For central bankers in rich countries the case in favour of tightening monetary policy sooner rather than later is finely balanced. Wait too long and inflation could get out of hand, go too early and the still-fragile recovery could falter. For emerging markets, on the other hand, the arguments are tilted firmly towards one side.
That is why, on Wednesday, the National Bank of Poland became the latest to join a club of middle-income countries, alongside Hungary, Russia, Mexico, Colombia and Brazil, that have already started to raise rates. The increase was modest, raising rates from 0.1 per cent to 0.5 per cent, but it was a prudent move. Central banks have less breathing room to wait and see whether price rises and supply bottlenecks are temporary.
For a start, inflation has increased even faster in middle-income countries than it has in rich ones. The Polish rate was 5.8 per cent in September — the highest for 20 years. It is closer to double figures in Brazil and in Mexico the core inflation rate accelerated to the fastest rate since 2017 in September. These higher rates of inflation are partly because food accounts for a larger proportion of consumption and therefore inflation baskets than in richer countries. Food prices increased 40 per cent over the previous 15 months according to the UN’s Food and Agriculture Organization, the biggest increase since the Arab Spring in 2011.
The IMF in a chapter of its World Economic Outlook dedicated to inflation, published before the group’s annual meetings next week, forecasts that inflation rates will peak at 6.8 per cent in emerging and developed economies before falling to about 4 per cent next year. In contrast, advanced economies are likely to see more modest inflation: peaking at 3.6 per cent this autumn, before falling to 2 per cent.
While higher interest rates can do little to stop food from getting more expensive, central banks are less trusted in emerging economies and have to work harder to keep expectations of price rises under control. Periods of high inflation are, frequently, not cautionary tales but fresh memories, especially in Latin America. In Turkey, president Recep Tayyip Erdogan advocates the unorthodox view that higher interest rates cause price rises rather than quelling them. He fired the last central bank chief who tried to raise rates. With the central bank undermined and still cutting rates, inflation has reached almost 20 per cent.
It is smart, too, to get ahead of the rich countries. When the Federal Reserve, the US central bank, began tapering its quantitative easing program in 2013, capital rushed out of emerging market economies and exchange rates depreciated. Higher domestic rates protect against such an eventuality. Indeed, the IMF points out that persistently high rates of inflation are associated with fiscal deficits in rich countries. In poorer ones they are similarly correlated with large current account deficits — depreciating currencies raise import costs.
Less space to support economies through fiscal and monetary stimulus is one reason why the economic recoveries in emerging markets and richer countries are likely to diverge further. This is due not only to the uneven rollout of coronavirus vaccines, but also to a slowing China, providing less demand for commodities, as well as a retreat of the globalisation that has lifted millions out of poverty. When officials from the IMF, the World Bank and elsewhere gather in Washington next week, the focus must be on how to deliver a truly global recovery.
Source: Economy - ft.com
