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The Economist: Emerging economies struggle to contain high inflation

In recent months, the world economy has come to resemble a poorly heated dinner in the microwave: generally hot, but some parts barely warm and some too hot. Global consumer prices are likely to rise 4.8% this year, according to the IMF, which would be the fastest rise since 2007.

But price increases in emerging markets are ahead of those in the rich world, and some unfortunate, such as Argentina, Brazil and Turkey they are feeling a particular pain. Their experience helps illustrate how and when inflation can get out of control.

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 2010, as did those in the rich world. The average inflation rate among emerging economies fell from 10.6% in 1995 to 5.4% in 2005 and 2.7% in 2015, thanks to events that boosted efficiency, such as globalization and improved macroeconomic policy making.

The IMF expects consumer prices in emerging economies to rise 5.8% this year, which is not a huge departure from recent trends; Prices rose at a similar rate in 2012, but some economies have deviated well above the average. Inflation stands at 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 and many emerging economies, a jump in prices usually triggers a restrictive response from the central bank. That answer is most powerful when central banks are credible, say because inflation has been low in the past and the fiscal outlook is benign. So, people behave as if a price increase will not last (for example, by moderating wage demands), which reduces inflationary pressure.

This happy state can be altered in several ways. Sometimes compromising central bank independence is enough to raise the temperature. Recep Tayyip ErdoganPresident of Turkey, has declared himself an enemy of interest earnings and has relied on the central bank to reduce its benchmark rate, a step that he says will reduce inflation.

Over the years, Erdogan has fired several central bank officials, most recently three members of the bank’s monetary policy committee in October. Such eccentricities have contributed to capital outflows and the fall of the lira. The sinking currency, by raising the cost of imports, has helped drive inflation by roughly eight percentage points over the past year, at a rate around four times the central bank’s target.

Brazil demonstrates how inflation can spiral out of control despite the best efforts of a central bank, due to fiscal problems. After experiencing hyperinflation in the early 1990s, when the annual inflation rate approached 3,000%, Brazil it was placed on a firmer macroeconomic footing through the adoption of budget reforms and improved central bank independence. But from 2014 to 2016, and again over the past year, the central bank’s ability to fight inflation has been threatened by an erosion of confidence in public finances.

Public spending on Brazil it has skyrocketed since the start of the pandemic. Jair Bolsonaro, the president, plans to extend aid payments despite rising inflation. Concerns about debt sustainability have lowered investor sentiment, leading to lower asset prices and a weaker currency. Despite the boom in foreign demand for exports of raw materials from Brazil, the real has plummeted almost 30% since the beginning of 2020.

Higher 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. However, interest rates may be approaching levels where the additional fiscal cost they impose on the government exacerbates concerns about debt sustainability and further weakens the currency, leaving the central bank at a standstill. The real has fallen nearly 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 again at its next meeting in December.

What if you can’t count on monetary or fiscal policy for economic discipline? Here Argentina provides an illustration. The government has long relied on the printing press to cover budget deficits and has had a particular need for monetary financing since it defaulted on its debt, for the ninth time in its history, in May 2020. For the past two years, the amount of money in circulation has increased at an annual average rate of more than 50%. The peso has fallen more than 60% against the dollar since the beginning of last year.

Argentina, What Brazil, has experienced hyperinflation in recent times. Your financial situation can still be saved. But as policy makers in rich and poor countries face the enormous economic and budgetary costs of COVID-19, some may be tempted to deviate from the rules around monetary and fiscal policy. The result, in some unhappy places, could be inflation too hot to handle.

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