Friday, Nov 16, 2018

Caribbean faces challenges if global inflation rises

Caribbean faces challenges if global inflation rises
08 Nov
2018

The World Bank has warned that further upward acceleration of global inflation from record low levels may impair efforts in emerging and developing economies, such as those in the Caribbean, to sustain the low inflation environment achieved over the past several decades.

In a groundbreaking examination of inflation in the emerging and developing world, the World Bank on Wednesday said that the adverse effects of high inflation can fall disproportionately on the poor, “who hold most of their assets in cash and rely heavily on wage income, welfare benefits and pensions.”

The World Bank said in “Inflation in Emerging and Developing Economies: Evolution, Drivers and Policies” that high inflation has historically also been associated with slower economic growth, “making efforts to maintain low and stable inflation crucial for reducing poverty and inequality.”

“Recent research into inflation, its causes and characteristics has largely ignored its impact on emerging and developing economies. This work fills that gap,” said Acting World Bank Chief Economist and Senior Director for Development Economics Shanta Devarajan. “The new study will be extremely valuable in designing policies that will protect the most vulnerable people and economies from the regressive effects of high inflation.”

To investigate the impact of inflation on emerging and developing economies, the World Bank said its Prospects Group produced the first wide-ranging analysis of inflation and its implications for these economies in a long time.

The new study also includes a global inflation dataset that covers more than 175 countries over 1970-2017.

The study documents the confluence of structural and policy factors that have fostered low global inflation over the past five decades.

Foremost among these has been unprecedented international trade and financial market integration, the report says.

“The adoption of more resilient monetary, exchange rate and fiscal policy frameworks among some emerging and developing economies has facilitated better control of inflation,” it says.

But it warns that external factors that have held inflation at bay over the past decades may lose momentum or be rolled back.

“Many emerging and developing economies have recorded an extraordinary decline in inflation over the past five decades. This is a monumental achievement,” said World Bank Development Economics Prospects Group Director Ayhan Kose, a co-editor of the volume. “However, in a highly integrated global economy, maintaining low inflation can be as great a challenge as achieving low inflation. These economies need to be ready for sudden changes in global inflation by strengthening monetary, fiscal and financial policy frameworks.”

With a focus on the emerging and developing world, the study looks into the evolution of inflation and the global and domestic factors that drive it; how inflation expectations affect price stability; and how exchange rate fluctuations can pass through to cause inflation.

The study further looks specifically at how monetary policy and food price movements affect inflation in low-income countries.

“A nuanced policy approach is necessary to mitigate the impact of global food price shocks on poverty without adverse side-effects,” said World Bank Development Economics Prospects Group Manager Franziska Ohnsorge, another co-editor of the volume. “The use of certain trade policies to insulate domestic markets from food price shocks may compound the volatility of global prices and may ultimately be counterproductive in protecting the most vulnerable people. Instead, storage policies and targeted safety net interventions can mitigate the negative impact of these shocks while avoiding the broader distortionary impacts of other policies.”

The research’s key findings say a global inflation cycle appears to have emerged over the 2000s.

Since 2001, the findings note that movements in global inflation have accounted for a substantial share of inflation variation in advanced and emerging market and developing economies.

“The influence of this global inflation cycle has been most prominent in countries that are more developed and more integrated into the global economy,” the report says.

It says that the global inflation cycle has fluctuated with movements in global demand and abrupt swings in oil prices.

The report says inflation expectations in emerging market and developing economies are more sensitive to global and domestic developments than inflation expectations in advanced economies.

Emerging market and developing economies with lower public debt and greater trade openness tend to experience “better-anchored inflation expectations,” the report says.

It says that exchange rate movements can amplify the impact of global forces on national inflation in emerging markets and developing economies.

The report also says that greater central bank credibility and independence have been associated with significantly lower pass-throughs of exchange rate fluctuations to inflationary pressures.

“The downward trend of exchange rate pass-through in the last 20 years may in part reflect improved central bank policies and a firmer anchoring of inflation expectations,” it says.

In addition, the report says improved inflation performance of low-income countries appears, to a considerable extent, to have reflected external forces.

“If global inflation rises, low income countries may see rising inflationary pressures as well,” the report says.