The senior International Monetary Fund (IMF) official said Wednesday he saw significant risks that inflation would stay high or accelerate in many emerging markets and urged central banks to maintain tight monetary policies.
The first deputy managing director of the IMF, Gita Gopinath, told a conference organized by the central bank of Brazil that the markets were probably “too optimistic” about what it would take to reduce inflation in emerging countries.
“Despite the encouraging signs, I am concerned that price pressures appear entrenched in many economies and that upside risks to inflation are substantial,” she said in prepared remarks.
“Central banks must remain steadfast in maintaining tight monetary policies and recognize that insufficient monetary tightening now could require even more painful action in the future,” he added. This was a lesson learned in the high-inflation period of the 1970s and “applies very well today,” Gopinath said.
He said fiscal tightening could support central banks’ fight against inflation and that financial instruments could improve the “trade-offs” in the event of pronounced financial stress, if used judiciously.
Gopinath said emerging economies have maintained growth in recent years aided by sound monetary policy frameworks and reforms that have reduced credit and currency risks.
But those countries still face “significant downside risks” due to monetary policy tightening in advanced economies, and conditions could worsen “significantly,” he said. The hike in US interest rates, for example, came under conditions that were still favorable, but that could change in the future, she said.
Gopinath said she is less optimistic than the markets about reducing inflation in emerging markets, as it has already been unexpectedly high and persistent and often rising faster than expected, according to her.
Services inflation has been strong and monetary policy tightening has not significantly cooled labor markets, with wage growth still robust in many emerging market economies, Gopinath said.
He said a number of factors could be contributing to the stubbornness of inflation, including demand stifled by the pandemic, a shift in demand from goods to services, and a reduction in potential output and employment.
Given the few historical records of inflation falling from very high levels without a significant economic slowdown, Gopinath said that “fairly strong” labor markets and activity indicate “significant upward pressure on inflation”.
He said firms could pass on higher costs rather than absorb them into their profit margins, and that workers could demand correction of real wage losses. This means that the longer inflation remains elevated, the more difficult it will be to reduce it and the greater the contraction in output needed to cool it.
These challenges are global, but the risks are greatest for emerging markets, Gopinath said, underscoring the need for emerging market authorities to continue to strengthen their monetary, fiscal and financial policy frameworks.
Source: Terra
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