Inflation in Developed World

Subject – Economy

Context – For many decades now inflation has remained very low in evolved economies.

Concept –

For many decades now inflation has remained very low in evolved economies. In the 2010- 20 decade, it remained lower than 2 per cent.
In fact, if media reports are to be believed a third of the people who live in the developed world today have not seen average inflation exceed 5 per cent in their life time.
Such being the case, governments and central banks have taken inflation for granted, cut interest rates to almost zero and borrowed heavily to fuel economic growth (rich world’s public debt is 125 per cent of their GDP and still no one is alarmed).
Post-pandemic, inflation has started to rise and that is bringing memories of the 1970s when price rise was a major challenge.

How are the central banks in these economies reacting?

The US’ Federal Reserve (Fed) is maintaining that this inflation is ‘transitory’ and caused by supply-chain bottlenecks created by Covid. It expects prices to come down next year once supplies improve.
- It has announced that it will reduce its bond purchases that ensured a loose monetary policy.
European Central Bank (ECB) too has taken a similar stand.
Both have ruled out any immediate increase in interest rates to tame inflation as that could smother the fledgling economic recovery post-Covid.

How will high inflation in developed countries impact emerging markets?

Persistent high inflation will force them to increase interest rates and such a move may impact emerging markets including India.
Foreign portfolio investors pumped in as much as $37 billion into India in FY21 alone in search of better returns. Increase in interest rates in the US or Europe will cause some of them to shift to those markets. This could trigger a sell-off in the markets (remember the taper tantrum of 2013!).
Taking advantage of low (or near zero) interest rates Indian companies have borrowed as much as $130 billion in the last five years. These borrowings could turn costly and future external commercial borrowings could become unattractive.
If the dollar outflow is heavy and inflow drops, rupee could come under pressure. A weakened rupee (along with high fuel prices) could fuel domestic inflation and smother economic growth.