The tightening cycle in emerging markets
In this paper, Servaas Storm, highlights the risks of non-coordinated interest rate hikes in EMDEs in the context of monetary and fiscal policy tightening in the OECD.
Storm summarizes published evidence (table below), mostly provided by central bank economists, on the responses of the inflation rate and real GDP to a one-percentage-point hike in the policy interest rate in Brazil, China, India, Mexico, Nigeria, and South Africa. He shows that small increases in interest rates will not do enough to bring down demand and rising inflation in emerging economies in a significant way. On the other hand, the cost of monetary tightening, which Storm calls the “sacrifice ratio”, defined as the decline in real GDP associated with the degree of monetary tightening necessary to reduce the inflation rate by one percentage point, is quite high.
If further monetary tightening in the US during 2022-23 triggers a worse global recession than the one occurring during the early 1980s, the potential growth rate in the developing economies will take a hit—and the permanent damage to economic development in these countries will be large. This permanent scarring of potential growth, in turn, will have dire implications for developing countries’ indebtedness: the volume of supportable (or serviceable) debt must decrease. The risk of another, avoidable, round of EMDE’s debt crises increases—and another ‘decade lost to economic development’ is in the cards, if the current phase of monetary tightening goes too far.
Collateral Damage From Higher Interest Rates
By: Servaas Storm – Delft University of Technology
