Macro policies targeting low inflation : revisiting the conventional wisdom in selected developing countries of Asia

Abstract

This thesis questions the validity of macroeconomic policies that emphasise targeting low inflation rather than economic development. It provides systematic research in the context of Asian developing countries to raise doubts about this conventional wisdom of keeping inflation at a low single digit level. In this connection, the study addresses three questions relating to the growth-inflation nexus. The first question is whether there exists an inflation threshold at 5 per cent; in other words, whether inflation becomes harmful to economic growth when it exceeds 5 per cent. This is because the International Monetary Fund (IMF) advises developing countries to restrict the inflation rate to not more than 5 per cent per annum. It is regarded as safe and conducive to long term economic growth. The second question is whether the threshold level varies according to country-specific circumstances and levels of development. The purpose is to examine the validity of IMF's policy advice of keeping inflation at 5 per cent irrespective of country-specific circumstances. The final question is on the nature of policy suggestions relating to growth and inflation in country reports by the IMF. This is to determine whether the advice in the IMF reports have any reflection of the need for a change suggested by leading economists, including the Chief Economist of the IMF, in the aftermath of the global economic crisis of 2008-2009. The findings of the research provide strong empirical evidence that an inflation rate beyond 5 per cent is not necessarily detrimental to economic growth. The cross-country panel study shows that the threshold varies between 8 and 15 per cent. Similarly, results from country-specific study on Bangladesh reveal that the threshold is around 15 per cent. Empirical evidence also suggests that the threshold level varies according to the levels of development. Poorer and less developed countries demonstrate a higher inflation tolerance. Analyses from the IMF country reports show that policy advice of achieving low inflation at around 5 per cent or less continues to receive priority in general. There is little evidence that IMF's policy prescription reflects the need for a change in the wake of the recent global economic crisis. Nor is it consistent with country-specific historical experience on inflation and growth. The results, in short, help to conclude that the empirical basis for maintaining inflation at 5 per cent or below in developing countries of Asia is weak. We also conclude that targeting inflation should be done after a careful consideration of country-specific circumstances and levels of development. Taking all these into account, the IMF should rethink its macroeconomic policy advice to developing countries and policy makers should highlight their country-specific circumstances during Article IV consultations with the IMF officials or when they negotiate with the IMF to access its support facilities. Thus the analyses and findings of this thesis reveal its two important contributions. First, it provides a unique contribution to the literature pertinent to the growth-inflation nexus. Secondly, it helps rethinking macroeconomic policy making in the developing countries that still follow a rule of low inflation targeting policies. Macroeconomic policies require a broader perspective, creating a balance between the need for stabilisation and development. The study suggests that the developing countries should give priority to poverty reduction and employment creation instead of pursuing a restrictive policy of low inflation.

Date of Award	2013
Original language	English