Crisis of Inflation, Debt and Weak SDR Allocation Response – Opinion
“We have entered an era where supply constraints are driving inflation rather than excess demand. This will likely lead to more macroeconomic volatility and force policymakers to live with higher inflation. – An excerpt from the article published by the BlackRock Investment Institute “A world shaped by supply”
In terms of the economic impact on countries around the world, the current Covid-19 pandemic crisis appears to be the worst in over a century, as Martin Wolf argued in his recent Financial Times (FT ) “The looming threat of a long financial Covid”, and saving developing countries — who are in turn the most vulnerable given the underlying lack of resilience — from a “lost decade” would require “determined action “.
According to the article, “Economic activity contracted in 90% of the world’s countries in 2020. This exceeded the proportion affected by the two world wars, the Great Depression and the global financial crisis. …Among the most enduring legacies could be financial legacies, especially in emerging and developing countries. The specter of a lost decade hangs over vulnerable nations. Determined action will be required to prevent this.
The main aspects of the economic consequence of the pandemic have been high inflation and a significant increase in debt levels; and one of the main responses to support developing countries remained quite weak in terms of low level of SDR allocation.
This lack of “determined action” by rich and advanced countries and multilateral institutions means that developing countries continue to face the challenge of pushing the limits of the use of macroeconomic policy instruments to fight inflation effectively. mainly by pursuing a policy of managing aggregate demand, and at the same time, keeping the debt sustainable and ensuring the necessary stimulus/development spending. It therefore makes little sense not to address inflation from supply-side policies, given that the current surge in inflation is mainly due to aggregate supply constraints.
A recent FT article “A Third Response to the Inflation Debate” by Robert Armstrong highlighted the fact that supply is the main driver of inflation and requires more supply-side policy. Therefore, the article points out that in order to deal with inflation properly, it is necessary that, if on the one hand, it is not necessary to pursue policies that excessively suppress aggregate demand, and on the other hand, nor does it mean that central banks use very little monetary tightening, believing that the current surge in inflation is only temporary.
Overall, Robert Armstrong in the same article recommended “But there is a third option. Excerpt from a January article [titled: ‘A world shaped by supply’] published by BlackRock’s internal think tank: Central banks should live with supply-driven inflation, rather than destroying demand and economic activity – provided inflation expectations remain anchored. When inflation is the result of a sectoral reallocation, accommodating gives better results.
More than central banks, the International Monetary Fund (IMF) should also understand the importance of fighting inflation as a supply-side phenomenon, and therefore, in turn, enable program countries like the Pakistan to deal with inflation on the basis of counter-cyclical policies – for example, allowing lower taxes, greater subsidies and a more interventionist exchange rate management policy.
In addition, anti-inflation policy should adopt a more microeconomic perspective, as the same article by Robert Armstrong points out: “Jean Boivin, one of the authors of the article…emphasizes a sectoral vision . … Boivin expects the pandemic dislocations to linger for years – so inflation won’t come down any time soon. But unlike inflation hawks, he thinks the cost of controlling inflation is too high, as long as inflation expectations remain anchored. Central banks should accept high inflation as the least-worst alternative.
Failure to adopt a counter-cyclical approach would likely create a debt crisis for developing countries, as rising interest rates would lead to higher debt servicing due to the already high debt position of developing countries. Quoting from a recently published World Development Report by the World Bank titled “Financing for an Equitable Recovery”, Martin Wolf in his same article pointed to a difficult debt sustainability situation and, in this regard, cited the Bank’s Chief Economist, Carmen Reinhart, who supervised the report during preparation, as follows: “She notes: ‘In 2020, the average total debt burden of low- and middle-income countries increased about 9 percentage points of gross domestic product, compared to an average annual increase of 1.9 percentage points in previous decades. .
Fifty-one countries (including 44 emerging economies) experienced a downgrade in the credit rating of their sovereign debt. Fifty-three percent of low-income countries are now considered at high risk of debt distress.
In addition, to significantly help developing countries cope with inflation and avoid a debt crisis, not to mention the necessary stimulus and health sector spending, the IMF would have to grants more allocations linked to special drawing rights (SDRs). Above all, this would require an appropriate green signal backed by legislation from the US Congress.
In a recent article published by Project Syndicate (PS) entitled “Freeing up the money we need”, Jayati Ghosh highlighted a more urgent and meaningful SDR allocation approach: “One of the main reasons for the recovery highly unequal global economy is the huge variation in fiscal responses between wealthy countries and the rest of the world.
An annual issuance of Special Drawing Rights, the reserve asset of the International Monetary Fund, could contribute to a fairer and more climate-friendly rebound. …Unfortunately, SDRs are distributed according to countries’ IMF quotas, which are highly dependent on their GDP.
Low- and middle-income countries therefore only received about $250 billion. [in a total SDR issuance at $650 billion last August], while rich countries have received nearly $400 billion, most of which they are unlikely to use. This SDR allocation system is clearly outdated and illogical…’
Moreover, responding to criticisms regarding the issuance of SDRs, Jayati Ghosh pointed out in the same article: “Those who are concerned about the monetary consequences of annual SDR allocations should note that the proposed sum is insignificant compared to the increase $25 trillion of liquidity fueled by accommodative monetary policies in advanced economies since the 2008 global financial crisis.
At $943 billion, SDRs currently represent 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 author holds a doctorate in economics from the University of Barcelona; he previously worked at the International Monetary Fund) He [email protected]
Copyright Business Recorder, 2022