The world is facing the risk that major central banks will undertake competitive interest-rate hikes that may look desirable for their countries individually but could drag the world economy into an unnecessary recession.
Aggressive interest-rate increases designed to combat high inflation at home make sense in isolation. For example, in view of the US Federal Reserve's prolonged underestimation of the persistence of US inflation, Chair Jerome Powell's recent vow to continue hiking rates. Across the Atlantic, the European Central Bank and the Bank of England have also vowed to raise interest rates to deal with the highest inflation seen in decades.
The problem with this approach is that an interest-rate hike by any major central bank has the effect of exporting inflation to other countries, forcing other central banks to raise interest rates more than they otherwise would have done. For example, when the Fed raises its interest rate, if the BOE and the ECB do not respond, the pound and the euro would depreciate against the US dollar, leading to higher import prices and adding to the already high inflation. If the BOE and ECB respond by further raising their interest rates, they export a bit of extra inflation back to the United States and to other economies. The result is an interest-rate spiral that is more damaging to world output and employment than these countries may wish to see collectively.
