IN LAST MONTHS the global economy ended up looking like an undercooked microwave dinner: usually hot, but with a few bits just lukewarm and others positively scorching. Global consumer prices are expected to rise 4.8% this year, according to the IMF, which is said to be the fastest rise since 2007. But price increases in emerging markets outstrip those in the rich world, and a poor few, such as Argentina, Brazil and Turkey, are suffering particularly. Their experience helps illustrate how and when inflation can get out of hand.
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Although inflation rates in emerging markets tend to be higher and more volatile than those in advanced economies, they generally declined between the 1970s and 2010s, as did those in the rich world. The median inflation rate among emerging economies fell from 10.6% in 1995 to 5.4% in 2005 and 2.7% in 2015, thanks to efficiency-promoting developments such as globalization and improved macroeconomic policy making. The IMF expects consumer prices in emerging economies to increase 5.8% this year, which is not much different from recent trends; prices have increased at a similar rate as recently as 2012. But some economies have moved far above average. Inflation is 10.2% in Brazil, 19.9% in Turkey and 52.5% in Argentina.
Such high inflation reflects more than soaring food and energy prices. In advanced economies and many emerging countries, a rise in prices usually triggers a restrictive central bank response. This response is more powerful when central banks are credible, for example because inflation has been low in the past and the fiscal situation is favorable. Then people behave as if a price spike won’t last, by moderating wage demands, for example, which reduces inflationary pressures.
This happy state can be disturbed in several ways. Sometimes it is enough to compromise the independence of the central bank to raise the temperature. Turkey’s President Recep Tayyip Erdogan has declared himself an enemy of interest income and relied on the central bank to cut its key rate, a move he says will reduce inflation. Over the years, he sacked a number of central bank officials, most recently three members of the bank’s monetary policy committee in October. These antics contributed to capital outflows and a fall in the pound (see chart). The fall in the currency, by increasing the cost of imports, has helped push inflation up by about eight percentage points over the past year, to a rate about four times the bank’s target. central.
Brazil shows how inflation can get out of hand despite the best efforts of a central bank, due to fiscal issues. After experiencing hyperinflation in the early 1990s, when the annual inflation rate approached 3,000%, Brazil has strengthened macroeconomically by adopting fiscal reforms and strengthening the independence of the central bank. But from 2014 to 2016, and again in the past year, the central bank’s ability to fight inflation was threatened by an erosion of confidence in public finances.
Public spending in Brazil has increased since the start of the pandemic. Jair Bolsonaro, the president, plans to expand relief payments despite skyrocketing inflation. Concerns about debt sustainability have reduced investor confidence, leading to lower asset prices and a weaker currency. Despite surging foreign demand for Brazil’s commodity exports, the real has fallen nearly 30% since the start of 2020.
Rising import prices have contributed to stubbornly high inflation, forcing the central bank to raise its benchmark interest rate by nearly six percentage points since March. Yet interest rates may approach levels at which the additional fiscal cost they impose on the government exacerbates concerns about debt sustainability and further weakens the currency, leaving the central bank in a dead end. The real has fallen almost 2.5% since the end of October alone, after the central bank raised interest rates by 1.5 percentage points and promised to do the same at its next meeting in December.
What happens if neither monetary nor fiscal policy can rely on economic discipline? Argentina provides an illustration here. The government has long relied on the printing press to cover budget deficits, and has been in particular need of monetary financing since its debt defaulted, for the ninth time in its history, in May 2020. Over the past two years, the amount of money in circulation has grown at an average annual rate of over 50%. The peso has lost more than 60% against the dollar since the start of last year.
Argentina, like Brazil, has experienced hyperinflation lately. His economic situation may still be saved. But as policymakers in rich and poor countries alike face the enormous economic and fiscal costs of covid-19, some may be tempted to deviate from monetary and fiscal policy norms. The result, in some unfortunate places, could be inflation too hot to handle. ■
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This article appeared in the Finance and Economics section of the print edition under the title “Living the High Life”