The Reserve Bank of Australia’s decision to raise the cash rate may backfire and cause economic instability
In addition, higher interest rates cannot address supply side factors such as Covid-19, especially China’s dynamic zero approach, as well as geopolitical events, trade restrictions, resource scarcity, climate change and the powerful oligopolies in certain industries with pricing power. They will also not alterHigher interest rates can feed inflation. Businesses, many who have borrowed heavily during the pandemic, will pass on increased expenses to consumers.
Plus, they can have adverse currency effects. With local interest rates lagging in the US, the Australian dollar has declined against the US currency by about 10% since 2021, increasing the cost of imported goods. Higher rates and a devalued currency affect businesses especially those reliant on imported items. In the 1980s, a recession, inflation and high interest rates made manufacturing in the US difficult and drove the exodus of manufacturing to Asia.
Central banks believe that high interest rates slew the early 1980s US inflation monster. While a factor,, particularly deregulation of many industries and weakening of union power. The integration of China, India and eastern Europe and Russia into the global trading system supplied cheap labour and commodities which lowered the cost of goods and services. The low inflation of the last three decades may reflect these one-off factors, many of which are now reversing.
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