Macroscope | Central banks’ anti-inflation missiles make a global debt crisis seem inevitable

The roots of the crisis go deeper than the financial shocks produced by Covid-19, the Ukraine war, inflation and rising interest rates

Advanced economies, whose banks are significantly exposed to emerging markets, cannot shrug off the impending distress

Reading Time:3 minutes

A customer pays for fruit at a market in London on July 20. With UK inflation hitting a 40-year high, the Bank of England raised interest rates. Photo: EPA-EFE

Published: 3:30am, 22 Aug 2022

Picture a situation in which one country is firing missiles at another in rapid succession and then lowers its firing rate a little, whereupon the attacked country feels relief that the situation is easing even though missiles already in-flight are about to rain down destruction.

This is one way of analogising what is happening now in the global economy as what economists refer to as the “lagged effects” of tighter monetary policy threaten to produce not only a global economic recession but also a new international debt crisis.

This is a clear danger as anti-inflation missiles launched by the US Federal Reserve, the Bank of England, the European Central Bank and others in the form of interest rate rises cruise toward their targets. Yet, financial markets do not appear to have an eye on the sky.

Even if they did, there is little they could do. There is an awful sense of inevitability about the advancing debt crisis, and its roots go deeper than the series of financial shocks produced by Covid-19, the Ukraine war, inflation and rising interest rates.

The new shock is likely to be sudden and painful, and it is by no means impossible that a series of systemic crises could appear as lenders (chiefly, but not exclusively, banks) and borrowers (governments, corporations and households) all run into serious debt distress.

Interest rates are set to continue rising this year and probably beyond, whatever happens to inflation. So, debt service costs will bite even harder. The lagged impact of monetary tightening will become a whiplash effect with a sting in the tail.

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.css-1m2rp1p{color:#34b8b5;}Macroscope | Central banks’ anti-inflation missiles make a global debt crisis seem inevitable

Macroscope | Central banks’ anti-inflation missiles make a global debt crisis seem inevitable