Our readers don’t need reminding that Inflation has been on the rise globally (although the present financial crisis could knock that on the head). The poor are being hit hard by rising food prices – the price of rice in Asia has doubled, causing real distress in countries without effective social protection. Africa is scrambling to respond.
Macro-economists in central banks and finance ministries are worried people. Today looks alarmingly like 1979-81: inflation pushed up by the second oil price spike and recession looming. That combination of inflation and recession – stagflation – is the worst scenario for policymakers. Inflation requires demand restraint, recession requires demand expansion – and policy-makers have a difficult time in choosing which direction to go down. The early 1980s are a warning of what can happen. Real interest rates (the interest rate minus the inflation rate) turned from negative to positive – pushing up the real cost of borrowing for firms already hit by weakening sales. Eventually the oil price collapsed, bringing inflation down with it, but also distress for over-borrowed oil producers such as Mexico and Nigeria. That then set the stage for the debt crisis that took a full decade to work itself out, with massive social fall out, and poverty spiking higher (the 1980s were Latin America’s “lost development decade”).
So what should today’s policy-makers do? The Centre for Development Policy and Research at SOAS has a new Development Viewpoint out on global inflation. The author, Terry McKinley, argues that they must be clear on the causes, otherwise the response could make the situation worse. Since the sources of recent oil and food inflation are ‘globalised’, developing countries cannot hope to maintain low domestic inflation by the standard practice of raising domestic interest rates, argues Terry. Such a misguided “monetarist response” would only heighten the risks of recession, he concludes. Go here for the paper, a timely contribution to the present debate — and a warning from the past.