent rate hikes having an impact larger than envisioned by central bankers should have our attention. What is expected to be a mild and short recession in Canada may be pre-empted by a larger, more global and more damaging financial crisis.
Fasten your seat belts!
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