Archive for September 2nd, 2008

IMF should call a spade a spade

September 2, 2008

I have noted quite a few flips from IMF when it comes to making a case for developed economies. First was Monetary Policy should look at housing bubbles, second which was even more worrisome was its support for fiscal stimulus for reviving the US economy.

Now, IMF’c chief economist in his recent article criticises the emerging markets for following righteous policies. Yeah!

He first discusses how they have fared since 1980s. I will skip all that and come to what he says for current times:

Emerging markets have grown fast during the past 10 years. They have sustained this growth, in the face of substantial financial turbulence in advanced economies during the past 12 months, for three main reasons.

First, although emerging markets are highly connected to the world in terms of goods flows, they are not (yet) fully connected in terms of financial flows. The banks in emerging market countries perhaps became more cautious after the problems of the 1990s.

Second, emerging markets have continued to maintain sound economic polices. Unlike during some previous booms, they did not throw fiscal caution to the wind. And problematic behaviors, such as various forms of rent-seeking or corruption, seem to have been controlled much more effectively in this boom compared with past booms.

Third, global trade remains strong and so-called south-south trade (not involving advanced economies) has proved resilient. Countries understand that throwing up trade barriers should be avoided at all costs. The global trading rules have held up so far under considerable pressure. This has been of great benefit to emerging markets.

As a result, over the past year, it is emerging markets that have played a relatively stabilizing role, helping to offset repeated waves of financial concern

So far so good. Now comes the turnaround ( in economists parlance the other hand):

No good deed goes unpunished, and the same is true for economic policies. It is precisely the resilience of emerging markets that now underpins high commodity prices, including for energy, food, and industrial inputs. This adds an inflationary shock to the mix facing all countries.

This inflationary shock comes at the same time as, and in spite of, a slowdown in the United States and in some other advanced economies 

There are many good reasons to believe that developed countries can avoid the slowdown in growth and acceleration of inflation that plagued the 1970s. Their economies (and real wages) have become more flexible, and they are able to adjust in the face of higher energy prices.

On all these dimensions, emerging markets are more vulnerable. They may not face stagflation per se—this will depend on their policy responses. But they are certainly at risk of higher inflation. Price expectations in many of these countries are not well measured, and this means it is hard to know if they are still, in central bank parlance, “anchored”.

I have heard this blame gaming umpteen times. And what does he mean by good policies getting punished? Shouldn’t emerging markets grow? IMF has told us time and time again that inflation is because Central banks keep an easy policy for a longer time. So, if inflation is happening in developed economies, it is a problem of developed economies as well. They can’t simply sit and expect emerging markets to tighten rates and they continue to target their financial markets. This inflation is a global problem and all need to fight it. Blame gaming doesn’t help.

Further he says:

The emerging market crises of the 1980s were about high levels of public external debt, unsustainable budget deficits, and, in some instances, borderline hyperinflation. The crises of the 1990s and early 2000s were more about private sector borrowing and vulnerabilities created through large current account deficits

Most likely it would be centered again on a failure to control inflation, except through raising interest rates late and in dramatic fashion. ….. Luckily, drastic negative outcomes are avoidable, particularly if key emerging markets act quickly to slow down their economies and—most important—move to allow more exchange flexibility, which will allow them to run independent monetary policies appropriate for their own conditions.

He simply  passes on the blame to emerging economies. Why doesn’t he tell the developed economies not to interfere too much in financial markets? IMF tells the virtues of free – markets, price stability, less reliance on fiscal stimulus etc to emerging economies. Why can’s it say the same to developed economies?

I am not saying that emerging markets are not responsible but developed are as responsible for all the mess we are in. They lower rates in each crisis, leading to investors searching for higher yield assets, leading to bubbles in those assets and another bust and another easing. Earlier it was IT, then housing assets and now commodities. As commodities influence inflation more than other bubbles, we are seeing higher inflation. Now they blame emerging markets. What are their central banks doing?

There is a lot of talk about IMF becoming more democratic and involving emerging markets in their operations. I don’t see that happening unless they change their views on emerging markets. You need to call a spade a spade and that is what is expected from IMF.

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RBA cuts rates as well

September 2, 2008

Reserve Bank of Australia was amongst the few developed economies’ central banks (others are ECB, Riksbank so far) that was looking at inflation.

Now RBA has also cut its rates. It says:

Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that household demand will remain subdued and overall economic growth slow over the period ahead.

Inflation is likely to remain relatively high in the short term, with the CPI affected by the high global oil prices in mid year and other increases in raw materials prices.

But looking further ahead, the outlook for demand suggests that inflation in both CPI and underlying terms is likely to decline over time, provided wages growth remains contained. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

So much so for inflation targeting. Just like RBNZ, BoE  RBA also cuts rates despite expecting inflation to be higher. It says it expects demand to slow down and this would dampen inflation. It also says “wages growth remains contained”. How will wages be contained?

I am not sure what is going on. Ignore inflation at your peril.

Assorted Links

September 2, 2008

WSJ Blog points to Fedspeak – Krozner who says US economy is not decoupled

Mankiw points to using prices to allocate scarce airport landing slots


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