Low inflation hits all hard
LIMITED MOVES: EMERGING MARKETS ARE AT THE MERCY OF BIG CENTRAL BANKS’ POLICIES
High interest rates relative to inflation hurt by keeping policy conditions tight.
For years, low inflation looked like a classic richworld problem. Plenty of developing economies now have some version of it too.
Central banks have responded like their developed-country peers: by lowering interest rates. They have more room to keep going – but they also face more obstacles on the way down.
The biggest ones are their currencies, which don’t loom so large for rich-world central bankers (although US President Donald Trump thinks they should). Emerging-market exchange rates get bounced around as capital shifts in and out – flows that have been amplified by years of cheap money in developed countries. And when money leaves and currencies weaken, it has a bigger impact on prices than in developed countries. The emerging economies are “at the mercy of the big central banks,” said Nariman Behravesh, chief economist at IHS Markit. They have “less room to manoeuvre”.
That’s one reason why emerging markets can’t hit the gas. They’re expected to help the world economy with more monetary easing in 2020. But policymakers in countries like Mexico, scarred by currency crises, are reluctant to slash borrowing costs – even with low inflation.
The result is high interest rates, relative to inflation – and strong currencies. It’s an alluring combination for investors struggling to find returns elsewhere.
But it can hurt economies by keeping policy conditions unnecessarily tight, according to Gabriel Sterne at Oxford Economics.
The lesson from rich countries, where inflation has consistently undershot, is “don’t be too conservative,’’ said Sterne, who worked at the Bank of England for 20 years. “That’s hard for central banks in emerging markets, because they’re used to inflation. Having won that credibility, you don’t want to lose it quickly.’’
‘Everyone fears’
“Lowflation is linked to structural factors: ageing, new technology, the level of debt,’’ he said. Rapid rate-cuts won’t address those, but “may create some currency volatility”. And keeping rates high also leaves room to respond “in case 2020 is the global recession everyone fears”.
In some developing countries, like South Africa, large budget deficits are seen as a barrier to significantly lower interest rates – even when there’s little inflation.