Central banks hike interest rates in sync to tame inflation pressures
During the pandemic, central banks in both advanced and emerging market economies took unprecedented measures to ease financial conditions and support the economic recovery, including interest-rate cuts and asset purchases.
With inflation at multi-decade highs in many countries and pressures broadening beyond food and energy prices, policymakers have pivoted toward tighter policy.
As the chart below illustrates, central banks in many emerging markets proactively started to hike rates earlier last year, followed by their counterparts in advanced economies in the final months of 2021.
The monetary policy cycle is now increasingly synchronised around the world.
Importantly, the pace of tightening is accelerating in several countries, particularly in advanced economies, in terms of both frequency and magnitude of rate hikes.
Some central banks have begun to reduce the size of their balance sheets, moving further toward normalisation of policy.
Stable prices are a crucial prerequisite for sustained economic growth.
With risks to the inflation outlook tilted to the upside, central banks must continue normalising to prevent inflationary pressures from becoming entrenched.
They need to act resolutely to bring inflation back to their target, avoiding a de-anchoring of inflation expectations that would damage credibility built over the past decades.
Monetary policy can’t resolve remaining pandemic-related bottlenecks in global supply chains and disruptions in commodities markets due to the war in Ukraine.
It can however slow overall demand to address demand-related inflationary pressures, so a tightening of financial conditions is the goal.
The high uncertainty clouding the economic and inflation outlook hampers the ability of central banks to provide simple guidance about the future path of policy.
But clear communication by central banks about the need to further tighten policy and steps required to control inflation is crucial to preserve credibility.
Clear communication is also critical to avoid a sharp, disorderly tightening of financial conditions that could interact with, and amplify, existing financial vulnerabilities, putting economic growth and financial stability at risk down the road.
This article first appeared here.
Global current account balances widen war and pandemic
The war in Ukraine and resulting increase in commodity prices are expected to contribute to a further widening this year.
The lingering pandemic and Russia’s invasion of Ukraine are dealing a setback to the global economy.
This is affecting trade, commodity prices, and financial flows, all of which are changing current account deficits and surpluses.
Global current account balances – the overall size of deficits and surpluses across countries – are widening for a second straight year, according to the IMF’s latest External Sector Report.
After years of narrowing, balances widened to 3% of global gross domestic product in 2020, grew further to 3.5% last year, and are expected to expand again this year.
Larger current account balances aren’t necessarily negative on their own.
But global excess balances – the portion not justified by differences in countries’ economic fundamentals, such as demographics, income level and growth potential, and desirable policy settings, using the IMF’s revised methodology – could fuel trade tensions and protectionist measures. That would be a setback for the push for greater international economic cooperation and could also increase the risk of disruptive currency and capital flow movements.
Pandemic effects in 2021
The pandemic widened global current account balances, and it’s still having an asymmetric impact on countries depending, for example, on whether they are exporters or importers of tourism and medical goods.
The pandemic and associated lockdowns also shifted consumption to goods from services as people reduced travel and entertainment.
This also widened global balances as advanced economies with deficits increased goods imports from emerging market economies with surpluses.
In 2021, the IMF estimates that this shift increased the United States deficit by 0.4% of GDP and contributed to an increase of 0.3% of GDP in China’s surplus.
Surplus economies like China saw also increases due to greater shipments of medical goods that often flowed to the US and other deficit economies.
Surging transportation costs also contributed to widening global balances in 2021.
War and tightening in 2022
Commodity prices are one of the biggest drivers of external positions, and last year’s rally in oil prices from pandemic lows affected exporters and importers asymmetrically.
Russia’s February invasion of Ukraine exacerbated the surge in energy, food, and other commodity prices, widening global current account balances by raising surpluses for commodity exporters.
Monetary policy tightening is driving currency movements as rising inflation is leading many central banks to accelerate the withdrawal of monetary stimulus.
Revised expectations about the pace of the US monetary tightening brought about sizable currency realignment this year, contributing to the projected widening of balances.
Capital flows to emerging markets were disrupted so far in 2022 by increased risk aversion triggered by the war, with further outflows amid changing expectations about the increased pace of monetary tightening in advanced economies.
Cumulative outflows from emerging markets have been very large, about $50 billion, with a magnitude that’s similar to outflows during March 2020 but a pace that’s slower.
The IMF’s outlook for next year and beyond is for a steady decline of global current account balances as pandemic and war impacts moderate, though this expectation is subject to considerable uncertainty.
Global current account balances could continue to widen should fiscal consolidation in current account deficit countries take longer than expected.
Moreover, the stronger dollar could widen the US current account deficit and increase global current account balances.
Other factors that could widen these balances include a prolonged war that keeps commodity prices elevated for longer, the varying degrees of central bank interest-rate increases, and greater geopolitical tension causing economic fragmentation, disrupting supply chains, and potentially triggering a reorganization of the international monetary system.
A more fragmented trade system could either increase or decrease global balances, depending on how trade blocs are reconfigured.
Either way, though, it would reduce technology transfers, and decrease the potential for export-led growth in low-income countries and thus unambiguously erode welfare gains from globalization.
The war in Ukraine has exacerbated existing trade-offs for policymakers, including between fighting inflation and safeguarding economic recovery and between providing support to those affected and rebuilding fiscal buffers.
Multilateral cooperation is key in dealing with the policy challenges generated by the pandemic and the war, including to tackle the humanitarian crisis.
Policies to promote external rebalancing differ based on individual economies’ positions and needs.
For economies with larger-than-warranted current account deficits that reflect large fiscal shortfalls, such as the US, it’s critical to reduce government deficits with a combination of higher revenue and lower spending.
Rebalancing is a different proposition for countries with excessive surpluses, such as Germany and the Netherlands, which can be reduced by intensifying reforms that encourage public and private investment and discourage excessive private saving, including by expanding social safety nets in some emerging markets.
This article first appeared here.
Who Relies on Taiwanese Trade?
Following an official visit of US Speaker, Nancy Pelosi to Taiwan, relations between the island state – Taiwan (also known as the Republic of China) and its direct neighbour, the People’s Republic of China, have cooled considerably.
Apart from an increasing number of military exercises off the coast of Taiwan stoking fears of an escalation of the long-running conflict, the People’s Republic also has, to a certain extent, halted trade with Taiwan.
While an import ban on certain Taiwanese fruits and fish is unlikely to become a source of global tensions, China’s export stop on sand, a resource essential for the manufacturing of semiconductors, could prove devastating for countries like the US.
62% of the US’ total trade volume with Taiwan came from imports in 2021. The majority of these goods fall into the IT and electronics sector, with companies like Apple, Qualcomm and NVIDIA relying on chips manufactured in the large-scale semiconductor foundries of Taiwan.
Next to the war in Ukraine and the impact of the coronavirus pandemic, China’s sand ban could become another exacerbating factor to the ongoing chip shortage.
The US are not the only one profiting from Taiwanese exports. Germany, South Africa, Brazil, Saudi Arabia and Japan are Taiwan’s principal trade partners. Germany and Japan are especially reliant on Taiwan’s industry.
The basis of the tensions between China and Taiwan is the hitherto unresolved question of independence. After the end of the Chinese civil war in 1949, the remaining supporters of the defeated Kuomintang retreated to the island. Once established there, they proclaimed the Republic of China, while the People’s Republic sees the island, which is now governed democratically, as its own province.