According to the National Institute of Economic and Social Research (NIESR), the global economy had the slowest growth in 2023 since the global financial crisis (GFC) of 2008, excluding the COVID-19 pandemic year of 2020. They reported that this was primarily due to the aggressive monetary policy tightening caused by high inflation.
One monetary policy to ease high inflation is increasing interest rates. When central banks increase interest rates, taking out loans becomes costlier. In this environment, both businesses and consumers are likely to reconsider borrowing. This consequently slows down spending, which, in turn, lowers overall demand and hopefully reduces inflation.
How about on a global scale? How will inflation and interest rates affect economies around the world? Let’s check it here:
Reduced Purchasing Power
As inflation rises, the value of money decreases, which means consumers buy less with the same amount of money. This reduction in purchasing power affects household budgets globally, forcing families to cut back on spending and even limit their ability to save and invest. This situation significantly affects many low and middle-income families both in developing and developed countries, which further exacerbates poverty levels and economic inequality.
In response to this financial pressure, many individuals turn to alternative financing, especially to reliable lenders like CreditNinja. These loans can help them cover immediate expenses as their purchasing power dwindles. However, many of these credit products are unsecured. Hence, they often come with high fees and short repayment terms, which, if not managed properly, may worsen their financial difficulties.
To address this challenge, governments and financial institutions (both traditional and alternative) worldwide should promote sustainable financial products and improve access to lower-cost credit options. This will prevent consumers from falling into a debt cycle and allow them to continue spending on goods and services, which will eventually support demand in the economy.
Reduced Savings and Shifting Investments
The reduction in purchasing power not only strains household budgets but also directly impacts savings and investments. As inflation erodes the value of money, savings also lose their purchasing power over time, leaving account holders with less financial security for the future.
This weakened financial resilience may discourage saving. This is particularly true in economies with persistently high inflation rates, as people may feel that holding cash is futile. Instead, they convert savings into hard assets or foreign currencies to preserve value. While these measures benefit them, doing so reduces the effectiveness of traditional savings vehicles, which can have broader implications for both individuals and the economy.
First, individuals may lack liquidity. Compared to hard assets and foreign currencies, cash is still the most accessible resource for emergencies and even day-to-day needs. Second, hard assets and foreign currencies are subject to market volatility. When their value drops, individuals could also face significant financial losses.
Lastly, large withdrawals from savings accounts can destabilize banks and reduce their ability to fund loans. This makes credit more expensive or difficult to obtain, which lowers borrowing rates and, in turn, slows economic growth.
Wage-Price Spiral
The wage-price spiral is a global economic phenomenon that describes a self-reinforcing cycle between rising wages and increasing prices. It starts when inflation causes the costs of commodities and services to rise, resulting in higher living costs. In such cases, workers demand higher wages to maintain their standard of living.
In response to high wage costs, businesses raise the prices of their products and services to offset these increased labor costs. This leads to further inflation, which triggers additional wage demands once more, and the cycle continues. This situation can occur when countries experience inflationary pressures, and its effects can spread across economies, influencing international trade and global markets.
The wage-price spiral is often seen during sustained inflation and can be difficult to break without intervention, such as monetary policies that control inflation by raising interest rates. However, despite such measures, many countries will still fall into it. For example, despite 12 consecutive interest rate hikes, Bank of England Governor Andrew Bailey stated that the UK still experienced a wage-price spiral in 2023 due to persistent inflationary pressures.
Global Spillover Effects
Inflation and interest rate policies in major economies like the United States and the Eurozone can have wide-reaching global ripple effects. For example, when the Federal Reserve increases interest rates to combat inflation in the US, it often leads to a stronger dollar.
A stronger US dollar can hurt several emerging markets by raising the costs of servicing debts often denominated in the currency. Additionally, capital flows may shift and cause capital flight, where investors may seek safer, higher-yielding assets in developed markets. This outflow of capital may weaken the country’s economy by reducing available funds or investments, increasing borrowing costs, and destabilizing financial markets.
Besides capital flight, stronger US dollars may also affect trade and imports, which are typically priced in US dollars on international markets. When the dollar strengthens, importers tend to pay more in local currency, which can lead to higher costs for businesses and consumers, contributing to inflation within the country.
Final Thoughts
Inflation and interest rates are significantly influencing global economies. These factors drive changes in consumer behavior, investment strategies, and financial stability across the world. However, this post only provides a general overview of their impact. For more detailed insights or personalized advice, readers should seek further information or consult financial professionals.
Lynn Martelli is an editor at Readability. She received her MFA in Creative Writing from Antioch University and has worked as an editor for over 10 years. Lynn has edited a wide variety of books, including fiction, non-fiction, memoirs, and more. In her free time, Lynn enjoys reading, writing, and spending time with her family and friends.
