Warning stories from emerging markets with high inflation

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IN LAST MONTHS the global economy now resembles a poorly prepared dinner: generally hot, but with some pieces just lukewarm and others downright scorching. Global consumer prices are likely to rise 4.8% this year, according to the IMFwhich would be the fastest increase since 2007. But price increases in emerging markets are ahead of those in the rich world, and some unfortunate people like Argentina, Brazil and Turkey are particularly hard hit. Your experience helps illustrate how and when inflation can get out of hand.

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Although inflation rates tend to be higher and more volatile in emerging markets than in advanced economies, they generally declined between the 1970s and 2010s, similar to what happened in the rich world. The average inflation rate in emerging markets fell from 10.6% in 1995 to 5.4% in 2005 and 2.7% in 2015 thanks to efficiency-enhancing developments such as globalization and improved macroeconomic policies. the IMF expects consumer prices in emerging markets to rise 5.8% this year, which is not a huge departure from recent trends; Prices rose at a similar pace in 2012. However, some economies have developed well above average. Inflation is 10.2% in Brazil, 19.9% ​​in Turkey and 52.5% in Argentina.

This high inflation reflects more than rising food and energy prices. In advanced economies and many emerging markets, a jump in prices usually triggers a cautious response from the central bank. This reaction is stronger if the central banks are credible, for example because inflation has been low in the past and the financial situation is favorable. Then people behave as if a price hike is not permanent – for example, by moderating wage demands – which reduces inflationary pressures.

This happy state can be disturbed in a number of ways. Sometimes it is enough to compromise the independence of the central bank to raise the temperature. Turkish President Recep Tayyip Erdogan has declared himself the enemy of interest income and has relied on the central bank to cut interest rates, a move he believes will lower inflation. He has fired a number of central bank officials over the years, most recently three members of the bank’s monetary policy committee in October. Such antics have contributed to capital outflows and a falling lira (see chart). The falling currency, by increasing import costs, has helped drive inflation about eight percentage points last year to a rate about four times the central bank’s target.

Brazil shows how, despite a central bank’s best efforts, inflation can get out of hand due to fiscal problems. After hyperinflation in the early 1990s, when the annual inflation rate approached 3,000%, Brazil has put itself on a more solid macroeconomic footing by adopting budget reforms and strengthening the independence of the central bank. But from 2014 to 2016, and also last year, the central bank’s ability to fight inflation was jeopardized by a loss of confidence in public finances.

Government spending in Brazil has risen sharply since the pandemic began. President Jair Bolsonaro wants to extend aid payments despite stormy inflation. Debt sustainability concerns have eroded investor confidence, leading to falling asset prices and a weaker currency. Despite booming foreign demand for Brazil’s raw material exports, the real has fallen by almost 30% since the beginning of 2020.

Higher import prices have contributed to persistently high inflation, forcing the central bank to raise its key interest rate by almost six percentage points since March. Still, interest rates could be nearing levels where the additional fiscal costs they are placing on the government exacerbate debt sustainability concerns and weaken the currency further, putting the central bank in a no-win situation. Since the end of October alone, the real has fallen by almost 2.5% – after the central bank hiked interest rates by a whopping 1.5 percentage points and promised to do so again at its next meeting in December.

What happens if neither monetary nor fiscal policy can be counted on in economic discipline? Argentina provides an example here. The government has long relied on the printing press to cover budget deficits and, for the ninth time in its history, in May 2020, has had to finance its debts primarily through monetary funding. Over the past two years, the money supply has increased by more than 50% on an annual average. The peso has fallen over 60% against the dollar since early last year.

Argentina, like Brazil, has seen hyperinflation recently. Its economic situation can still be saved. But as policymakers in rich and poor countries alike face the enormous economic and budgetary costs of Covid-19, some may be tempted to deviate from the norms of monetary and fiscal policy. The result, in some unfortunate places, could be inflation too hot to handle.

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This article appeared in the Finance & Economics section of the print edition under the heading “Living the high life”


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