Erdoganomics is spreading across the world
emerging markets, loose policy helps quell inflation. For countries that want firms to have access to cheap credit, in order to stimulate industrial growth, this is an appealing idea. One argument put forward is that less expensive borrowing will mean lower consumer prices.
Another is that it will boost exports, which may replenish foreign reserves. The problem with both arguments is that the economic activity boosted by low rates also buoys wages and makes firms optimistic about future prices, entrenching inflation. Low rates on government bonds also send foreign investors fleeing, whacking the currency.
It is nevertheless true that monetary policy works differently in emerging economies. Foreign investment matters more for market rates; aggregate demand matters less. In a recent paper Gita Gopinath, the imf’s first deputy managing director, and co-authors find that emerging markets’ policy rates have next to no impact on their real economies.
Looking at 77 developing countries since 1990, the researchers find that, just as in advanced economies, central banks raise the domestic rate at which they lend to local banks when inflation gets going. Unlike in advanced economies, banks do not pass the rate change on to government and household borrowers. To understand why, consider how banks borrow.
Emerging-market financial institutions struggle to find funds at home, since few households save and there are not many big firms. Instead, they turn to international markets. Counterintuitively, the risk premium demanded by foreign financiers tends to fall when inflation is rising, since at such times economic growth tends to be strong.
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