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Hello again. This week Argentina voted for another economic experiment, electing radical libertarian Javier Milei as president. Experience shows that it won’t go well. As the main analysis shows, the added difficulty for the South American country is the success of many other emerging economies that have dabbled in economic orthodoxy.
Elsewhere, inflation numbers performed exceptionally well in the US, UK and Eurozone in October, causing financial markets to ignore central bankers’ discussions of higher inflation rates for an extended period. Do you think central bankers are now behind the curve, still broadly right, or facing impossible communications challenges? Email me at firstname.lastname@example.org.
Advanced Tortoises and Emerging Hares
Since I began a career in economics more than three decades ago, it has been a rule that emerging markets should not be underestimated.
Correctly measured at purchasing power parity exchange rates, China has overtaken the USA as the largest economy In 2014 it reached the global peak (accurate to 1 percentage point of each nation’s share of global GDP) and was definitely ahead in 2018. I know people will complain about purchasing power parity exchange rates, and things can be different with market exchange rates, but purchasing power parities are the only way to do these long-term comparisons. The US can still be the strongest economy in the world despite producing fewer goods and services than China.
More broadly, developed countries accounted for more than 60 percent of global GDP in 1991 and have fallen to about 40 percent today.
Although these are economic facts, few thought that advanced economies had much to learn from emerging markets in the areas of central banking, inflation management and financial stability. Until now.
Robin Brooks, chief economist at the Institute of International Finance, tells me: “The major emerging markets have conducted monetary policy better than the developed world.” He said they have recognized the threat of inflation more quickly, raised interest rates more quickly and maintained their credibility better than the Fed, the ECB or the BoE.
He is not remotely alone. In its most recent global economic outlook, the IMF noted (somewhat reluctantly): “Monetary policy decisions in many areas [emerging economies] is better equipped to serve as a stability anchor than it was 15 years ago.”
Looking at the monetary policy response to the global inflation shock from the end of 2020, one cannot help but come to roughly this conclusion. Finally, emerging market central banks began raising interest rates in early 2021, about a year before their major counterparts on both sides of the Atlantic. They were rightly concerned about global supply chains, imported inflation as their currencies weakened against the rampant US dollar, and the possibility that temporary price increases would become persistent, as the chart below shows.
Emerging market central banks not only responded more quickly to inflationary pressures, they also loosened monetary policy more quickly Interest charges in Brazil, Chile, Peru, Costa Rica, Hungary, Poland, Georgia and Kazakhstan on the way down.
It’s one thing to praise emerging market central banks for their quick action. The medication also has to work. Separate data from Oxford Economics shows that core monthly inflation rates – excluding food and energy prices – have already fallen close to desired levels in the major emerging markets of Eastern Europe, Latin America and Asia, the Oxford Economics chart shows.
By far the most detailed examination of what emerging market central banks have done right is published in a Peterson Institute of International Economics article. It concludes that emerging markets began tightening monetary policy earlier, allowing the process to proceed more slowly, which on the one hand better controls inflation and, on the other hand, gives commercial banks more time to do so, unlike Silicon Valley Bank and Credit Suisse There is adaptation.
“In these critical areas of central banking, emerging markets appear to have overtaken the ‘masters’.”
Elina Ribakova, a non-resident fellow at PIIE and one of the report’s authors, told me the key to superior performance was that emerging market central banks did not provide strict forward guidance to keep monetary policy extremely loose for a long time during the pandemic and so they have “not dampened their response to inflation”.
The paper’s innovation is an extremely detailed look at how central banks in emerging markets communicate using various forms of AI and machine learning approaches.
The readability and transparency of emerging market central bank statements and other communications have been found to be at or above the level of the Fed and ECB. The difference, however, was that as the pandemic subsided at the end of 2020, emerging market central banks reacted more quickly to the threat of inflation, were clearer in their communication, did not rely on failing, failed economic models and did not get caught up in side issues. They were still behind the inflation curve, but not by that much.
As the sentiment index chart below shows, emerging market central banks have historically tended to make ambiguous statements when hawkish statements are positive and dovish statements are negative, but this time they were decisive and well ahead of the Fed and ECB.
Ribakova tells me that there was some luck in all of this, as many emerging markets had experienced recent bouts of inflation, but she added that “the clarity of the message” and the focus on the essentials were better than in advanced economies. The only area where emerging market central banks really need to improve is in ensuring they walk the talk, she said.
I cannot write such an analysis without highlighting some caveats.
First, the praise goes to many, but not all, emerging markets. Argentina and Turkey win no prizes. As MUFG wrote in a note last week, “It is difficult to make a constructive assessment of emerging markets on a homogeneous basis.”
Second, the IMF rightly points this out that emerging markets had a worse pandemic and suffered more production losses than developed countries compared to previous expectations.
It also says that inflation is likely to prove more persistent in emerging markets because budgets are not yet sufficiently forward-looking, meaning that price stability mandates are not yet fully embedded in the thinking. We will see, however, because as the fund’s chart from the same document below shows, inflation expectations in emerging markets for 2023 and beyond are as good or better than those in developed economies.
A chart that counts
I said I would bring you the latest inflation figures from the UK, US (CPI) and Eurozone. The graphic shows that the annual inflation development in the last few months has been significantly better than compared to longer periods.
What I have read and seen
Olivier Blanchard of the Peterson Institute warns that higher interest rates are putting pressure on public finances much less sustainable. It’s quite a change from his previous positionThis shows how important interest rates are. He explains in more detail in Unhedged.
Matt King argues that high national debt is associated with low, not high, interest rates. He argues that governments keep interest rates low when debts are high and economies are weaker, leading to lower interest rates. I’m not sure if the causality works, but it’s an interesting read.
We’ve heard a lot about how higher interest rates are making life more difficult for people in the green tech sector. Catherine Mann, an external member of the BoE’s Monetary Policy Committee, talks about how environmental policy affects monetary policy. Your conclusion: It’s complicated.
Martin Wolf switches gears and notes that the arguments for easing monetary policy are growing.