A simple solution to inflation

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An increasing number of commentators have pointed worryingly at growing inflation in many emerging markets. Inflation is around 8 percent in China and 11 percent in India. Part of the problem is the rising cost of energy resources, but that's not the whole story since inflation is afflicting both net energy importers and exporters. Russia, for example, is facing an inflation rate of around 15 percent. According to an article today in the Financial Times:

A weighted average of consumer price inflation in the 20 largest emerging markets rose from 4.5 per cent in March 2007 to 6.9 per cent in March 2008...

What can be done about this worrying trend? Anders Aslund, a senior fellow at the Peterson Institute for International Economics, proposes a simple solution for the transition economies: let their currencies float. 

Writing in the Moscow Times, Aslund had this to say:

Three countries [in the post-communist region] have successfully withstood the current inflationary test—Slovakia, Poland, and the Czech Republic. Their present annual inflation is a moderate 4 to 7 percent, and their high growth rates continue. These contries all pursue inflation targeting, which means that their independent central banks focus on keeping inflation within a low target band, while maintaining tight monetary policy with positive real interest rates. Hence, their floating exchange rates have risen significantly in relation to the euro.

Aslund points out that a number of other countries in the region maintain currency pegs of one sort or another, including Estonia, Latvia, the Ukraine, and Russia. All of these countries are suffering from rising levels of inflation. Aslund advises them - particularly Russia - to switch from their currency pegs to a float based on inflation targeting.

I tend to agree with this view; if Russia were looking for an opportune moment to switch from its peg, now would be the time. Oil prices are high and will probably not come tumbling down anytime soon. In addition, there is mounting pressure in Russia to spend some of its oil wealth on improved public services, which will only add to inflationary pressures. I wonder, though, what implications this could have for the dollar. If Russia (and a handful of other countries) were to end their dollar pegs, this could force other countries to follow suit as the dollar weakens and creates even greater inflationary pressures. Might we then see further loses in the value of the dollar?


Ryan Hahn

Operations Officer

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