Published on Monday, May 23, 2022

Spain | Unexpected consequences

The European Central Bank (ECB) is preparing to raise interest rates in a bid to control inflation without triggering a recession. But can it control the consequences of its actions as we move forward?

Key points

  • Key points:
  • The Spanish economy is a net debtor vis-à-vis the rest of the world. The increase in the financial burden will cause particular hardship for young people, those with negative equity and small businesses, which have very few options available for diversifying their sources of financing.
  • The reduction in expenditure will become more significant as the process transfers resources from debtors to creditors. The latter have a lower marginal propensity to spend, ensuring that the net effect on domestic demand takes the form of an adjustment in consumption and investment.
  • However, it is unclear how high the ECB will have to go in raising rates in order to succeed, especially as fiscal policy will continue to be expansionary amid increased utilisation of NextGenerationEU funds.
  • Aside from this inability to exert meaningful influence on many of the factors driving up inflation in this episode, we have the added problem that monetary policy may be less effective in steering the Spanish economy.
  • The ECB has claimed that rate hikes will be moderate, partly in view of the negative impact on economic activity of Russia's invasion of Ukraine and also assuming that businesses and households will keep their inflation expectations anchored given the credibility of the data.

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