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ECB interest rate hike will have a negative impact on the economy

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When the European Central Bank (ECB) raises interest rates, we have several consequences that can be directly or indirectly related to the region, the first of which is the slowdown of economic activity in the eurozone itself, said Dejan Šoškić, a professor at the Faculty of Economics in Belgrade, as a guest on the Takulin show, author Bojan Vučinić on Gradska RTV.

– The Eurozone, as the core of the EU, is slowly slowing down in its economic activity, and the entire region is largely tied to events in Germany, Austria, and Italy, as important trade and investment partners. Hence, it is possible to expect two unfavorable effects of the slowdown of economic activity in this zone – points out Šoškić.

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One is through the trade channel, and the other, he says, through the investment channel.

Montenegro, as an economy that is predominantly from the domain of services and has large revenues from tourism, will have, Šoškić explains, fewer guests from countries where recession occurs because people will have less money for travel.

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– When there is an increase in interest rates in major currency systems, such as the dollar, the euro and some others, as a rule, regardless of the fact that this measure is adopted to solve the problem of inflation in the eurozone in this case, this measure has collateral damage to the countries in development as a whole that want to enter the international market and borrow in euros. Anyone who wants to borrow in euros will have to pay a higher interest rate for their public debt due to the rise in interest rates dictated by the European Central Bank. This leads to the overstretching of the budgets of the developing countries where we belong – explains Šoškić.

When the ECB raises interest rates, he adds, all countries that will borrow in euros will have higher interest rates, that is, less favorable borrowing conditions.

Finally, the third effect is if there is a theoretical dollarization, and in our case euroization, if you have the largest part of loans – loans with a flexible interest rate are very often based on an interest rate that is generally known and recognized as calculation, which is freely formed on the market, and that is in this case the Euribor, which directly depends on the ECB interest rate.

– When the ECB raises the interest rate, as a rule, it will be reflected in the gradual growth of the Euribor and this will also raise the repayment installments for the citizens and the economy that took out loans with a flexible interest rate linked to the Euribor. There are several consequences, and none of them are favorable – points out Šoškić.

According to him, the current supply inflation is due to the fact that the supply has decreased, because the large supplier is actually excluded from the European and partially from the world market in domains that are imputs for the industry, but at the same time are felt directly on the budgets of the residents.

– If you reduce the offer in the field of energy, food, fertilizers, metals, etc., then you will have a situation where the prices of inputs for your production industry, food, heating, fuel, will increase, which the population will feel. This is immediately reflected in the growth of inflation, and then it causes central bank inflation – says Šoškić.

He adds that central banks, as a rule, have a much greater effect on curbing inflation if it comes from the demand side.

– The connection between wages and inflation is very problematic when it is established, because wages are both what we can spend on the market and input for our employer. Wherever we work, a higher salary will raise production costs and affect the price growth of the company we are engaged in – explains Šoškić.

He points out that there is an effect that occurs on the cost side and on the demand side.

– If everyone expects that there will be inflation in the coming period, they will be interested in raising the prices of their products and services already today, anticipating the need that in the future when they charge for it, they will have enough to charge imputations, which are probably more expensive at that moment – adds Šoškić.

This, he emphasizes, is a typical scenario that leads the European economy into stagflation, because there is an increase in costs due to a lack of supply and at the same time a decline in economic activity.

– Economic activity cannot take place without available energy. What is often lost sight of is that international competitiveness in conditions where the world trade organization rules with its rules is largely determined by how much the economy pays for energy for its production. If an economy decides to pay more expensive energy in the coming period, it is very likely that it will lose competitiveness on the global market compared to those economies that are not in a position to have to pay more expensive energy – says Šoškić.

Stagflation, he clarifies, is an atypical and abnormal relationship on the market for macroeconomics, where there is a simultaneous slowdown in economic activity (stagnation) with rising inflation.

– As a rule, the growth of inflation is a consequence of accelerating economic activity, growth in demand, significantly higher crediting, wage growth, etc. When you fill up the production capacity so that the economy cannot produce additional products and services, then, as a rule, prices rise. And this is where the growth of infection and the decline of economic activity is happening – said Šoškić.

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