The fight against inflation

Mahmoud Mohieldin
Monday 20 Dec 2021

The world’s advanced economies are facing inflation rates not seen for decades. Their policy response will have serious implications on emerging markets and developing economies.

As the world economy struggled over the past year to compensate for the losses sustained due to the Covid-19 pandemic, the final weeks of 2021 threw down the gauntlet with another variant of the virus: Omicron. 

Renewed uncertainty in the markets and a further succession of price hikes have delivered stunning blows to the recovery efforts. As the year draws to a close, the world’s advanced economies are grappling with inflation rates not seen since the 1940s. 

The US had the highest, with the consumer price index rising 6.8 per cent in November from a year earlier, the most rapid inflation the US has experienced since 1982. With the Congressional midterm elections on the horizon and the declining popularity figures of President Joe Biden and his administration, the Democrats have tried to play down the data with the claim that the change in the cost of living has recently come down, but not as fast as hoped.

The rest of the world is keeping a nervous eye on the measures the US Federal Reserve will take, since these will inevitably affect global interest rates and lending costs in the coming weeks and months. 

The officials heading the Federal Reserve, which issues the world’s most widely circulated currency, have acknowledged that the current inflation is not a temporary problem that will soon pass, as they had wishfully thought, but will be more enduring as a result of supply chain bottlenecks, increases in transportation and shipping costs, and the surge in consumer demand fed by the liquidity the developed countries have injected into their economies over the past two years. 

The time and money alone that it will require to enable supply lines to step up production to meet demand will need earlier steps to be taken to rein in inflation. This means raising interest rates after the tapering of the economic support the Federal Reserve has been providing by buying up some $120 billion of bonds a month much more quickly than was planned. 

The pace of such measures depends on how the experts read the latest data on real-time inflation and their models for consumer and investment behaviour in response to probable price rises.

Economists have come to recognise that maintaining a low inflation rate – of about two per cent for the developed nations – is a key to economic stability. They also understand that this rate has to be higher for developing nations due to structural problems, as long as it does not verge into double digits. At the same time, price stability is one of the highest priorities of public policymakers.

As far as the British economist John Maynard Keynes was from the Russian Marxist Vladimir Lenin, both agreed that the best way to destroy a country’s economy was “to debauch its currency.” History offers many cases of countries that have suffered such a degree of runaway inflation that their national currency has been debased and rendered worthless. 

It could cost more just to carry banknotes around that under increasingly dire conditions were better put to use as fuel to heat houses, as occurred in Germany in the 1920s when inflation hit 500 per cent, than to try to use them to buy goods. This was one of the factors that led to the rise of Nazism in Germany and the eruption of World War II. More recent cases are Zimbabwe in 2008 and Venezuela five years ago.

High inflation is one of the harshest and most unjust types of tax. It is imposed without legislation and is ungoverned by any legal text. It makes no distinction between the well-to-do and the poor. It undermines long-term contracts if they stipulate amounts that are not subject to incremental changes roughly equivalent to the inflation rate. 

Think of the rights of owners having to sustain rising costs for maintaining buildings while rents remain the same year in, year out. Think of employees on fixed wages whose purchasing power dwindles with every price hike. Given how costly it is to remedy such flaws, the best solution is to contain the damage before it happens by controlling inflation to ensure regulated rises commensurate with market mechanisms and the principles of social justice.

Central Banks will act appropriately before rising prices become inflationary waves and certainly before printing money not backed by increases in production. In the light of current circumstances and general expectations, priority should be given to the following four policies.

First, there should be accommodation for the impact of monetary tightening and the possibility of higher interest rates on capital flows to developing countries. According to a report in the UK Financial Times newspaper, financial flows to emerging markets turned negative last November for the first time since March 2020 at the outset of the pandemic. This coincided with a rise in the dollar against foreign currencies as US monetary policy shifted towards tightening credit and upping interest rates.

Second, there should be revisions to the G20 group of countries’ general framework for debt relief. Since this framework was introduced in 2020, only three low-income debt-encumbered countries have applied to benefit from it: Chad, Ethiopia and Zambia. Their experience is enough to tell us that the framework needs to be revised. 

This has become all the more urgent after the G20 ended the Debt Service Suspension Initiative for the low-income countries and because the current framework is flawed by its failure to include all creditors, especially private sector ones, in a manner that gives potential donors from middle-income countries the incentive to contribute. As inflation rates and global interest rates climb, more developing countries with high debt vulnerability will fall into the clutches of impending default, as I have warned in this newspaper before, but a fair and effective debt-management framework still does not exist.

Third, there needs to be urgent and equitable climate change management. The pledges made by participants at the COP26 meeting in Glasgow this year to reach carbon neutrality are not enough. They need to make sure that the developing nations receive more investment for climate mitigation, instead of having to go further into debt to counter the climate damage others have caused. 

In addition, the transition to carbon neutrality needs to be conducted in the framework of systematic and comprehensive economic and development policies. The present ad hoc and impulsive approach will only increase problems in providing energy in the absence of clean alternatives. An example of this is the way in which some European countries have reverted to coal, which is at once more polluting and more costly than gas. As I have mentioned previously, climate change policies not only need to be comprehensive, but they also need to help attain sustainable development goals and comply with the Paris Agreement.

Fourth, those who focus on short-term solutions to inflation may not realise the need to stress the importance of both private and public investment in the fight against it, especially in developing nations. The current wave has struck before the economic recovery was complete. If the US and other developed nations can resort to monetary measures to remedy or ward off inflation, the process is more complex for the developing nations. Not only do they need to coordinate between fiscal and monetary policies and social safety nets, but they also have to increase public and private sector and foreign investment in boosting productivity and economic growth. 

A good part of these investments must be channelled into maintaining and upgrading infrastructure, productive and value-added enterprises, research and development, digital transformation and the transition to the green economy, and creating jobs. All this requires a dynamic partnership between the public and private sectors that is geared to bringing the greatest possible benefit, leaving no one behind. 

* An Arabic version of this article appeared on Wednesday in Asharq Al-Awsat.

*A version of this article appears in print in the 16 December, 2021 edition of Al-Ahram Weekly.

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