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A recent International Monetary Fund (IMF) working document analyzes more than 100 inflation shocks from 56 countries since the 1970s, and concludes that curbing inflation may be more complex and long-lasting than generally expected. The IMF's research shows that in only 60% of the cases of inflation examined, it could be contained within five years, taking an average of more than three years to do so successfully. Especially in the cases where inflation was not resolved, policy easing was too fast, which initially led to a decline in inflation, but later to stagnation or even acceleration.
Countries that managed to tackle inflation effectively consistently pursued tight monetary policies, had lower nominal wage growth, and experienced less currency depreciation. Although these measures led to short-term production losses, no significant losses in employment or real wages were seen over a five-year period. This underlines the importance of credible policies and stability at the macroeconomic level.
The findings suggest that premature and ill-considered policy adjustments can lead to long-term and persistent inflation problems, and that careful and consistent policies are essential to successfully curb inflation, without major negative impact on the economy.
In particular, inflation remains persistent after trade shocks, such as a sudden increase in energy or food prices. Of the 111 situations reviewed by the IMF, only 12 returned to pre-shock levels within a year, mostly due to significant economic shocks such as the 2007-08 financial crisis. In 47 cases, inflation had not normalised even after five years. This persistence highlights the complexities in managing inflation and the potential risks of policy mistakes.
Monetary policy is seen as a crucial factor in tackling inflation. Countries that were successful in curbing inflation tended to charge higher interest rates, regardless of what caused the inflation. There was a statistically significant and large difference in policy tightening between countries that managed to control inflation and those that did not.
Countries in which inflation has been tamed have raised their effective short-term real interest rates by around 1 percentage point compared to the state of play before the economic shock. In contrast, real interest rates in countries that failed to tackle inflation were on average 4.5 percentage points lower.
Countries that were successful in controlling inflation had in common that they pursued a consistent and long-term tight monetary policy and restrictive fiscal policy. These countries also managed to keep their currencies stable or limit their devaluation and experienced moderate wage growth, in contrast to countries where wage growth accelerated and inflation was not brought under control.
A striking finding is that the sharp tightening of monetary and/or fiscal policy did not necessarily result in reduced growth or an increase in unemployment over a period of five years. There was no discernible difference in growth performance between countries that succeeded and those that did not control inflation. However, in general, inflation shocks reduced economic growth and increased unemployment.
The IMF working document provides historical insights, but making connections with the current economic situation is complex. A significant proportion of the cases studied stemmed from the 1973-79 oil crisis, which highlighted energy as a core component of inflation. However, recent inflation developments have been more varied, with initial drivers such as supply chain disruptions due to the pandemic and changes in consumer demand in the post-pandemic phase. This makes it difficult to draw direct parallels with the historical cases.
In today's diverse economic climate, the document's insights remain relevant. They underline the importance of tight and stable monetary policy in addressing inflation shocks, without significant negative impact on employment and growth. This highlights the need for careful and consistent policies to effectively navigate the current economic uncertainties.
The IMF document highlights the challenges of inflation management and the crucial role of stable monetary policy in fighting inflation, without having a substantial adverse impact on growth and employment. These observations are significant in the current fluctuating economic context, and point to the need for well-calibrated and sustained policy measures to efficiently maneuver through prevalent economic volatilities.
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Source: Financial Times
