inflitation

1. 1
Tackling High Inflation
in Emerging Markets
MAY 17, 2023
Gita Gopinath
First Deputy Managing Director
International Monetary Fund
Presentation at Banco Central do Brasil

2. 2
INTERNATIONAL MONETARY FUND
Overview and key issues
• What factors have accounted for the solid performance of emerging markets
(EMs) in the current global tightening cycle?
• What is the appropriate strategy for bringing inflation back to target?
• How should EM central banks respond to financial stresses that may pose
tradeoffs in achieving price stability goals?
• How can fiscal policy help in the fight against inflation?

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INTERNATIONAL MONETARY FUND
Many EMs have held up well in environment of sharply
rising global rates
…which helped keep capital outflows limited.
EMs tightened earlier and more aggressively than
AEs…
Ex-ante real monetary policy rates
(Percent)
Sources: Consensus Economics; Haver Analytics; national authorities; and IMF staff calculations.
Note: Real policy rate is the difference between the nominal rate and one-year ahead inflation
expectations. Aggregates are PPP GDP-weighted averages. Emerging markets = Hungary, India,
Indonesia, Malaysia, Philippines, Poland, Romania, Thailand; LA5 = Brazil, Chile, Colombia,
Mexico, Peru.
Sources: Emerging Portfolio Fund Research (EPFR) database; Haver Analytics; and IMF staff
calculations.
Note: Global Financial Crisis (9/10/2008); Taper Tantrum (5/22/2013); Fed Hike (1/5/2022).
Latin America: Cumulative bond flows
(Percent of initial allocation)
-12
-8
-4
0
4
8
12
0 6 12 18 24 30 36 42 48 54 60 66
Week
Global Financial Crisis (2008)
Taper Tantrum (2013)
Fed Hike (2022)
-6
-4
-2
0
2
4
6
8
Dec-19
Mar-20
Jun-20
Sep-20
Dec-20
Mar-21
Jun-21
Sep-21
Dec-21
Mar-22
Jun-22
Sep-22
Dec-22
Mar-23
LA5
Emerging markets
United States

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Improved credibility of monetary policy frameworks
has helped ease tradeoffs for central banks
Sources: Consensus Forecasts, IMF staff calculations.
Note: EMs include BGR, BRA, CHL, COL, HUN, IDN, IND, MEX, MYS, PER, PHL, POL,
ROU, RUS, and THA. Average is PPP-weighted; LT=long term.
..which has helped improve anchoring of
expectations across EMs
Frameworks in EMs improved markedly in the past
two decades..
EMs: Central bank transparency and IT frameworks
Sources: Rawat, Ye, and Gelos (2020)
Note: The Central Bank Transparency Index (Dincer, 2019) measures political, economic,
procedural, policy, and operational transparency. The chart shows the increase in mean
transparency among EMDEs over time.
EMs: Inflation expectations anchoring, 2005-21
(Left scale: percentage points; Right scale: index, lower=better anchored)
0.0
0.1
0.2
0.3
0.4
0.5
0
1
2
3
4
2005 2007 2009 2011 2013 2015 2017 2019 2021
Deviation of LT forecasts from target
Sensitivity of LT forecasts to inflation surprises (rhs)
0
1
2
3
4
5
6
7
8
0
5
10
15
20
25
30
35
2000 2003 2006 2009 2012 2015 2018
Inflation-targeting (IT) countries
Central bank transparency index (RHS)
Number of countries Index

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Reduced financial vulnerabilities also contributed to
resilience of EMs
EM banking sectors are better capitalized… …and reserves increased until the pandemic
Sources: IMF, World Economic Outlook database; and IMF staff calculations.
Note: Average is purchasing-power-parity GDP-weighted. Emerging markets = Brazil,
Chile, Colombia, Hungary, India, Indonesia, Malaysia, Mexico, Peru, Philippines, Poland,
Romania, Thailand.
EMs: Reserve assets
(Percent of GDP)
EMs: Tier-1 capital
(Percent of risk-weighted assets)
Sources: IFS, WEO, IMF staff calculations.
Note: Aggregates are PPP GDP-weighted averages. Emerging markets =
Hungary, India, Indonesia, Malaysia, Philippines, Poland, Romania, Thailand; LA5
= Brazil, Chile, Colombia, Mexico, Peru.
0
4
8
12
16
20
Emerging Markets LA5
2008 2021
0
5
10
15
20
25
30
2000 2004 2008 2012 2016 2020

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Financial markets remain optimistic about inflation
Inflation relative to mid-point of target range
(Percent)
Sources: Bloomberg, IMF WEO, IMF staff calculations.
Policy rate: Historical and forecast
(Percent)
Sources: Historical from national authorities; Forecasts from Bloomberg;
and IMF staff calculations.
Markets expect inflation to fall relatively quickly
including in EMs…
…which would allow policy rates to fall starting
this year.
-5
0
5
10
15
20
2021 2022 2023 2024
Latin America
Euro area
USA
CEE
Asia
-2
2
6
10
14
2021 2022 2023 2024 2025
Latin America
Euro area
USA
CEE
Asia

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However, inflation has proved persistent
Sources: Haver, OECD, and IMF staff calculations.
Note: Median of year-on-year core inflation rates across AEs and EMs.
…and services inflation has picked up markedly
Services inflation
(Percent, year-on-year)
Sources: Haver, OECD, and IMF staff calculations.
Note: Median of year-on-year core inflation rates across AEs and EMs.
ARG = Argentina; CHN = China; EA = Euro area; US = United States;
TUR = Türkiye.
Core inflation
(Percent, year-on-year)
0
1
2
3
4
5
6
7
8
9
2018 2019 2020 2021 2022 2023
Advanced Economies
Emerging Economies
0
1
2
3
4
5
6
7
8
9
2018 2019 2020 2021 2022 2023
AEs ex. US, EA
EMs ex. CHN, ARG, TUR
US
EA
Core inflation remains high…

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Monetary policy strategy

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Risk of inflation persistence argues for maintaining
tight monetary policy
• Several factors may help explain sticky
inflation and pose upside inflation risks
• Labor markets still strong and U* may
have risen significantly
• Wage and price indexation more
prevalent in EMs than in AEs
• EMs more vulnerable to upside inflation
surprises given higher passthrough of
shocks
• Strong rationale for maintaining tight
policies and reacting aggressively to
upside inflation surprises
Oil price shocks have a larger effect on CPI
price levels in EMs
Quarter
Core CPI response to an oil price shock
(Percent)
Source: Baba and Lee (2022)
Note: Sample covers European EMs and AEs. The figure plots the
responses to a 10 percent oil price shock
EM
AE

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Risk management approach suggests reacting
aggressively to upside inflation surprises…
Optimal targeting rule in simple New Keynesian model is instructive
• AS curve: 𝜋𝑡 = 𝑖𝑝𝜋𝑡−1 + 𝜗𝑥𝑡
• Targeting rule: push output down
more today if inflation expected to
persist
Source: IMF staff calculations.
𝑥𝑡= −
𝜅
𝜆 𝑗=0
∞
(𝛽𝑖𝑝)𝑗𝜋𝑡+𝑗
Model simulation: Cost shock under alternative targeting rules
• Simulation shows that cost shock
generates large inflation runup
when central bank underestimates
inflation persistence.

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…as correcting for unexpectedly persistent inflation later
is costly
• Simulation builds on previous one by
assuming that central bank shifts to
optimal rule (based on true structural
persistence parameter) after a year.
Model simulation: Cost shock under alternative targeting rules
Source: IMF staff calculations.

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Monetary policy and financial stress

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EMs may see heightened financial stresses
• Financial stresses could affect EMs through different channels than AEs
► Credit rather than duration risk; and pressures from capital outflows
• Additional tools may improve tradeoffs, including liquidity support or ELA in FX
► But should be used carefully, and be temporary/targeted
• IMF’s Integrated Policy Framework aims to identify when suitable to use FXI or CFMs
► Use needs to be guided by careful analysis of frictions and shocks

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Capital outflow and exchange rate pressures
Policy Responses under Financial Frictions
Deep FX markets Shallow FX markets
Low FX mismatches
Exposed to: Fundamental shocks
(e.g., US tightening)
Response:
Adjust policy rate to stabilize inflation,
allow depreciation.
Exposed to: Both fundamental shocks and UIP
shocks
Response:
Fundamental shocks: policy rate and
depreciation
UIP shocks: FXI and reduction in inflow CFMs
High FX mismatches
Exposed to: Both fundamental shocks
and sudden stops
Response:
Before shocks: may impose
CFM/MPMs on FX inflows to reduce
systemic financial risk
After shocks: adjust policy rate and
allow depreciation
Exposed to: Fundamental shocks, UIP shocks,
and sudden stops
Response:
Fundamental shocks / sudden stops:
CFM/MPMs to reduce systemic financial risk,
adjust policy rate, allow depreciation
Taper tantrums: FXI and reduction in inflow
CFMs, keep policy rate unchanged

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Fiscal policy and inflation

16. 16
INTERNATIONAL MONETARY FUND
Fiscal tightening can help cool inflation, reduce public debt
Source: Chen, Goncalves, Jakab, and Linde (2022)
Note: Simulations by IMF staff using a two-country dynamic stochastic general equilibrium heterogenous agent model based on Erceg and Linde (2012).
Fiscal tightening can help fight
global inflationary shock,…
.
…ease the burden on
monetary policy,…
…and reduce public debt.
Core inflation
(Percentage points, year-on-year,
deviation from baseline)
Policy rate
(Percentage points, annual percentage rate,
deviation from baseline)
Government debt
(Percentage points, percent of GDP,
deviation from baseline)
-0.5
0
0.5
Note: Average of first 12 quarters.
-1
0
1
Monetary Tightening Fiscal Tightening
Note: Average of first 4 quarters.
-6
-4
-2
0
2
4
6
Note: After 5 years.

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Fiscal expansion likely to boost inflation and government debt,
depending on how central bank responds
17
• Critical to provide targeted support to vulnerable populations
• But fiscal expansion boosts inflation and raises public debt
► If CB reacts aggressively, then large increase in government debt
► If CB accommodates, then large boost to inflation that may de-anchor inflation expectations
Source: Chen, Goncalves, Jakab, and Linde (2022)
Note: Simulations by IMF staff using a two-country dynamic stochastic general equilibrium heterogenous agent model based on Erceg and Linde (2012).
Output
(Percentage points, deviation from baseline)
Core inflation
(Percentage points, year-on-year, deviation
from baseline)
Government debt
(Percentage points, percent of GDP, deviation
from baseline)
0
0.5
1
1.5
Aggressive Policy Loose Policy
Note: Average of first 8 quarters.
0
0.1
0.2
0.3
0.4
Aggressive Policy Loose Policy
Aggressive Policy Loose Policy
Note: Average of first 12 quarters.
0
0.5
1
1.5
Aggressive Policy Loose Policy
Note: After 5 years.

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Government debt heightens key EM vulnerabilities
• Higher debt raises EM sovereign default risk when global financial conditions tighten
• Effects on domestic financial conditions may be amplified through sovereign-bank nexus
• Weak fiscal position heightens risks of fiscal dominance and de-anchoring of inflation expectations
More government debt raises default risk
and borrowing costs…
Source: GFSR (April 2022)
…and increases risk that inflation expectations
de-anchor
Source: Brandao-Marques, Casiraghi, Gelos, Harrison, Kamber (2023).
Note: Sample covers EMs. The figure plots the responses to a 10 percent
debt surprise.
5-yr Inflation Expectations response to a debt surprise
(Basis points)
Sovereign Default Risk Response to Financial Conditions Shock
(Percentage points)
-0.06
-0.02
0.02
0.06
0.10
0 2 4 6 8 10
Quarters after the shock
Average public debt level
High public debt level

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Conclusions

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Conclusion
• Main monetary policy priority is to bring inflation credibly back to target
► Insufficient monetary policy tightening now could necessitate more painful policy actions later
• Fiscal policy should support monetary policy
• Financial tools – judiciously used – can improve tradeoffs in event of pronounced stress
• Crucial to maintain independent central banks with strong policy frameworks
► Better frameworks – monetary and financial – have allowed EM central banks to pursue countercyclical
policies and withstand AE policy tightening
► Important to continue further refining and strengthening these frameworks
► Enhanced central bank transparency and communication will be a key component
► IMF heavily involved in promoting central bank transparency (including through CBT code reviews)