The Decline of Inflation in Emerging Markets: Can It Be Maintained?

decline in inflation in emerging market economies.1 By the end of 2000, average inflation in emerging markets had declined from triple-digit figures in the late 1980s to some 5 percent excluding a few outlier cases—Indonesia, Turkey, and Venezuela (Table 4.1). Such low levels of inflation have not been seen since before World War II, when, mostly under the discipline of the gold standard system of fixed exchange rates, prices were roughly stable and episodes of deflation were not uncommon. The recent decline of inflation in emerging markets looks all the more impressive against the background of the 1970s and 1980s. Inflation began to rise gradually in the 1950s, but it accelerated dramatically in the 1970s and early 1980s, culminating in several episodes of triple-digit annual inflation and four major hyperinflations in the late 1980s/early 1990s (Figure 4.1).2 From that point on, disinflation was steep. This rise and fall of inflation in emerging markets appears to reflect in part changes in the international monetary system and inflation trends in advanced countries. One notable feature of the post-World War II period was an increase in inflation persistence compared with earlier historical eras, when inflation was either generalized and gradual (e.g., following the gold discoveries of the fifteenth through the nineteenth century), or rapid and specific, reflecting exceptional fiscal strains (as during or immediately after wars).3 This gradual increase in the persistence of inflation, combined with the breakup of the Bretton Woods international system of commodity-based money and the associated removal of external constraints on accommodative monetary policies, made it possible for the supply shocks of the 1970s to push world inflation to unprecedented peacetime levels, producing the “Great Inflation” of the 1970s and early 1980s.4 To the extent that emerging markets imported this inflation, loosened fiscal policies, and also adopted increasingly accommodative monetary policies during the period, these external trends were reflected in those countries’ prices and magnified further. Conversely, as governments in advanced countries responded to public dissatisfaction with inflation, and institutional and operational changes were put in place to foster monetary and fiscal policy discipline, this helped bring inflation in advanced countries back under control. This combination of falling external inflation and the adoption of sounder macroeconomic policies, also in response to public dissatisfaction with high inflation, explains much of the recent fall in inflation in emerging markets.