Mohamed A. El-Erian
This article was originally published on blogs.ft.com on May 31, 2011.
As detailed in Tuesday’s FT (“Global economy: A high price to pay”), inflation is the major challenge facing emerging economies as they seek to sustain their growth rates, alleviate poverty, and navigate a complicated global context.
The article correctly points out that today’s inflationary pressures are fuelled by several factors – some domestic (including emerging economies’ success in closing their output gaps after the global financial crisis); others external (including the surge in commodity prices and the excessive liquidity being injected by central banks in advanced countries).
If left unchecked, high and accelerating inflation will have growing adverse economic, social and political effects. In addition to undermining overall growth and resource allocation, it imposes a very heavy burden on the poor and erodes political unity.
Emerging economies have no choice but to react. Indeed, the question is not whether they should counter the inflation threat but how. And this question becomes even more complex if the advanced countries continue to deny ongoing national and global re-alignments (and the evidence is that both Europe and the US are still in denial).
Look for emerging economies to use an unusually broad range of measures. Some will be familiar, such as additional hikes in interest rates and bank reserve requirements. But, as many resist excessive appreciation in their currencies, they will also experiment more with prudential measures aimed at moderating credit creation and slowing capital inflows. And policy makers will have to stay very alert as few of them (and analysts) are sufficiently confident on the kinds of macroeconomic outcomes that such an ad hoc mix of policy may produce, including unintended consequences.
How about the impact on the global economy?
In the old days, emerging economies were deemed “small” in the sense that they had to react to external influences but, in turn, their actions had limited impact on the global economy. This is no longer the case.In countering inflationary pressures, emerging economies will increase the probability of a renewed soft patch for the global economy given that advanced countries are structurally impaired and their policy-induced cyclical recovery is weakening.
The bottom line is threefold: Emerging economies will tap multiple policy brakes as they seek to counter mounting inflationary pressures; they will continue to grow, but not enough to pull up decisively the sluggish advanced countries; and, pending better global coordination that delivers proper structural reforms (in contrast to increasingly uncoordinated and ad hoc actions by individual countries), the global economy will face higher risks, including its old enemy of stagflation.
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