Federal austerity measures and war will reduce the GDP of emerging economies by 2.4 percent

The US Federal Reserve has been aggressively raising interest rates to curb inflation. In response, other countries are adopting similar policies to protect their currencies.

A one percent increase in interest rates in the US reduces GDP by 0.5 percent in developed countries and 0.8 percent in emerging economies three years later. In this context, if interest rates in the US increase by 3 percent after the Ukraine war, it could reduce the GDP of emerging economies by up to 2.4 percent.

Rising interest rates in the US are doing more than derailing global growth. This poses a threat to macroeconomic stability in developing countries. Because these economies are heavily burdened with foreign debt. The ratio of exports to external debt in developing economies averaged 127 percent, an 18 percent increase from the turbulent period of 2013. This was the period when central banks were struggling to buy bonds. This is especially important for low-income and lower-middle-income countries.

Earlier in the 1980s, the Federal Reserve's monetary tightening to control inflation became popular, but then the level of total debt (public and private) in emerging and developing countries was lower than it is today. A rise in US interest rates then was enough to push the button for a Third World debt crisis. Thus monetary tightening by the Fed (for emerging markets and developing economies) carries significant risks of triggering a new series of financial crises.

Aggressive monetary tightening to control high inflation is futile. This is the stance taken by the Federal Reserve, the Fed doesn't even care what happens in other parts of the world.

The UNCTAD report says that the inflation we are facing today is very different from the inflation of the 1970s. Therefore, aggressive fiscal tightening is not the right answer. First, recent increases in commodity prices in real terms have been lower than in the 1970s, and the energy-intensity of GDP has also declined, so such drastic measures are not needed to control inflation. Second, global inflation is being affected by fewer sectors than in the past. Today, core inflation (excluding food and energy prices) is much lower than headline inflation, while in 1979-80 the two were roughly equal.

The third and most important aspect is that wages do not rise with the pace of growth in consumer prices. Real wages fall everywhere.

Fourth is the increased importance of shadow banks as credit providers which greatly complicates monetary policy transmission. Broad central bank autonomy and inflation targeting do not necessarily make monetary policy more efficient and effective.

UNCTAD's skepticism about the wage-price cycle is also shared by the International Monetary Fund in its latest World Economic Outlook (October 2022). The IMF notes that real wages are falling today.

Today, coordination is not seen during a global financial crisis or pandemic. As India prepares to assume the presidency of the U20 in December, it should initiate greater global coordination in terms of policy measures needed to address the current challenges.