The IMF (International Monetary Fund) on
Wednesday warned that amidst high global food and fuel prices, central banks
need to clearly identify and communicate their inflation targets or risk
undermining their credibility in the markets.
The Fund on Wednesday released Chapters 3 and 4
World Economic Outlook, which includes the latest forecasts, will be
released next week - - on Tuesday, September 20th - - just ahead of
the annual meetings.
John Simon, senior economist, IMF Research
Department, told a press briefing in Washington DC that central banks should
focus on the medium-run element of inflation -- the element that is not
affected by short-run commodity price volatility. So that boils down to
targeting underlying inflation. He said what the economists find is that these
effects vary, depending on the nature of the country. And, in particular, there
seems to be a separation between advanced countries, which tend to have highly
credible central banks and relatively low shares of food in the consumption
basket, and emerging and developing economies, where there is less credibility
of the central bank, and generally higher shares of food in the consumption
And what the effect of these means is that in
these emerging and developing countries, food price shocks can have a much
larger effect on headline inflation. And so the challenges that these banks face
are much higher.
The IMF reiterated calls for accommodative
monetary policy in advanced economies and more aggressive action in some
Chapter 4 deals with fiscal policy and it says
fiscal tightening will be one of the key factors shaping the global economy over
the coming years. The economists said there are many advanced economies which
are tightening substantially to strengthen fiscal sustainability, and also many
emerging and developing economies which are tightening both to rebuild fiscal
policy room and, in some cases, to restrain overheating pressures.
So, one natural question to ask is, what effect
would these fiscal adjustments have on countries’ external balances?
Over a period of 30 years, the Fund found that
fiscal policy has a large and long-lasting effect on the current account. A
one-percent-of-GDP fiscal cut typically improves the current account by just
over half a percent of GDP within the first two years. And this improvement in
the current account persists over the medium term.
The improvement in the current account takes
place not just because imports fall as a result of lower consumption and
investment. The economists also found that exports rise, because the currency
tends to weaken following a fiscal tightening.
In countries where the exchange rate is
fixed, or where monetary policy is limited or constrained, "the good news is that one actually sees just as much of a
current account improvement -- just as much of a current account response to
The bad news is that it occurs in a more
painful manner. "And what we
mean by that is that you tend to see a bigger decline in economic activity,
because monetary stimulus can’t offset the negative effects of the fiscal
tightening. In addition, the real exchange-rate depreciation takes place via a
compression of domestic wages and prices, a process that’s sometimes referred to
as 'internal devaluation.'"
This is the situation in the Eurozone.
There is one special case where fiscal policy has
very small effects on the current account, and that’s when all countries are
tightening by exactly the same amount. In that case, countries are buying less
from the rest of the world, but the rest of the world is buying less from each
country as well, and the net effect is lower global demand but not much change
in current accounts.
The economists said that’s not the case
we’re in at present. "What we have now is many
countries tightening, but some countries are tightening fiscal policy by a
substantial amount, and other countries are tightening by much less. And in this
case, what matters is how much tightening a country is doing relative to the
Germany, for example, is consolidating, but
it’s doing so by less than the other Eurozone economies. And as a result, these
fiscal adjustments within the euro area will actually help reduce imbalances
within the Eurozone.
Similarly, emerging Asia is also planning to consolidate, but it’s going
to do so by less than the rest of the world. As a result, that will help bring
down that region’s large trade surplus.
And finally, in the United States, much of the tightening that’s in the
pipeline is actually exit from stimulus, rather than more permanent measures,
such as entitlement reform, that have the biggest impact on the current account.
And this relative lack of permanent fiscal measures, alongside the fact that
everybody else is also consolidating substantially, means the current US fiscal
plans will probably not contribute to reducing the US current account deficit."