Yellen warns of acute ‘spillover’ effects of interest rate hikes on developing countries

Treasury Secretary Janet Yellen on Thursday acknowledged the negative effects that continued interest rate hikes by the U.S. Federal Reserve and other central banks are having outside U.S. borders.

“For major economies facing high inflation, the immediate task is to return to an environment of stable prices. Central banks bear the prime responsibility. But it is important to recognize that macroeconomic tightening in advanced countries can have international spillovers,” Yellen said at an event Thursday at the Center for Global Development.

“Emerging markets and developing countries are often most acutely affected both by global shocks and by spillovers from the policies of advanced countries,” she said.

Her remarks come after a highly critical report from a United Nations economic body earlier in the week that urged against continued rate hikes that spelled trouble for the global economy.

The body said banks like the Fed should “revert course.”

Moreover, the report found that Fed rate hikes could be altogether ineffective against the specific type of inflation that global markets are now experiencing. Price increases were initially driven by excess demand and supply chain disruptions rather than a wage-price spiral.

“Continued monetary tightening — through rising central bank rates and the normalization of their balance sheets — will have little direct impact on the supply sources of inflation and will instead work indirectly to re-anchor inflationary expectations by further reducing investment demand and pre-empting any incipient labor market pressures,” the report from the United Nations Conference on Trade and Development (UNCTAD) found.

The comments from Yellen also come after the International Monetary Fund (IMF) on Thursday warned of a “darkening global outlook,” and other voices in the global economy have also expressed displeasure with the Fed’s rate hikes. 

OPEC+ announced a production cut of 2 million barrels of oil per day — much to the consternation of the Biden administration — as Saudi Arabia’s energy minister, Prince Abdulaziz bin Salman, pointed his finger in the direction of the Federal Reserve.

“With this severity that you see, you run a big risk that you lose growth,” he said. “Growth is coming down and there is a potential with more aggressive rate hikes that this growth will come even lower.”

The UNCTAD also warned that further rate hikes and the selling of central bank assets could lead to loan defaults and bankruptcies.

“Given the high leverage of non-financial businesses, rising borrowing costs could cause a steep increase in non-performing loans and trigger a cascade of bankruptcies. With direct price and markup controls ruled out as politically unacceptable, and if monetary authorities are unable to stabilize inflation quickly, governments might resort to additional fiscal tightening. This would only help precipitate a sharper global recession,” economists for the UNCTAD wrote.

Yellen sounded many of the same notes in her own speech, arguing that financial pressures stemming from higher interest rates can worsen debt vulnerabilities.

“Some countries will need considerable debt relief,” she said. “It will be crucial for all the world’s major bilateral creditors to meaningfully participate in debt relief so that lower- and middle-income countries can regain their footing after these years of extreme stress.”

These calls to action could be realized in part at next week’s meeting of the IMF and World Bank, which announced back in April a 15-month crisis response financing package of $170 billion to help countries address a range of crises.

Yellen also stressed a need to be “clear-eyed” about how much more lending can be done with current balance sheets.

Washington insider and former Democratic Treasury Secretary Larry Summers said in a Washington Post editorial on Wednesday that large creditor countries in the Group of 20 should suspend debt service for the poorest countries while making sure many countries “restructure their debt.”

He also argued for an “expanded role for the World Bank” that would “mean far more lending and advising.”

While Summers has consistently argued for rate hikes by the Fed, some commentators have criticized his advocacy, saying it’s too domestically focused.

“The world is going to hell in a handbasket, and we’re bitching about core inflation in the US running a few percentage points above target. Come on. Fed’s credibility is not more important than humanity,” former Federal Reserve banker Claudia Sahm wrote on Twitter in September.

“I am very concerned about how the macro policy conversation in the US is largely ignoring the global economic and geopolitical situation. They think they can forecast a US recession 2 years out but can’t see a global one in front of us,” she wrote.