Inflation may be one of the most familiar words in economics. It has plunged countries into long periods of instability and the probability of inflation returning in the next two to three years has increased significantly for several reasons. We discussed this topic with several international development consultants. Check their opinions below.
What could be the main reasons for the rise in inflation?
“COVID-19 hit just when mainstream economic theories were failing to explain the underlying dynamics of price formation in our modern interconnected societies. According to the data, in most developed economies price inflations have trended downwards in the last four decades and are now marching on a 2-4% plateau against central banks’ widespread quantitative easing measures at a massive scale, 25% annually. This clearly created another major blow to Monetarist theories which are based on the infamous premise of Freidman “inflation is always and anywhere a monetary phenomenon.” Likewise, Keynesian theories are scattering with only some life blood left for Philips Curves but not enough to offer a complete life line. In brief, we are heading into uncharted waters and COVID-19 is merely pressing the throttle.”
“Developing economies and emerging markets in the past half a century have adopted expansionary economic policies. These policies have led to an increase in Foreign Direct Investments (FDI) and stimulated aggregate demand and economic output. The governments have also adopted regimes focusing on interest rate (monetary policy rate) targeting or inflation targeting. The reduced monetary policy rates have led to increased FDIs along with increased fiscal expenditure. These have resulted in an attendant increase in inflation.”
“In the past 20th century, the causes of inflation were explained from the theoretical perspective of Keynes (Equations of Aggregate Demand vs Aggregate Supply) or rather from a Monetarist point of view (Interest Rates and Money Supply). However, in the current scenario of globalization and International Trade, and from another point of view in accordance with the School of Salamanca (Juan de Mariana and Tomás del Mercado) and the Austrian School (Misses and Hayek), the main causes of inflation are correlated to the successive rising level of Public Debt to sustain high levels of Public Expenditure Programs (the state has become one more economic actor), interventionism in currency devaluations and, finally, due to State Protectionism spoiling local interest groups.”
What are the consequences of the rise in inflation on global development?
“Since COVID-19 is still set to persist with its course, its major impact vectors are going to play out in full force in the modern complexity of our economic system: 1. Demand Shock (consumer income and spending collapsing for numerous product groups and services), 2. Supply Shock (loss of output associated with lockdown measures and massive disruptions in global value chains), 3. Financial Shock (resulting in credit hunger and squeeze in profits and liquidity), 4. Policy Shock (Fiscal and Monetary Policy counter measures at unprecedented scales). We are in the eye of a perfect storm and our conventional measures and theories are failing to explain the emerging complex dynamics during the crisis. Hyperinflation, deflation or price stability, three distinct itineraries for the global economic system, remain to be solved and foreseen with new thinking and an agile response.”
“Over the years, monetary and fiscal authorities in developing economies have prioritized economic growth at the expense of inflation. The secret is having a mix with its attendant trade-offs between an increase in growth, interest rates and inflation that will drive the desired or targeted economic growth. The rise in inflation in developing economies has led to a weakened performance in both micro and macroeconomic indicators, for example, the rise in inflation has led to weaker exchange rates and less competitive markets with governments playing a leading role both as a regulator and a market player. This has led to protectionism and weaker participation in global trade.”
“Actually, the most obvious consequences are the harassment of the middle classes, in other words, a decrease in purchasing power. In addition, another consequence observed (this in Policy) is the addiction to chronic debt suffered by governments around the world to stimulate their economy and produce new economic cycles.”
What actions should be taken to halt this rise?
“Since Global Value Chains have created a world of interconnected complex production systems, nearly half of global trade is carried out by these networks. This is a tremendous change not only in the depth and scale of the economic system but also the dynamics are fundamentally different from conventional beliefs. Traditional policy measures designed and applied by nation states are not equipped well to deal with economic consequences well beyond national borders. From trade to monetary measures, literally a whole set of macro policies is set to be determined increasingly at a global scale. Hyper-connectedness undermines the effectiveness of conventional macro policy vectors on the one hand, but they also create opportunities for nation states to understand and act beyond borders on the other hand. The need for functioning multilateral institutions and effective global cooperation has not been at this level of urgency and prominence before.”
“To halt the rise in inflation, developing economies and emerging markets need to adopt the right mix of both fiscal and monetary policies to reduce inflation along with the appropriate economic plan to grow the economy. Governments need to review fiscal policies to focus on a comprehensive tax and spending regime to balance the effects of inflation and economic growth.”
“Establish a new Payment method or International Currency based on a gold Standard which guarantees market price stability and avoids whatever adulteration exists regarding exchange rate/value of currencies; move out of the current system of Central Banks with more manipulable currencies based on a dollar standard. A good historical example of this was the Real Peso de 8/Spanish dollar which was the most appreciated currency with a stable value deposit and trade guarantees and which was involved in the kick-off of globalization, inaugurated in the 16th century.”
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