Persistent and high inflation worldwide and the actions central banks have taken to rein it in are depressing economic activity, weakening household and business confidence and roiling financial markets. In major advanced economies, including the euro zone, Japan and the UK, sluggish and tepid policy responses have compounded the effects of external shocks, knocking growth trajectories off track.
Consequently, many developed countries face the challenges that have long characterised periods of economic and financial stress in emerging economies:
steep currency depreciations relative to the US dollar, rising government bond yields, strained public finances and tightening policy constraints.
The US economy, for its part, is rife with conflicting signals. On the positive side, consumer demand remains strong and employment has continued to grow at a reasonably healthy pace.
At the same time, GDP growth is anaemic while inflation remains high by any measure. This leaves the US Federal Reserve with little choice but to
raise interest rates further, despite the tightening of financial conditions caused by a strong dollar and falling asset prices.
In Europe, energy supply disruptions are fuelling inflation and constraining growth, stoking fears of
energy shortages in the winter and undermining confidence in the private sector.
The recent plunge in
the pound’s value is emblematic of the many challenges facing the UK economy, including adverse external circumstances, the ongoing fallout from Brexit and the country’s undisciplined fiscal policies. In many other European countries, populist policies could increase the risk of fiscal and financial instability.
Japan is the only major advanced economy that has the luxury of maintaining an easy monetary policy thanks to its
low inflation rate. This could help the country sustain stable albeit low growth, as the yen’s rapid depreciation has not had any appreciable negative effects thus far.
While emerging economies face similar challenges, including high inflation and depreciating currencies, they generally have better growth prospects than their advanced counterparts. Still, weak demand worldwide and tighter financial conditions will increase pressure on developing economies with current account deficits.
But barring a few exceptions such as Türkiye,
Sri Lanka and Venezuela – where rampant economic mismanagement has precipitated currency collapses – most emerging markets do not seem to be heading toward a balance of payments crisis.
That said, China faces a raft of problems resulting from the government’s rigid adherence to its zero-Covid policy, a faltering
real estate sector and unsustainable pressures in the financial system. While inflation remains under control, the renminbi’s depreciation relative to the US dollar has limited the People’s Bank of China’s ability to cut interest rates.
The government and the central bank have implemented several fiscal and monetary
stimulus measures, but these have had limited effect on private consumption and investment. Export growth, too, is likely to be restrained by weak global demand.
India’s economy, on the other hand, remains a bright spot. The country is likely to register strong growth this year and in 2023 as exports rise owing to the rupee’s depreciation and the beneficial effects of various reforms undertaken in recent years. However, the Reserve Bank of India’s ongoing struggle to rein in high inflation is a constraining factor.
Meanwhile, Russia’s economy has been battered by the sanctions Western powers have imposed since its invasion of Ukraine, although rising export revenues and weak imports have softened the blow by strengthening the rouble.
Latin American currencies have done surprisingly well this year, but Brazil and many other countries in the region face
challenging political environments. This could dampen domestic demand and growth, scare off foreign investors and foment economic instability.
Governments and central banks no longer have the luxury of stabilising growth and offsetting adverse shocks with unfettered fiscal and monetary stimulus. At a minimum, governments must avoid poorly targeted fiscal measures and other unhelpful populist policies, do what they can to overcome supply bottlenecks and support central banks as they strive to restore price stability.
An ineffective policy response endangers those hit hardest by
food and energy price increases: the world’s poorest economies and the poorest households in every country. With little room for error, policymakers must coordinate fiscal and monetary measures to alleviate short-term inflationary pressures and focus on reforms that can improve long-term growth.
In addition to mitigating labour supply and trade constraints, they must create incentives for investment in green technologies and other types of infrastructure. Such measures are crucial to supporting private sector demand and confidence in the short term and to re-anchoring inflation expectations.
Eswar Prasad, a professor at Cornell University, is a senior fellow at the Brookings Institution and the author of “The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance”. Aryan Khanna also contributed to this article. Copyright: Project Syndicate 
