The Real Drivers of Inflation

Introduction

The financial world was rocked recently by the collapse of Silicon Valley Bank (SVB), sending shivers through the banking industry. How did a bank with supposedly safe investments go bankrupt so quickly? The answer is rising interest rates, part of the US central bank’s anti-inflation policy. But is this policy a wise one? What are the real drivers of inflation, and are interest rate hikes the solution? Let’s delve deeper.

Rising Interest Rates and Bond Market Collapse

SVB did not invest in high-risk assets but rather in US Treasury bonds. However, the rapid rise of interest rates as part of the US central bank’s anti-inflation policy led to bond markdowns, leaving SVB customers scrambling for cash to restore liquidity. SVB’s emergency also triggered the collapse of Silvergate Bank and Signature Bank, causing contagion fears throughout the banking industry. It’s important to note that this is not just a banking problem but a clear indication that central banks’ monetary policy is flawed.

Flawed Monetary Policy of Central Banks and Labor Market Inflation

Central banks seem determined to raise interest rates weekly in response to the increasing inflation rates. Interest rates have been hiked six times since July 2022. However, European Union inflation remains over three times higher than the European central banking system’s two-per cent target. This begs the question of whether rising interest rates are helping curb inflation at all or exacerbate inflation rates in the labor market. Instead of price controls benefiting labor markets, the principle is “let the workers suffer while I sit on a pile of gold.”

Unemployment Risk and Income Inequalities

While interest rate increases are supposed to keep inflation in check, there’s a risk that rising unemployment rates and falling living standards could be unintended consequences. Despite the reported skilled labor shortages, interest rate hikes could lead to medium-term unemployment risks. Furthermore, these hikes will only intensify income inequalities, where workers again bear the brunt.

Related Facts

• The collapse of SGV was caused by the markdowns in US Treasury Bonds due to rising interest rates driven by the US Federal Reserve’s anti-inflationary policy.
• Interest rate hikes have been the monetary policy response of central banks worldwide, including the European Central Bank and the Bank of England, which have raised interest rates in recent months to curb inflation.
• Central banks appear to believe that deviating from their current path of raising interest rates could signal their concerns about their respective banking systems—resulting in the need to reassure markets that banks are robust.

Key Takeaway

Interest rate hikes may lead to falling value in the bond market, causing unintended consequences such as rising unemployment and income inequalities.

Conclusion

The collapse of SVB is a stark reminder that there are flaws in the current monetary policies, particularly with interest rate hikes. With rampant labor market inflation, policymakers must reevaluate their policies and ensure that workers are not left to suffer. The economy should be a means to serve everyone, not just a few, and it’s about time we prioritize people’s welfare over strategic policies.