Ukraine incursion, world stagflation

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR: Finger pointing in the blame game over Russia’s Ukraine incursion obscures the damage it is doing on many fronts. Meanwhile, billions struggle to cope with worsening living standards, exacerbated by the pandemic and more.

Losing sight in the fog of war

US Secretary of State Anthony Blinken insists, “the Russian people will suffer the consequences of their leaders’ choices”. Western leaders and media seem to believe their unprecedented “crushing sanctions” will have a “chilling effect” on Russia.

With sanctions intended to strangle Russia’s economy, the US and its allies somehow hope to increase domestic pressure on Russian President Vladimir Putin to retreat from Ukraine. The West wants to choke Russia by cutting its revenue streams, e.g., from oil and gas sales to Europe.

Already, the rouble has been hammered by preventing Russia’s central bank from accessing its US$643bn in foreign currency reserves, and barring Russian banks from using the US-run global payments transfer system, SWIFT.

Withdrawal of major Western transnational companies – such as Shell, McDonald’s and Apple – will undoubtedly hurt many Russians – not only oligarchs, their ostensible target.

Thus, Blinken’s claim that “The economic costs that we’ve been forced to impose on Russia are not aimed at you [ordinary Russians]” may well ring hollow to them. They will get little comfort from knowing, “They are aimed at compelling your government to stop its actions, to stop its aggression”.

As The New York Times notes, “sanctions have a poor record of persuading governments to change their behavior”. US sanctions against Cuba over six decades have undoubtedly hurt its economy and people.

But – as in Iran, North Korea, Syria and Venezuela – it has failed to achieve its supposed objectives. Clearly, “If the goal of sanctions is to compel Mr. Putin to halt his war, then the end point seems far-off.”

Russia, major commodity exporter

Undoubtedly, Russia no longer has the industrial and technological edges it once had. Following Yeltsin era reforms in the early 1990s, its economy shrank by half – lowering Russian life expectancy more than anywhere else in the last six millennia!

Russia has become a major primary commodity producer – not unlike many developing countries and the former settler colonies of North America and Australasia. It is now a major exporter of crude oil and natural gas.

It is also the largest exporter of palladium and wheat, and among the world’s biggest suppliers of fertilizers using potash and nitrogen. On 4 March, Moscow suspended fertilizer exports, citing “sabotage” by “foreign logistics companies”.

Farmers and consumers will suffer as yields drop by up to half. Sudden massive supply disruptions will thus have serious ramifications for the world economy – now more interdependent than ever, due to earlier globalization.

Sanctions’ inflation boomerang

International Monetary Fund Managing Director Kristalina Georgieva has ominously warned of the Ukraine crisis’ economic fallouts. She cautions wide-ranging sanctions on Russia will worsen inflation and further slow growth.

No country is immune, including those imposing sanctions. But the worst hit are poor countries, particularly in Africa, already struggling with rising fuel and food prices.

For Georgieva, more inflation – due to Russian sanctions – is the greatest threat to the world economy. “The surging prices for energy and other commodities – corn, metals, inputs for fertilizers, semiconductors – coming on top of already high inflation” are of grave concern to the world.

Russia and Ukraine export more than a quarter of the world’s wheat while Ukraine is also a major corn exporter. Supply chain shocks and disruptions could add between 0.2% to 0.4% to ‘headline inflation’ – which includes both food and fuel prices – in developed economies over the coming months.

US petrol prices jumped to a 17-year high in the first week of March. The costs of other necessities, especially food, are rising as well. US Treasury Secretary Janet Yellen has acknowledged that the sanctions are worsening US inflation.

The European Union (EU) gets 40% of its natural gas from Russia. Finding alternative supplies will be neither easy nor cheap. The EU is Russia’s largest trading partner, accounting for 37% of global trade in 2020. Thus, sanctions may well hurt Europe more than Russia – like cutting one’s nose to spite one’s face.

The European Central Bank now expects stagflation – economic stagnation with inflation, and presumably, rising unemployment. It has already slashed its growth forecast for 2022 from 4.2% to 3.7%. Inflation is expected to hit a record 5.1% – way above its previous 3.2% forecast!

Developing countries worse victims

Global food prices are already at record highs, with the Food Price Index (FPI) of the Food and Agricultural Organization up more than 40% over the past two years.

The FPI hit an all-time high in February – largely due to bad weather and rising energy and fertilizer costs. By February 2022, the Agricultural Commodity Price Index was 35% higher, while maize and wheat prices were 26% and 23% more than in January 2021.

Besides shortages and rising production costs – due to surging fuel and fertilizer prices – speculation may also push food prices up – as in 2007-2008.

Signs of such speculation are already visible. Chicago Board of Trade wheat future prices rose 40% in early March – its largest weekly increase since 1959!

Rising food prices impact people in low- and middle-income countries more as they spend much larger shares of their incomes on food than in high-income countries. The main food insecurity measure has doubled in the past two years, with 45 million people close to starvation, even before the Ukraine crisis.

Countries in Africa and Asia rely much more on Russian and Ukrainian grain. The World Bank has warned, “There will be important ramifications for the Middle East, for Africa, North Africa and sub-Saharan Africa, in particular”, where many were already food insecure before the incursion.

The Ukraine crisis will be devastating for countries struggling to cope with the pandemic. Unable to access enough vaccines or mount adequate responses, they already lag behind rich countries. The latest food and fuel price hikes will also worsen balance-of-payments problems and domestic inflationary pressures.

No to war!

The African proverb, “When two elephants fight, all grass gets trampled”, sums up the world situation well. The US and its allies seem intent to ‘strangle Russia’ at all costs, regardless of the massive collateral damage to others.

This international crisis comes after multilateralism has been undermined for decades. Hopes for reduced international hostilities, after President Biden’s election, have evaporated as US foreign policy double standards become more apparent.

Russia has little support for its aggressive violation of international law and norms.Despite decades of deliberate NATO provocations, even after the Soviet Union ended, Putin has lost international sympathy with his aggression in Ukraine.

But there is no widespread support for NATO or the West. Following the vaccine apartheid and climate finance fiascos, the poorer, ‘darker nations’ have become more cynical of Western hypocrisy as its racism becomes more brazen.

Inflation targeting constrains development

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR: All too many developing countries have been persuaded or required to prioritize inflation targeting (IT) in their monetary policy. By doing so, they have tied their own hands instead of adopting bolder economic policies for growth, jobs and sustainable development.

Why inflation targeting?

IT refers to monetary policy efforts to keep the inflation rate within a certain low range. Many countries – developed and developing – have adopted this policy priority following New Zealand’s 1989 lead, arbitrarily aiming to keep inflation under 2%.

Initially, developing economies adopted IT after crises to get financial support from the International Monetary Fund (IMF), e.g., after the 1997-98 Asian financial crisis. From the mid-1970s, many had borrowed heavily to accelerate growth. After the US Fed raised interest rates sharply from 1980, many succumbed to debt crises.

The IMF insisted on severe short-term stabilization policies to keep inflation and debt low. The World Bank complemented it with medium-term structural adjustment policies demanding market liberalization and other reforms.

Price stabilization policies to keep inflation low have been an IMF priority since. But instead of accelerating growth, as promised, IT has actually slowed it. Yet, developing countries have jumped on the IT bandwagon – 25 had formally adopted IT by 2020, while most others strive to keep inflation very low.

How bad is inflation?

Most believe that inflation is the greatest threat to the economy and growth. Many presume inflation creates uncertainty, causing resource misallocation. All this is said to retard growth – meaning fewer jobs, less tax revenue and lasting poverty.

Higher prices hurt by reducing purchasing power, especially harming wage-earners. On the contrary, price stability – implying low and steady inflation – is believed to be more conducive to ensuring growth and prosperity.

Another core IT belief is that money only temporarily affects growth, but permanently affects prices. IT advocates believe central bankers should mainly strive for price stability – not employment or growth. They usually presume independent central banks are better at doing so.

Many central bankers and economists dogmatically believe – without evidence – that tightly reining in inflation actually spurs growth. Acknowledging developing countries are more prone to external and supply shocks, the IMF recommended targets of up to 5% – higher than developed countries’ 2%.

Most developing countries aspiring to become emerging market economies have formally adopted IT – e.g., South Africa’s 3–6% or India’s 2–6%. By setting successively lower short-term inflation targets, they believe financial markets are impressed.

But by doing so, they prevent themselves from realizing their full economic potential. Striving to emulate the developed countries’ 2% target constrains both growth and structural transformation. After all, it was quite arbitrarily set for no economic reason, except the NZ finance minister liking the ‘0 to 2 by ’92’ slogan!

Arbitrary targets

While there is little disagreement about likely problems associated with ‘hyper-’ or very high inflation, the threshold beyond which inflation becomes harmful is a moot issue on which there is no consensus.

Inflation targets are arbitrarily set, as acknowledged in an IMF paper. Hence, “any choice of a medium-term inflation target for these [developing] countries is bound to be arbitrary”. Harry Johnson had found early IMF empirical studies of the inflation-growth relationship to be inconclusive.

Later studies did not settle the matter. For example, Michael Bruno and William Easterly at the World Bank concluded that inflation under 40% did not tend to accelerate or worsen, and “countries can manage to live with moderate – around 15–30 percent – inflation for long periods”.

MIT’s Rudiger Dornbusch and Stanley Fischer, later IMF Deputy Managing Director, came to similar conclusions. They found moderate inflation of 15–30% did not harm growth, noting “such inflations can be reduced only at a substantial short-term cost to growth”.

A 2000 IMF paper suggested 11% inflation was optimal for developing countries; 7% inflation would have “an insignificant negative effect” on growth, while 18% inflation remained positive for growth. Yet, it recommended an IT target of 7–11% and “bringing inflation down to single digits and keeping it there”.

The IMF Independent Evaluation Office’s 2007 report on Sub-Saharan Africa found “mission chiefs are evenly divided on whether (or not) the Fund should tolerate higher [than 5%] inflation rates…IMF policy staff acknowledge that the empirical literature on the inflation-growth relationship is inconclusive”.

Hence, very low inflation targets are quite arbitrary without any sound theoretical and empirical bases. But the IMF and its chorus of economists have not hesitated to insist on keeping inflation very low by promoting IT for all, especially to susceptible developing country policymakers.

Constraining development

Very low inflation targets particularly constrain low-income countries (LICs). LIC governments face modest revenue bases and limited domestic savings. Hence, they should borrow more from central banks to finance their development spending.

But such borrowings are prohibited by law in many developing countries – especially those which have formally embraced IT – to prove their anti-inflationary commitment. Thus, a potentially major means for central banks to be more developmental is denied by statute.

By raising interest rates to keep inflation very low, central banks reduce not only consumer spending, but also business investments. Such policies also increase both public and private debt burdens, in turn constraining spending.

Thus, overall aggregate demand remains depressed, limiting growth unless compensated by greater export demand. But higher interest rates attract capital inflows, causing exchange rates to appreciate, undermining export competitiveness.

Means deny ends

IT policy is problematic for two major reasons. First, it demands debilitatingly low targets. Second, it denies central banks’ potential developmental role by insisting on price stability – read ‘containing inflation’ – as its principal goal.

IMF researchers have acknowledged, “identifying the growth effects of moving from, say, 20 percent inflation to 5 percent has been challenging”.

They concluded, “pushing inflation too low – say, below 5 percent – may entail a loss of output …, suggesting a need for caution in setting very low inflation targets in low-income countries… In particular, inflation targets should be set so as to help avoid risks of an unintended contractionary policy stance.”

Also, San Francisco US Federal Reserve Bank research has concluded, “developing economies that adopted an inflation target did not show any substantial gains in growth in the medium term compared with those that did not adopt a target”.

Thus, developing countries prioritizing IT have, often unwittingly, curtailed their own economic prospects. Falsely promoted as means to enhance growth, jobs and development, IT, in fact, constrains them – the ultimate con!

Rejecting the IT fetish does not mean doing nothing about inflation. Instead, developing countries need to better know the economic challenges they face and the efficacy of their policy tools. National economic priorities should be comprehensively addressed without subordinating all policy goals to the god of IT.

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Inflation targeting voodoo

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR: All over the world, people expect policies by central bankers trained in economics to have a sound scientific base. But in fact, inflation targeting is an article of faith with neither theoretical nor empirical basis.

Policy inspiration

The two per cent (2%) inflation target is now virtually an “economic religion”. US Federal Reserve chairman Jerome Powell noted it had become a “global norm”.

In 1989, New Zealand became the first country to adopt a 2% inflation target. “The figure was plucked out of the air”, acknowledged Don Brash, then Governor of the Reserve Bank of New Zealand (RBNZ), its central bank.

It was prompted by a “chance remark” of NZ Finance Minister Roger Douglas during “a television interview on April 1, 1988, that he was thinking of genuine price stability, ‘around 0, or 0 to 1 percent’.” Meanwhile, Brash seemed to think his role was to keep inflation positive, but under 2%.

In the RBNZ’s annual report to March 1989, Brash was “confident that inflation could be reduced below 2 percent by the year to March 1993”. The finance minister welcomed this, asking “whether it might be feasible to achieve that by the end of calendar year 1992 – he liked the sound of ‘0 to 2 by ’92’”!

Thus, “‘0 to 2 by ’92’ became the mantra, repeated endlessly”. Brash and his colleagues “devoted a huge amount of effort” preaching this new mantra “to everybody who would listen – and some who were reluctant to listen”.

This involved “many hundreds of informal speeches to Rotary Clubs, Chambers of Commerce, farmers’ groups, church groups, women’s groups, and schools”. A new cult –inspired by RBNZ’s inflation targeting – was thus born.

Parliamentary mandate

When the bill setting the RBNZ inflation target between zero and 2% reached the legislature, parliamentarians were about to adjourn for Christmas. Also, “one of the bill’s strongest opponents was laid up in the hospital”.

Nevertheless, the debate over the legislation was robust. Labour unions were worried that an inflexibly narrow target would raise unemployment. The New Zealand Manufacturers’ Federation warned, “This is wrong in principle, undemocratic and inflexible”.

A real estate developer asked Brash to announce his body weight, for him to work out what rope would be needed to hang the RBNZ Governor from a lamppost in NZ’s capital, Wellington. But the bill passed as leaders of the ruling Labour Party brushed aside concerns.

Weak evidence, strong conclusion

Since the RBNZ’s adoption of 2% inflation, “plucked out of the air” as a target, leading economists – some of whom have served as senior officials at the major international financial institutions and central banks – studied long time series for many countries.

However, none could find any strong evidence to justify a single digit inflation threshold beyond which inflation may negatively impact economic growth. Yet, they concurred with a single digit inflation target!

For example, Stanley Fischer concluded, “however weak the evidence, one strong conclusion can be drawn: inflation is not good for longer-term growth”. And Robert Barro asserted, “the magnitude of [negative] effects are not that large, but are more than enough to justify a keen interest in price stability”.

A Reserve Bank of Australia study found “Average inflation is…a fragile explanation of economic growth”. Yet, it concluded, “While the results are not as robust as one would like, the most obvious interpretation of the evidence ... is that the negative correlation between inflation and growth arises from a causal relationship”.

Pierre Fortin – past President of the Canadian Economics Association – emphasized, “Strong claims that there are large macroeconomic benefits to be reaped … are not presently founded on robust quantitative evidence. They are premature”.

Cheerleaders claim inflation-targeting has delivered low inflation. But others have alternative explanations for the Great Moderation. The “one-size-fits-all” mantra has also effectively shut the door to alternative strategies for robust, sustainable and inclusive growth.

Harm’s way

Inflation targeting can be harmful, especially as monetary authorities have little control over external sources of inflation. Current inflationary pressures are largely due to rising international food and fuel prices.

Targeting also harms the economy when inflation is caused by supply shocks, such as production and distribution disruptions, e.g., due to pandemic related lockdowns or other restrictions.

Raising interest rates or monetary tightening to achieve targets when inflation is largely due to external or supply shocks will exacerbate the debt burdens of households, businesses and governments, thus reducing economic growth and employment prospects.

Central bankers trying to “cool” labour markets in their anti-inflation crusade hurt labour by raising unemployment and worsening working conditions. It is likely to be socially less costly to ‘accommodate’, i.e., accept supply or external shock inflation than mechanically achieving an arbitrary inflation target.

Inflation targeting has also privileged price stabilization at the expense of other central bank responsibilities, including maximizing employment, growth and progress.

Of course, central bankers should be monitoring prices of key goods and services (e.g., food, fuel, housing, healthcare) which weigh heavily on consumer spending. Policymakers must design alternative policy tools to address such essential price rises rather than relying solely on raising interest rates.

Targeting a specific inflation rate is against the International Monetary Fund (IMF)’s Articles of Agreement. Article IV states, “each member shall: (i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances”.

Thus, IMF members are obliged to foster economic growth, and maintain “reasonable” price stability – not chasing a fixed inflation target, presuming that growth would follow. There is no ‘one-size-fits-all’ policy or universal target. And policy design depends on country specific circumstances.

Counter revolution

Inflation targeting should never have become monetary policy. It should have been rejected long ago if policymaking was informed by theory and experience. But central banks have been targeting inflation, supposedly to enhance growth and employment!

Some assert money is “neutral”, insisting central bankers cannot affect real economy variables, e.g., output, employment, investment. Thus, they have “discounted the role of money in … monetary policy more than is justified”.

But money is far from neutral, impacting the real economy quite significantly. This was evident after the 2008-2009 global financial crisis and during the COVID-19 pandemic. Policymakers should instead be primarily concerned about the real economy – output, employment, sustainable development.

Unsurprisingly, inflation targeting has not accelerated growth, especially in developing countries. Even in developed countries, it seems to have exacerbated “secular stagnation”, i.e., anaemic growth.

Thus, instead of increasing growth, employment and structural transformation, the inflation obsession has slowed economic growth. Universal rejection of the inflation targeting hoax will thus advance human progress.

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