Impact of the Pandemic on the World Economy
The Covid-19 pandemic, which started in late 2019 and had an extremely heavy impact as of 2020, has affected the world economy in many ways. Most noticeably, many countries suffered economically due to the decline in global trade. The most affected sectors are:
Tourism
Tourism was among the sectors most affected by Covid-19. Due to the Covid-19 pandemic, travel restrictions were imposed in many countries and borders were closed. In many countries, people could not leave their homes for months. And due to all these developments, there was a serious decline in the accommodation and tourism sectors.
Aviation
The closure of borders and the introduction of travel restrictions have greatly affected the aviation industry. Declining travel demand around the world has led to a sharp drop in airlines' earnings. The infrequent travels and the extra precautions taken have increased the costs significantly.
Logistics
The logistics industry has been hit hard by the closure of borders and the stagnation of global trade during the pandemic. Many logistics companies have declared bankruptcy due to supply chain problems and increased quarantine practices.
Negative Effects of Quantitative Easing
In addition to the sectors mentioned above, different businesses from different sectors had to close or stop their production during the pandemic, which caused unemployment rates to increase. That is why states provided large amounts of fiscal stimulus and loosened their monetary policies to fight against the economic impact of the pandemic. In the process of quantitative easing provided by low interest rates, easy credit accessibility and high money supply relieved financial markets. However, after a while, the negative effects of monetary easing emerged. Inflation figures rose rapidly all over the world. The U.S. and Europe saw the highest inflation figures in years. In June 2022, the inflation rate in the U.S. reached 9.1%, the highest level in the last 41 years. For this reason, countries started to increase interest rates to suppress inflation.
Efforts to Combat Inflation and Results
Countries that saw the highest inflation figures in recent years started to take measures to stop the increase in inflation. Many central banks, especially the Fed, began to increase interest rates. The chart below shows the Fed funds rates. After seeing high inflation figures, the Fed started to increase interest rates and implemented monetary tightening in 2022.
The effects of the monetary tightening approach that emerged with the increase in interest rates began to be felt as of June 2022. The inflation rate in the U.S., which was 9.1% in June 2022, decreased to 5% in approximately 11 months. The chart below shows U.S. inflation rates.
Negative Effects of Monetary Tightening
Every action in the economy has a positive and negative effect. While the decline in inflation figures as a result of the monetary tightening approach is positive, this approach also has negative effects. The slowdown in the economy due to the cost of borrowing, the decrease in consumer spending and the increase in unemployment rates are among the most negative effects. Banks holding old low-interest bonds were also affected by rising interest rates. The high yields of new bonds after the interest rate hikes in the bond market caused the demand for old low-interest bonds to decrease. This causes banks holding a substantial amount of bonds to experience a liquidity crisis due to the low demand. Many banks have faced this situation, including Silicon Valley Bank (SVB).
Will the Fed Change Its Stance on Interest Rates Soon?
Many are worried that the Fed will continue to raise rates in the wake of problems at banks such as SVB, Signature Silvergate, and First Republic Bank. Although the interest rate in the U.S. has declined from 9,1% to 5%, “sticky inflation” is seen in services. The chart below shows that although inflation in “All Items” has decreased, some items such as “Shelter” and “Food Away from Home” have never kept pace with the downward trend in inflation.
“Our banking system is sound and resilient,” Fed Chairman Powell said at a FOMC meeting amid concerns that while bankrupt banks are relatively small, the current situation could trigger a larger banking crisis. Following the Fed's statement, there was a significant decline in the U.S. banks index. When we examine Powell's latest statement, it is clear that the possibility of a slowdown in the Fed interest rate hikes is now quite likely. However, in the event of any deterioration in inflation or failure to reach the desired figures such as unemployment and wage figures, the possibility of the Fed continuing to raise interest rates was emphasized once again at the last meeting. It is also an often-expressed opinion that the Fed will not ignore the problems in the banking sector and will not want to cause a much deeper crisis. Based on this idea, the latest increase may be the final rate hike of the Fed.
