Emerging markets need a Volcker... - Views on News from Equitymaster

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Emerging markets need a Volcker...

Jul 7, 2008

"Policy makers in emerging economies from Russia to Vietnam may have to start acting less like Ben S. Bernanke and more like Paul Volcker if they want to bring inflation under control," says the International Herald Tribune (IHT). The newspaper reports that countries having their currencies tied to the US dollar have had to keep their monetary policies linked to the Federal Reserve's. Now, after the Fed has seen its most aggressive easing (interest rate cuts) in two decades, central bankers in these nations (those with currencies pegged to the dollar) find themselves with interest rates too low for their economies. They are in fact facing the worst inflation in several decades. The answer thus lies in the central bankers raising interest rates more aggressively, the way the former chairman of the Federal Reserve Paul Volcker did in the early 1980s.

As a matter of fact, faced with inflation that approached 15% in 1980, Volcker pushed interest rates as high as 20% and drove the US into its deepest recession since the 1930's Great Depression. However, this move ended the US' stagflation crisis (something that is talked about these days as well) of the 1970s by limiting the growth of the money supply, abandoning the previous policy of targeting interest rates. Inflation, which peaked at 13.5% in 1981, was successfully lowered to 3.2% by 1983. Volcker's moves also brought some sanity to the US dollar that had reached the brink where it looked like a worthlessness currency (some say it looks the same these days as well!).

  • Also read - Lessons from history

    What next?
    Central banks in Taiwan, the Philippines, Chile, Mexico, Egypt, Brazil and Russia all raised interest rates last month. However, the fact that they've already waited too long for inflation to surge like wildfire, has increased the risks of these economies moving into a slowdown. Even in case of India, where the Reserve Bank of India (RBI) has probably waited for too long before taking its actions on the inflation front, talks abound of a slowdown in economic activity over the coming few quarters.

    Probably, a second coming of Volcker could lead to world economies (both developing and developed ones) saving themselves from going 'down the drain'!

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