J. Soedradjad Djiwandono: Recent Fed Rate Increases and Their Implications

Recent Fed Rate Increases and Their Implications

By: Prof. J. Soedradjad Djiwandono, Ph.D., Emeritus Professor of Economics, Faculty of Economics and Business, Universitas Indonesia, and Adjunct Professor of International Economics, S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University (NTU), Singapore

 

Recent Development

Independent Observer – (13–19/5/2022) Lately there have been discussions as to whether the Russian invasion of Ukraine, followed by the launch of economic sanctions against Russia and its allies by the USA would inadvertently result in the decline of the USD as a trusted international reserve currency and universally-accepted means of international payment. This followed countries being confronted by a Russian ultimatum to receive payment for its exports of oil and gas in gold-backed roubles, forsaking the United States Dollar, a fiat currency which western European countries have been continuously relying on up until the present.

Monetary experts such as Professor Barry Eichengreen of the University of California, Berkeley, along with others in recent commentaries are generally in agreement that, even if this is going to happen, the process will be gradual and will only manifest over time. It will be an evolution, not a revolution. One of the obvious reasons mentioned was that at present there is really no workable alternative to replace the role of the USD, the dominant currency commonly-accepted globally as a means of payment and investment financing, since the end of WWII.

In recent history, the world witnessed a major shift from the British Pound Sterling to a USD-based system of international payments, actually in motion from the end of WWI to maturation in WWII. The Bretton Woods Agreement of 1944 also gave birth to two sister institutions, the World Bank and the International Monetary Fund. It was even called the “Bretton Woods system of payments”. This was not an abrupt change, as clearly seen from the start. Thus, the world will still be obliged to rely on the USD as an acceptable international reserve holding and means of payments, possibly for quite some time. Some might propose the Euro or Renminbi, but in fact neither are ready yet.

Another issue is the Federal Reserve decision to raise the target for the Fed funds rate by half a point, to 0.75%- 1%, a move taken in the most recent Board meeting. This was the second consecutive rate hike, and the biggest rise in borrowing cost since 2000, and was obviously aimed to calm the rate of inflation. What is not clear is whether or when it will achieve this stated objective. Would another interest increase be needed to do the job? For sure, the Fed must be watchful of increasing expenditures by the Biden Administration, both for financing domestic expenditures and the Ukraine war, with money for weaponry and humanitarian aid.

Further Development

For certain, increasing government expenditures do not just apply to the US, but to other developed economies, particularly US allies. This can only put further pressure on prices to rise, in other words, to stoke the inflation rate upward.

But a more pressing worry must be felt by developing economies, those that already carry a heavy national debt burden in USD. And for sure, for the least-developed economies, the burden would even be more dire, crushing economic growth and fuller employment.

And The Implication For Indonesia?

As this news journal has carried warnings before about the peril of national debt, Indonesia has been accumulating significant volumes of debt in USD in recent years. In this development we suffer a double blow, from strengthening of the USD to the increase in cost of borrowing. With a very low tax ratio (the ratio between tax revenues and GDP of 9%) this is nothing to be proud of, is it?

I do not question the need for foreign borrowing nor its utilization. However, maybe we all still remember how a few years ago people were urged to declare their assets squirreled away in foreign countries. Would it not only be natural if the government now forced them to pay their income taxes accordingly?

 

Source: Independent Observer. Edition: May, 13-19, 2022. Rubric Opinion. Page 6.