SYDNEY and KUALA LUMPUR, 8 March (IPS) – All developing countries have been persuaded or forced to prioritize Inflation target (IT) in their monetary policy. In doing so, they have tied their own hands instead of adopting bolder economic policies for growth, jobs and sustainable development.
Developing economies initially adopted post-crisis IT to obtain financial support from the International Monetary Fund (IMF), for example after the 1997-98 Asian financial crisis. Since the mid-1970s, many have borrowed money to accelerate growth. After the US Fed raised interest rates sharply in 1980, many people were unable to withstand the debt crisis.
The IMF insists on strict short-term stabilization policies to keep inflation and debt low. The World Bank has supplemented it with medium-term structural adjustment policies that require market liberalization and other reforms.
Price stabilization to keep inflation low has been an IMF priority ever since. But instead of accelerating growth as promised, IT actually slowed it down. However, developing countries have jumped into the IT race – 25 have officially adopted IT by 2020, while most others have managed to keep inflation very low.
How bad is inflation?
Most believe that inflation is the biggest threat to the economy and growth. Many inflationary assumptions create uncertainty, causing misallocation of resources. All of this is said to slow growth – meaning fewer jobs, less tax collection and prolonged poverty.
Higher prices reduce purchasing power, especially to the detriment of wage earners. In contrast, price stability – which implies low and stable inflation – is believed to be more beneficial for ensuring growth and prosperity.
Many central bankers and economists dogmatically believe – without evidence – that tight curbs on inflation actually promote growth. Acknowledging that developing countries are vulnerable to external and supply shocks, the IMF recommends a target of up to 5% – higher than the 2% level of developed countries.
Most developing countries that aspire to become emerging market economies have officially adopted IT – for example, 3–6% of South Africa or 2–6% of India. By consistently setting lower short-term inflation targets, they believe the financial markets are doing well.
But in doing so, they prevent themselves from reaching their full economic potential. Strive to compete with the 2% target of developed countries that restrict both growth and structural transformation. After all, it was coined quite arbitrarily for no economic reason, except that the NZ finance minister liked the slogan ‘0 to 2 equals ’92’!
Arbitrary goal
Although there is little disagreement over the possible issues related to ‘hyper’ or very high inflation, the threshold at which inflation becomes harmful is a matter of controversy for which there is still no consensus.
Inflation targets are set arbitrarily, as admitted in a IMF paper. Thus, “any choice of medium-term inflation targets for these countries is bound to be arbitrary.” Harry Johnson found that initial IMF empirical studies on the inflation-growth relationship were inconclusive.
Subsequent studies did not resolve the issue. For example, Michael Bruno and William Easterly at the World Bank concluded that inflation below 40% does not tend to accelerate or worsen and that “countries can manage to live with moderate inflation – around 15–30% – over the long term.” “.
of MIT Rudiger Dornbusch and Stanley Fischer, later Deputy Managing Director of the IMF, reached the same conclusion. They find that moderate inflation of 15–30% is not harmful to growth, noting that “such inflationary episodes can only be alleviated at a substantial short-term cost to growth”.
ONE 2000 IMF report proposed 11% inflation as optimal for developing countries; 7% inflation would have a “negligible negative effect” on growth, while 18% inflation would remain positive on growth. However, it recommends an IT target of 7–11% and “reducing inflation to single digits and holding there”.
IMF Independent Review Office Report 2007 in sub-Saharan Africa found that “mission chiefs are equally divided on whether (or not) the Fund will tolerate higher rates of inflation… IMF policy staff acknowledge that the empirical literature is on the inflation-growth relationship is not convincing”.
Therefore, very low inflation targets are quite arbitrary without any solid theoretical and empirical basis. But the IMF and its chorus of economists have not hesitated to be determined to keep inflation very low by promoting IT for all, especially for policymakers in developing countries. sensitive development.
Constraining growth
Very low inflation targets are particularly restrictive for low-income countries (LICs). LIC governments face modest revenue bases and limited domestic savings. Therefore, they should borrow more from central banks to finance their development spending.
But such loans are prohibited by law in many developing countries – especially those that have officially adopted IT – to demonstrate their commitment to fighting inflation. Thus, a potential primary vehicle for central banks to develop more has been negated by legislation.
By raising interest rates to keep inflation very low, central banks not only reduce consumer spending but also business investment. Such policies also increase public and private debt burdens, which in turn limit spending.
As a result, aggregate demand remains depressed, limiting growth unless offset by greater export demand. But higher interest rates will attract capital inflows, causing the exchange rate to appreciate, reducing export competitiveness.
Means refuse to end
IT policy matters for two main reasons. First, it requires a debilitating low goal. Second, it negates the potential development role of central banks by emphasizing price stability – read as ‘inflation restraint’ – as its primary goal.
IMF researchers have admit“Determining the growth effects of moving from 20% to 5% inflation is challenging.”
They conclude, “pushing inflation too low – for example, below 5% – can lead to a loss of output…, suggesting caution in setting very low inflation targets in low-income countries… Especially in low-income countries… In particular, the inflation target should be set so as to help avoid the risk of an unintended adjustment in the policy stance. ”
In addition, research by the US Federal Reserve Bank of San Francisco has conclude“Developing economies with inflation targeting have not shown any significant growth over the medium term compared with economies without targeting.”
As a result, developing countries that prioritize IT often unwittingly constrain their own economic prospects. Mispromoted as a means to enhance growth, employment and development, IT is, in fact, limiting them – taboo!
Rejecting the IT fetish doesn’t mean doing nothing about inflation. Instead, developing countries need to know better the economic challenges they face and the effectiveness of their policy tools. National economic priorities need to be addressed in a holistic manner that is independent of all policy goals for the IT god.
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© Inter Press Service (2022) – All rights reservedOrigin: Inter Press Service
