'Without modification, Western economic policy is heading for a head-on collision'

‘Without modification, Western economic policy is heading for a head-on collision’

Governments cannot continue to accumulate budget deficits and debt at a time when inflation is rising and central banks are raising policy rates sharply, says Trends chief economist Daan Killemaes.

Without adjustment, Western economic policy is headed toward a head-on collision. Fiscal policy remains largely expansionary, while monetary policy has become more restrictive. These options do not match. Governments cannot continue to accumulate budget deficits and debt at a time when inflation is rising and central banks are raising key interest rates sharply. In the long term, higher interest rates threaten to jeopardize the sustainability of public finances. A direct clash between spending politicians and wary central bankers is inevitable.

Without adjustment, Western economic policy is headed toward a head-on collision.

In the UK, Prime Minister Liz Truss’ government has already collapsed. Absurd budget plans proved incompatible with the financial environment. Truss amended plans, but the credibility of her government is as good as … Total Bertie. In Belgium too, fiscal policy is on the wrong track with regard to the ECB’s policy choices. The De Croo government doesn’t seem to realize that the negative interest rate free lunch has run out. High long-term interest rates have become a millstone around the neck of government finances.

The collapse could be avoided if the central banks also made some adjustments. In the UK, the Bank of England intervened to prevent an excessive rise in long-term interest rates. The harsh reality is that most Western governments cannot handle long and sharp interest rate hikes. So central bankers cannot simply lead the way in the fight against high inflation. They will also make adjustments at some point, with the result that inflation does not return to 2 percent anytime soon.

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Without adjustment, Western economic policy is headed toward a head-on collision. Fiscal policy remains largely expansionary, while monetary policy has become more restrictive. These options do not match. Governments cannot continue to accumulate budget deficits and debt at a time when inflation is rising and central banks are raising key interest rates sharply. In the long term, higher interest rates threaten to jeopardize the sustainability of public finances. A direct clash between spending politicians and wary central bankers is inevitable. In the UK, Prime Minister Liz Truss’ government has already collapsed. Absurd budget plans proved incompatible with the financial environment. Truss amended the plans, but the credibility of her government is almost complete. In Belgium too, fiscal policy is on the wrong track with regard to the ECB’s policy choices. The De Croo government doesn’t seem to realize that the negative interest rate free lunch has run out. High long-term interest rates have become a millstone around the neck of government finances. The collapse could be avoided if the central banks also made some adjustments. In the UK, the Bank of England intervened to prevent an excessive rise in long-term interest rates. The harsh truth is that most Western governments cannot handle long and sharp interest rate hikes. So central bankers cannot simply lead the way in the fight against high inflation. They will also make adjustments at some point, with the result that inflation does not return to 2 percent anytime soon.

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