In the 1990s a new metaphor was devised to describe the global economy: the Goldilocks economy, meaning one that, like Goldilocks’s porridge, was neither too hot nor too cold, with growth chugging along and inflation kept in check.
For policymakers it was the perfect outcome in which they had little to do except to keep an eye on the latest numbers. Some heralded the Goldilocks economy as a new paradigm. Like most new paradigms it proved to be a busted flush but policymakers in emerging markets must now wish that they were overseeing Goldilocks-type economies.
Growth rates of 7%, 8%, 9% sound good in theory but can be a nightmare for central bankers worried about overheating economies, asset bubbles and runaway inflation.
China’s GDP rise of 10.3% last year seems more like an economy burning out of control than one on a sustainable path to enrichment. In India, too, excitement about the country’s strong growth is giving way to concerns about its inflation outlook. Global investors have become net sellers of Indian equities for the first time since May, primarily because of worries about the pace of price rises. India’s wholesale price index rose 8.4% year on year in December. Few analysts think the level has peaked.
Inflationary pressures are most acute in emerging Asia but other developing countries are equally vulnerable – Brazil, Chile, Turkey and Russia are all facing risks, although not on the scale of China.
The stock policy response from governments has been fairly predictable: increases in interest rates and bank reserve requirements and the imposition of capital controls (or more accurately additional taxes on foreign investments). Some countries have tried an unorthodox approach. In Turkey, for example, the central bank is simultaneously pursuing a tight and loose monetary policy. It cut the policy rate by 75 basis points last month to take some heat out of the lira while pushing up reserve requirements to curtail credit growth.
The trouble is, no matter what central bankers do there’s a limit to the effects. Inflationary pressures and asset bubbles are being stoked by several different factors. There’s little any emerging markets central banker can do about fast-rising food and energy prices, for example.
And thanks to ultra-loose monetary policy in the US and Europe, capital flows into developing countries will continue to shoot up. Net private capital flows to these economies totalled more than $900 billion last year, according to the Institute of International Finance, 50% up on 2009, and are forecast to reach $1 trillion by the end of 2012.
The onus for action falls on governments, not just the central banks. Exogenous issues mean that China will face an inflation problem this year no matter what but the economy would be better served if the Communist Party were to rein in credit growth. Letting the renminbi appreciate would help too.
The best way for Brazil’s economy to grow in a more sustainable way is for the government to tighten fiscal policy, so allowing interest rates to be cut, not raised, and taking pressure off the real.
Emerging markets do not face the challenges western economies are up against but the road ahead is a tricky one. The Goldilocks economy looks a long way off.
