Herrera warns interest rate hikes will slow economies already struggling with inflation

Arturo Herrera sat down in the library of Mexico's Colegio de México, surrounded by shelves of poetry and literature, less than two months before leaving for Washington to take up his new role as the World Bank's global director of governance. The 56-year-old economist from Hidalgo had just been officially named to the position on a Friday—the culmination of a months-long selection process that had winnowed hundreds of candidates down to five, then to him. It was a vindication of sorts. Seven months earlier, in November 2021, President Andrés Manuel López Obrador had asked him to step down from his post as finance secretary to become governor of Mexico's central bank, then abruptly reversed course, leaving Herrera in professional limbo. Now, with the World Bank appointment, that chapter had closed.

He arrived at the interview as Mexico and the world grappled with an inflation rate that had already exceeded 7.6 percent annually. Central banks everywhere were watching anxiously—the pandemic still disrupting supply chains, geopolitical tensions sharpening, and monetary conditions tightening. Herrera's new mandate was to strengthen public institutions in the world's most vulnerable countries: Chad, South Sudan, Afghanistan, Azerbaijan, and others. But the conversation kept returning to a single, urgent question: Could interest rate increases actually solve the inflation crisis without strangling economies that had not yet fully recovered?

Herrera's answer was nuanced and sobering. He laid out three parallel causes of current inflation, each operating independently. First, the pandemic: microchip shortages had driven up car prices; supply chain fractures were still reverberating through global markets. Second, Russia's invasion of Ukraine had disrupted supplies of oil, gas, and wheat—two countries that were major producers of all three. Neither of these could be solved by raising interest rates. The third cause was purely economic: the United States, responding to the pandemic, had unleashed enormous monetary and fiscal stimulus. That had worked—unemployment had fallen to its lowest level since the Korean War—but it had also overheated the American economy. Raising rates was the tool to cool it down.

The problem, Herrera explained, was that the United States did not exist in isolation. When the world's largest economy tightens monetary policy, the effects ripple outward. Other countries were not overheated. Mexico, for instance, had recovered nearly all the jobs lost during the pandemic, yet 800,000 new people entered the economically active population each year. Those workers needed employment. If interest rates rose too aggressively while recovery was still incomplete, the result would be a sudden stop—the economy grinding to a halt just as it was finding its footing again. This was the risk that Agustín Carstens, head of the Bank for International Settlements, had warned against. Herrera agreed with the concern.

When pressed on whether Mexico specifically faced this danger, Herrera did not hedge. Every country faced it, he said. The United States was attempting what economists called a soft landing—slowing growth without triggering recession. But Mexico was not even at that stage. The country was simply trying to avoid derailing its recovery altogether. And yet, he acknowledged, the risk was real. Every time interest rates went up, the economy slowed. Mexico's central bank, he noted, had a single legal mandate: controlling inflation. It did not have the flexibility to weigh employment or growth.

On the López Obrador administration's recently announced anti-inflation plan, Herrera offered cautious support. Removing tariffs on basic goods would have an immediate effect, he said, since tariffs were embedded in prices. The strategy of targeting items in the basic basket made sense—inflation hurt the poorest hardest—but the basket represented only a subset of all goods that fed into the overall price index. The program might ease suffering among the most vulnerable, but its impact on the broader inflation measure would be modest.

When asked when inflation might ease in Mexico, Herrera shifted focus to expectations. The real question was not whether inflation was high today, but whether it would stay high tomorrow. Inflation expectations—what people believed prices would do in two or three years—seemed anchored at relatively low levels. That suggested markets believed the pandemic's distortions would fade, microchip shortages would resolve, and perhaps even Ukraine would stabilize. But that last assumption was geopolitical, not economic. It made the current moment extraordinarily complex.

Yet Herrera saw possibility in the crisis. Mexico was navigating the downturn with stable macroeconomic fundamentals, manageable debt, well-capitalized banks, and the world's most important trading partner on its border. The global upheaval was forcing a fundamental rethinking of where production happened. Mexico had advantages: proximity to the United States, a freshly renewed free trade agreement, and the distinction of being the only emerging economy in the North American trade bloc. It would not provide cutting-edge technology, but it could offer workers willing to labor at lower relative cost. That positioning, Herrera suggested, might prove decisive in the years ahead.