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‘We’ve entered an era where supply constraints are the driving force of inflation rather than excess demand. This will likely bring more macro volatility and force policymakers to live with higher inflation.’ — An excerpt from BlackRock Investment Institute published article ‘A world shaped by supply’

In terms of economic impact on countries globally, the current crisis of Covid-19 pandemic seems to be the worst in over a century, as argued by Martin Wolf in his recent Financial Times (FT) article ‘The looming threat of long financial Covid’, and saving the developing countries — which in turn are the most vulnerable given the underlying lack of resilience — from a ‘lost decade’ would require a ‘determined action’.

As per the article, ‘Economic activity contracted in 90 per cent of the world’s countries in 2020. This exceeded the proportion hit by the two world wars, the Great Depression and the global financial crisis. …Among the most long-lasting legacies could be financial ones, especially in emerging and developing countries. The spectre of a lost decade looms for vulnerable nations. Determined action will be needed to prevent this.’

The main aspects of the economic consequence of the pandemic have been high inflation, and a significant rise in debt levels; and one of the main responses to support developing countries has remained quite weak in terms of low level of SDR allocation.

Such lack of ‘determined action’ by rich, advanced countries and multilateral institutions has meant that developing countries remain challenged in terms of stretching the limits of using macroeconomic policy instruments to effectively deal with inflation through pursuing an aggregate demand management policy primarily, and at the same time keep debt sustainable, and ensure making needed stimulus/development expenditures. So, it makes little sense to not deal with inflation from policies that have a supply-side focus, given the current surge in inflation is mainly due to aggregate supply constraints.

A recent FT article ‘A third response in the inflation debate’ by Robert Armstrong, highlighted the fact that supply to be the main driver of inflation, and requires policy, which has a more supply-side focus. Hence, the article underlines that to properly deal with inflation, it requires that while on one hand, there is no need for pursuing policies that over-suppress aggregate demand, and on the other, it does not also mean that central banks use very little monetary tightening, thinking the current surge in inflation is only transitory.

Overall, Robert Armstrong in the same article recommended ‘But there is a third option. From a January paper [titled: ‘A world shaped by supply’] published by BlackRock’s in-house think-tank: Central banks should live with supply-driven inflation, rather than destroy demand and economic activity – provided inflation expectations remain anchored. When inflation is the result of sectoral reallocation, accommodating it yields better outcomes.’

More than central banks, the International Monetary Fund (IMF) should also understand the importance of tackling inflation as a supply-side phenomenon, and therefore, in turn allow programme countries like Pakistan to deal with inflation on the basis of counter-cyclical policies – for instance, allowing lowering taxes, greater subsides, and more interventionist exchange rate management policy.

In addition, inflation-tackling policy should adopt a more microeconomic lens, as pointed out in the same article by Robert Armstrong: ‘Jean Boivin, one of the paper’s authors… emphasises a sectoral view. …Boivin expects pandemic dislocations will persist for years – so inflation will not subside soon. But unlike inflation hawks, he thinks the cost of curbing inflation is too high, so long as inflation expectations stay anchored. Central banks should accept elevated inflation as the least-worst alternative.’

Not taking a counter-cyclical approach would likely create a debt crisis for developing countries, since rising interest rates would result in greater debt servicing burden at the back of already high debt situation facing developing countries. Citing a recently published World Bank’s World Development Report ‘Finance for an equitable recovery’, Martin Wolf in his same article pointed towards a difficult debt sustainability situation, and in this regard quoted Bank’s chief economist, Carmen Reinhart, who oversaw the report during preparation, as follows: ‘She notes, “In 2020, the average total debt burden of low- and middle-income countries increased by roughly 9 percentage points of the gross domestic product, compared with an average annual increase of 1.9 percentage points over the previous decades.

Fifty-one countries (including 44 emerging economies) experienced a downgrade in their sovereign debt credit rating.” Fifty-three per cent of low-income nations are now seen to be at high risk of debt distress.’

In addition, to meaningfully support developing countries in dealing with inflation, and avoiding a debt crisis, not to mention making needed stimulus and health-sector related expenditures, would require greater special drawing rights (SDRs)-related allocations by the IMF. This foremost would require appropriate legislation-backed green signal from US Congress.

In a recent Project Syndicate (PS) published article ‘Free the money we need’, Jayati Ghosh highlighted a more urgent and meaningful SDR allocation approach: ‘One major reason for the highly uneven global economic recovery is the huge variation in fiscal responses between rich countries and the rest of the world.

An annual issuance of special drawing rights, the International Monetary Fund’s reserve asset, could help to bring about a more equitable and climate-friendly rebound. …Unfortunately, SDRs are distributed according to countries’ IMF quotas, which depend heavily on their GDP.

Low-income and middle-income countries therefore received only around $250 billion [in a total SDR issuance at $650 billion last August], while rich countries got nearly $400 billion, most of which they are unlikely to use. This system of SDR allocation is clearly outdated and illogical…’

Moreover, replying to critics with regard to SDR issuance, Jayati Ghosh in the same article pointed out: ‘Those who worry about the monetary consequences of annual SDR allocations should note that the proposed sum is trivial compared to the $25 trillion increase in liquidity fueled by loose monetary policies in advanced economies since the 2008 global financial crisis.

At $943 billion, SDRs currently account for only 7% of the $12.8 trillion in global reserves. Even if the share of SDRs in global reserves were limited to, say, 30-50%, there is clearly significant scope for more issuance.’

(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund) He [email protected]

Copyright Business Recorder, 2022

Dr Omer Javed

The writer holds a PhD in Economics from the University of Barcelona. He previously worked at the International Monetary Fund. He tweets @omerjaved7


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