This paper deals with the economic situation in the world. It is divided in three main sections: (1) problems, (2) policies, and (3) prospects. The paper concludes with a short statement on the role of the Fund in helping to deal with the economic situation.
This paper deals with the economic situation in the world. It is divided in three main sections: (1) problems, (2) policies, and (3) prospects. The paper concludes with a short statement on the role of the Fund in helping to deal with the economic situation.
The subject matter of this paper may be of interest to China for many reasons. International trade, as well as the cost of foreign capital, is of growing importance to China. The prospects for peace in the world depend significantly on economic conditions.
This paper derives its analysis from Fund staff reports to the Executive Board and from the Fund annual publication entitled World Economic Outlook.1 In this paper, major groups of countries rather than individual countries will be referred to. These are the groups commonly referred to in Fund analyses. They are the 21 industrial countries, the 12 major oil exporting countries, and the non-oil developing countries that comprise the 113 other members of the Fund, including China.
Three major economic problems confront the world. The first is the high rate of inflation; the second is the low rate of growth of output and employment; and the third is the large size of the imbalances in countries’ international payments.
The rate of inflation in the world is high, pervasive, persistent, and uneven. It is high in the sense that it is currently more than twice the level of the 1960s and early 1970s. For example, the rate of consumer price inflation in industrial countries in 1981 was 10 percent, compared with an average of about 4 percent per annum during 1963-72. The rate has been decreasing this year and may average slightly more than 8 percent in 1982.
The rate of inflation is pervasive because the current high rate extends to all country groups. Specifically, this year the figure will be more than 11 percent in the oil exporting countries and more than 31 percent in the non-oil developing countries.
The rate of inflation is also persistent because it has remained above 7 percent in the industrial world and above 10 percent in the developing world since 1973.
It is uneven, however, because it varies from country to country. Among the industrial countries, rates as low as 5–6 percent were experienced in the Federal Republic of Germany and Japan in 1981, and among the non-oil developing countries, rates varied from an average of 62 percent for the major exporters of manufactures to an average of 10 percent for the low-income countries in 1981.
The current rates of inflation are a problem for the world economy for several reasons. First, inflation slows down economic growth. This is partly because it adds to uncertainty and therefore makes government and business less willing to undertake the major capital investments that contribute to growth and productivity. Inflation slows down growth also because it leads all sectors in the economy to seek greater economic security through higher nominal incomes and through investment of wealth in protected rather than productive assets. Moreover, as inflation destroys competitiveness, it stifles trade. Second, inflation disrupts international economic relations. Disparities in inflation rates create disparities in interest rates. These latter disparities disturb and distort international capital flows. All of these effects on trade and capital flows generate exchange rate changes, often of a volatile kind, that are difficult for traders to interpret and therefore inhibit international commerce. Third, inflation tends to make richer countries less willing to extend aid and concessional loans to poorer countries just when slower growth and disturbed exchange conditions are making it more difficult for poorer countries to export.
Output and employment
The second major problem of the world economy—low rates of growth of output and employment—derives in considerable part from inflation and also from the effects of demand restraint policies in the industrial countries to reduce inflation. The decline in growth rates has been substantial. In the 14 industrial countries, real gross national product growth in 1980 and 1981 was only about 1 percent, compared with slightly less than 5 percent per annum on average in 1963–72. In 1982, the figure will be virtually zero. It was negative in 3 of the 7 major industrial countries in 1981 and will be negative again in some of them in 1982.
It is more difficult to assess the recent growth performance of the non-oil developing countries because of the wide diversity of experience among them. But after averaging 6 percent per annum during 1968-72, the rate declined to 2¾ percent in 1981, and in 1982, it may be even less than that. Among the major exporters of manufactures, the decline in output growth was from an average of 8 percent in 1968-72 to less than ½ of 1 percent in 1981.
The oil exporting countries experienced a marked reversal in real growth during 1980 and 1981. This was due primarily to reduced oil exports resulting from the strong and sustained response of consumers to the steep rise in oil prices from 1978 to 1980, as well as from the current recession in industrial countries.
The slow growth and associated high unemployment rates of the past two years have imposed heavy economic and social costs on the residents of industrial countries. But their problems have created great difficulties for the developing countries. It has been estimated that each 1 percent decline in economic activity in the industrial countries is associated with about a 1.3 percent decline in the volume of exports of the non-oil developing countries. In addition, slow growth in industrial countries typically weakens developing country export prices. It also leads to greater pressure in industrial countries for protection against imports. These two factors compound the effects of slow growth in industrial countries on developing country export earnings. During 1973–80, non-oil developing countries exhibited a certain resiliency against the impact of slower growth in industrial countries. These developing countries were able to increase their share of industrial country imports, and they were able to concentrate their exports to some degree on the faster-growing markets. But, as indicated by the lower growth figures for 1981, such opportunities are limited.
An average annual growth rate of 2.5 percent in a group of countries in which the average population growth is proceeding at approximately the same rate implies no real increase in the average standard of living for these countries as a group but does indicate a drastic decrease in the standard of living of some of these countries.
The third major problem of the world economy is the large size of the imbalances in countries’ international payments.
Before discussing this problem, it must be mentioned that statistics for the balances of payments of countries of the world show some inconsistencies that have become worse in the last couple of years. Conceptually, the sum of the current account positions of all countries must be zero. In practice, because of inadequacies of national statistics, the actual figures do not add to zero. The asymmetry—surpluses too small or deficits too large—has grown considerably. The figure for 1982 is some US$70 billion according to Fund estimates. The Fund staff, like that of other international and national institutions, is naturally concerned about this asymmetry and has attempted to identify its sources. Although its study is incomplete, the Fund staff has found that the problem is concentrated in the categories of flows of services and private transfers rather than merchandise trade, and it is probably attributable to errors and inconsistencies in the accounts of industrial and oil exporting countries (where transfers and services loom large and have increased rapidly during the past few years).
Major swings in current account positions (measured in terms of the balance on goods, services, and private transfers) have been associated with the changes in the price of oil. After the first oil price increases in 1973 and 1974, the surplus of the oil exporting countries rose about tenfold to some US$70 billion, the industrial countries swung from surplus into deficit (about US$14 billion), and the deficit of the non-oil developing countries more than trebled (to US$37 billion). By 1978, the surplus of the oil exporting countries had all but disappeared, the industrial countries had developed a surplus of about US$30 billion, and the non-oil developing countries continued to have a deficit of about the same size (US$39 billion) as in 1974 in nominal terms—though, of course, a much smaller one in real terms. In 1980, the new oil price increases of 1979 and 1980 led to an enormous surplus (US$115 billion) for the oil exporting countries, a renewed deficit (US$45 billion) for the industrial countries, and more than a doubling of the deficit (to US$86 billion) of the non-oil developing countries. In 1981, the industrial countries’ deficit virtually disappeared, and the surplus of the oil exporting countries fell dramatically (to less than US$70 billion), but the deficit of the non-oil developing countries continued to increase, to about US$100 billion.
The problem with these imbalances is their sustainability. It is normal for countries with fairly high productivity of additional investment to draw savings from the rest of the world and to record a deficit on current account and a surplus on capital account. As long as the funds thus imported are applied so as to increase income and thus permit servicing of the debts incurred, the payments situation may be described as sustainable. But legitimate questions may be raised as to the sustainability of the 1981 rates of capital inflow to some of the smaller industrial countries and to some of the non-oil developing countries. The debt servicing requirements in some of these countries have risen substantially during the 1970s and may have reached levels that the countries themselves or their creditors feel should not be exceeded. This is a major problem in the world economy at this time. Countries that must reduce their inflow of capital from capital markets have only limited alternatives. They may hope for increased grants or concessional loans, but the prospects for increases in these flows are not bright. Such countries may hope to increase their exports, but because of the slow growth of export markets, these prospects are not good either. Indeed, the volume of world trade did not increase at all in 1981. The only other alternative is to reduce imports. Because of the importance of imports in the production processes of the deficit economies, this form of adjustment frequently means lower output and employment rather than the substitution of domestically produced goods for imports.
The three main problems of the international economy are related. Inflation impairs growth; impaired growth inhibits adjustment of payments balances. In a sense, therefore, inflation is at the root of the problem. As such, reducing inflation should command priority in the setting of policies. Of course, the same policy prescription is not appropriate for all countries. In this paper, it is not possible to discuss the issues of policy in particular countries. Attention will be given, however, to the policy problems as they occur in groups of countries.
Because of their great weight in international trade and therefore in the performance of the entire world economy, the policies of the industrial countries, particularly the larger ones, are of special importance. In these countries, priority has been given for many years to the reduction of inflation. The sources of inflation include the overly ambitious demands of social and other policies on the economy, excessive cost increases combined with declining productivity growth, careless monetary policy, and intermittent surges in the prices of food and energy. Whatever the causes of the inflation, its intensity and persistence during an extended period have led to deep-seated expectations that it will continue. These perverse expectations have been nourished by repeated reversals of policy, and they now make the reduction of inflation very difficult.
The main instrument of policy that is used against inflation in the major industrial countries is control over the rate of growth of money. It is widely agreed that the control of monetary growth is absolutely necessary to reduce inflation. But it is also widely recognized that steeply rising fiscal deficits can lead to the loss of monetary control or to the expectation of such a loss and, in this way, inhibit progress toward lower rates of inflation. Nevertheless, in many industrial countries, fiscal policy has not adequately supported monetary policy. Similarly, it is recognized that increases in incomes that are greatly in excess of productivity growth lead to rises in costs that must be reflected in prices if enterprises are to survive. It has proved very difficult, however, in the industrial countries to implement and sustain incomes policies that, together with fiscal discipline, give adequate support to monetary policy.
The excessive reliance on monetary policy has tended to produce interest rates considerably higher than the rate of inflation, particularly in some of the industrial countries. These high interest rates have tended to slow economic growth to a degree greater than might otherwise have been necessary. These two results—higher interest rates and lower growth than necessary to avert inflation—have created special problems for other countries, especially the smaller industrial countries and the developing countries. Beyond these broad aspects of policy in industrial countries, it must be noted that more technical features of the application of policy have resulted in an unwelcome volatility of interest rates and exchange rates. The Fund’s approach to policy for the industrial countries has been to emphasize not only the essential role of control of the money supply but also the supportive roles of other policies. The Fund has stressed the importance of adequate fiscal restraint. The Fund has recognized the difficulty of achieving good results through application of incomes policies; but it has noted that such policies, particularly of the flexible or informal type to restrain the growth of incomes, have in some countries served as useful adjuncts to fiscal and monetary policies. Finally, the Fund has encouraged the mature economies of the industrial world to undertake the structural adaptations that are necessary in the face of changing technology and changing relative scarcities. In particular, it has fully supported efforts to conserve the use of energy and to develop sources of energy other than petroleum and has welcomed the considerable success of these efforts.
Non-oil developing countries
The non-oil developing countries display a great variety of situations, and only a few valid generalizations can be made about policies required in them. They are, however, afflicted by the same three economic problems that are troubling the world in general. In many of these countries, these problems are more acute than in the industrial countries, especially the problem of deficits in the current account of international payments. Although improvement of performance by the industrial countries in respect of inflation and output would greatly assist the developing countries, there remains a wide scope for the exercise of policy initiatives by the developing countries themselves.
The management of domestic demand has very often been inadequate because of a tendency to allow fiscal deficits to become excessive. A variety of factors contribute to this result, with different ones being more important in some countries than in others. These factors include excessive spending on social capital or social programs, inadequate control over public sector wages, budget support of uncompetitive industries, subsidizing of key commodities, faulty tax administration, shrinkage of tax bases, and unwillingness to increase tax rates when needed to reduce deficits. In many developing countries, because of the limitations of the domestic capital market, there is little scope for domestic financing of fiscal deficits other than through an increase in central bank monetary liabilities. Accordingly, an overly large fiscal deficit is usually accompanied by a monetary expansion greater than is warranted in existing conditions of inflation.
In some instances, the situation might improve if interest rates were allowed to rise. Higher rates would probably have only a limited effect on the amount of savings. Nevertheless, they would be more likely to induce savings flows into financial institutions, as opposed to inflation hedges, and through such institutions into productive investments. On the whole, real interest rates have tended to be positive in those developing countries that are major exporters of manufactured goods. Limited flexibility of interest rates has tended to curb the effectiveness of policy, especially in the primary producing countries.
Exchange rate policy has also inhibited improvement of performance in certain countries. On the whole, those countries that followed a flexible exchange rate policy were more successful in keeping their prices in line with world prices, and thereby retaining competitiveness, than those countries that did not allow their exchange rates to reflect relative inflation rates. If exchange rate changes are to exert their full impact on the economy, they must be accompanied by supportive monetary and fiscal policies as well as measures pertaining to performance in specific sectors or industries.
There have also been instances in which policies of financial management have not been appropriate. It has been essential for most non-oil developing countries to increase their import of capital during the difficult years of adjustment to the many consequences of the rapid increases in oil and other prices. These countries have had to determine the sustainable level of the capital inflow. The judgment they have made has not always been wise, and when mistakes have occurred they have usually been in the direction of permitting too large a capital inflow. This has resulted in the piling up of payments arrears, debt rescheduling, and a general reduction in creditworthiness of the country in question as judged in the world capital markets. This is not to deny that there have been circumstances in which quite unpredictable events have unfortunately placed countries in positions that required debt rescheduling.
The Fund’s approach to the policy problems of developing countries has two features. The first feature concerns the policy actions that may be taken by the developing countries themselves. The second feature concerns the help that wise policy in the industrial countries can render.
The Fund has urged developing countries to maintain control over fiscal deficits in order to avoid the excessive monetary expansion that may be induced through the financing of these deficits. Although the Fund does not express specific views to governments concerning the allocation of expenditure or the sources of their revenues, the Fund has advised against unduly large wage increases in the public sector and against widespread or extensive programs for subsidizing the costs of basic commodities or public services. In addition, the Fund has urged countries to avoid negative real interest rates and to encourage savings and the development of financial institutions and markets. The Fund also seeks to judge the appropriateness of its members’ exchange rates and to make its views on this matter known to the authorities of the country concerned. The Fund also offers advice on the policies that might usefully accompany or support any change in a member’s exchange rate.
In respect of the help that industrial countries can render to the developing countries, the Fund has stressed the following points. It has urged the view that slow growth in the developed world greatly damages developing countries. It has also noted the very serious impact of high interest rates on the deficits of the developing countries. The Fund has urged the developed countries to keep their markets open. In particular, it has repeatedly stressed the importance of avoiding protection or restrictions against imports of goods and services. Equally, it has pointed to the need to keep capital markets open for the appropriate use of developing countries. Finally, it has urged the industrial countries, especially in the recent period, to maintain the flows of aid and concessional finance to the poorest countries. These countries have little access to capital markets and have virtually no capacity to adjust payments imbalances other than by reducing their standards of living.
Before commenting on the outlook for 1983, it would be well to recall the three major assumptions on which the projections are based. First, current economic policies will apply through 1983. Second, the exchange rates prevailing in mid-June 1982 will prevail through 1983. Third, the average price of oil will remain constant in nominal terms in the second half of 1982 and will remain constant through 1983 in real terms (as defined by the prices paid for their imports by the oil exporting countries). It should be noted that the projections described here were those available in the Fund in mid-July 1982.
Turning first to the problem of inflation, it can be reported that some progress is being made. The overall rate of inflation in the industrial countries, as measured by the gross domestic product (GDP) deflator, peaked in 1980 at 9 percent. For 1982, it probably will be some 1½ percentage points below the peak and will drop further in 1983, perhaps by as much as ½ or 1 percentage point.
In the non-oil developing countries, as measured by the consumer price index, the peak of inflation was also reached in 1980 at about 32 percent. By 1982, the average will have dropped slightly. The net oil exporters2 are still experiencing increases in their inflation rates on average. The inflation rate of the net oil importers among the non-oil developing countries has probably dropped by about 3 percentage points between 1980 and 1982. Some further drop in inflation rates in 1983 is expected among both the net oil exporters and the net oil importers.
As noted above, in 1982 there has been virtually no growth of output, on average, in the industrial world. In the United States, the figure is likely to decrease by more than 1 percent. For 1983, some revival in the growth of output is expected for the industrial countries; the rate might reach 2½ percent.
Growth among the oil exporting countries has been declining in each of the last three years, owing principally to the reduced demand for oil. This year, the decline—at some 2.5 percent—will be less than the decline of 4.5 percent experienced in 1981. The expectation for 1983 is that, with a revival of world demand for oil, real growth in these countries may increase by some 7 percent.
The non-oil developing countries, which grew at a rate of some 2.8 percent in 1981, are growing at a rate of 2.5 percent in 1982. In 1983, the expectation is that their growth performance will have improved to a rate of 4 percent, in line with the expected modest revival of economic activity in the industrial world.
Turning now to the current account of the balance of payments, the oil exporting countries had a surplus of some US$70 billion in 1981. Owing to a further projected decline in the volume of oil exports and a further projected decline in their terms of trade, the current account surplus is expected to decline to about US$15 billion in 1982. In 1983, the pickup in the world demand for oil will lead to an increase in the overall current account surplus of the oil exporting countries to perhaps US$25 billion.
For the industrial countries, the combination of a soft world oil market and continued slow growth should transform the 1981 deficit of US$4 billion into a surplus of US$8 billion in 1982. While the surplus of the industrial countries is forecast to grow to perhaps US$ 13 billion in 1983, the movements within the industrial countries will be disparate. The United States has increased its surplus somewhat in 1982, but it is expected to have virtually no surplus in 1983, as its oil imports rise and more particularly as the recent appreciation of the dollar begins to show its effects on trade. The Federal Republic of Germany and Japan are in the process of a major increase of surplus positions in 1982–83. The United Kingdom, on the other hand, is experiencing a considerable decline in its surplus during 1982 and 1983. The industrial countries, other than the United States, Japan, the Federal Republic of Germany, and the United Kingdom, recorded a combined deficit of some US$36 billion in 1981. This deficit is expected to be lower in 1982 and in 1983. Indeed, in 1983 it may be only about half as large as in 1981.
The combined current account deficit of the non-oil developing countries, which was about US$100 billion in 1981, is expected to fall in both 1982 and 1983, reaching US$90 billion in 1983. Expressed in real terms, for example, as a percentage of the value of exports, the projected deficit in 1982 and 1983 will be at a level corresponding to the average of the late 1960s and early 1970s and will be below the level of the peak deficits of 1974-75 and 1980-81. The projected decline in the real current account deficit occurs exclusively in those non-oil developing countries that are net importers of oil and, within that group, primarily in the larger countries having considerable flexibility in their external transactions. Two principal “plus factors” that help to reduce the real deficit are the stabilization of oil prices and the reduction in inflation in industrial countries. Both of these factors moderate the growth in the costs of imports in non-oil developing countries. Adjustment policies that help to reduce the growth of imports in terms of volume also reduce the real deficit in these countries. Among the “minus factors” that limit the improvement in the real deficit are the continued slow growth in industrial countries and the rising costs of servicing the accumulating debt of the non-oil developing countries.
In summary, inflation rates are now generally moving in the right direction, and rates of output, though still low, are rising—albeit somewhat uncertainly. But the structure of payments is still unsatisfactory, particularly with respect to many smaller industrial countries and non-oil developing countries. The sustainability of the deficits of many countries in these categories is highly questionable. Adjustment of their positions either through improvement of their export growth or curtailment of imports must be contemplated in the medium term.
The medium term
In its consideration of medium-term prospects, the Fund staff has developed alternative scenarios. These scenarios are elaborated in the World Economic Outlook published in April 1982. Their general character and implications are summarized here. The purpose of the scenarios is to assess the medium-term implications of alternative policy stances in industrial countries on the industrial world itself and on the performance of the non-oil developing countries.
The central scenario is based on the assumption that industrial countries affected by inflation will persist with policies of monetary restraint and will reinforce those policies with supportive fiscal policies and policies to reduce structural rigidities in goods and labor markets. A more pessimistic scenario is also elaborated in which fiscal and monetary policies are not combined harmoniously to reduce inflation, either because of an untimely relaxation of monetary policy or because of inadequate fiscal support for the monetary policy.
In the central scenario, economic growth in the industrial countries would average slightly more than 3 percent per annum during 1984–86. This improvement over projected rates for 1982–83 would not be sufficient to reduce unemployment significantly below current levels. An improvement in the rate of inflation (as measured by GDP deflators) to about 5–5½ percent by 1986 is also projected in this scenario. The more pessimistic scenario contains a projected annual growth rate of only about 2 percent in 1984–86 and a rate of inflation of some 8½ percent.
In elaborating the implications of these alternative scenarios for the non-oil developing countries, a number of assumptions were made. It must be remembered that the results of the analysis depend explicitly on these assumptions. With respect to policies, a crucial assumption is that the developing countries that are confronted with serious external imbalances will implement comprehensive programs of adjustment, programs that are more severe according to the more pessimistic scenarios than according to the more moderate central scenario. In addition, it is assumed that real interest rates in international markets will be reduced to about 2 percent by 1986, that oil prices will remain constant in real terms at their 1983 levels, that the trade protectionism of the industrial countries against the exports of the non-oil developing countries will not change, and that official development assistance will be maintained in real terms from 1981 through 1986.
In the central scenario, growth rates would be higher in the non-oil developing countries in 1984–86 than in 1982. This increase would vary among the different groups of countries.
The non-oil developing countries as a group would show a lower ratio of current account deficit to exports in 1986 than in 1982 in the central scenario. In the more pessimistic scenario, however, there would be virtually no change.
The improvement of the current account position according to the central scenario is particularly marked for the net oil exporters and for the major exporters of manufactures. The low-income group of developing countries (excluding India and the People’s Republic of China), which has the highest deficit/export ratio, would experience some reduction in this ratio between 1982 and 1986, but it would still remain substantially above its 1972 level. This group’s debt service ratio would show a similar pattern of movement. The other developing countries, consisting mainly of middle-income countries exporting chiefly primary products, would experience reductions in their deficit/exports and deficit/debt service ratios, but both ratios would remain above 1972 levels. Both India and the People’s Republic of China are expected to maintain relatively low levels of external debt. India’s current account deficit is projected to decline significantly up to 1986 in the central scenario. China’s current account deficit is expected to remain moderate.
The results for the central scenario envisage a very considerable adjustment effort on the part of the non-oil developing countries. This effort would be greatly assisted by the modest resumption of growth and the lower interest rates in the industrial world. It is the Fund’s judgment that the payments deficits envisaged according to these scenarios are capable of being financed. This is not to imply that the financial system may not be under some strain. On the contrary, if many difficult debt reschedulings are required or if negotiations of some reschedulings break down and confidence in the banking or financial system is affected, the system will be under considerable strain.
The much less favorable results according to the more pessimistic scenario raise more serious questions as to whether the deficits envisaged under that scenario could be financed in the circumstances.
The analysis embodied in the scenarios emphasizes the very great need to implement and maintain policies of adjustment that will reduce inflation throughout the world economy, permit resumption of growth, and establish a structure of viable payments positions.
The Role of the Fund
The Fund’s critical and unique role is in helping countries to design and implement appropriate adjustment programs. In the design of such programs, the aim is to reduce current account deficits to a level that can be serviced out of a growing income. Sound fiscal and monetary policies are central to an adjustment program, but complementary measures to improve economic efficiency and to extend a country’s productive base are usually also called for. Commercial financial institutions are, and will continue to be, the principal source of balance of payments financing. But in the light of balance of payments disturbances of recent years, the Fund has increased its capacity to support appropriate adjustment programs. It has also increased members’ access to its resources relative to their quotas and has extended the period during which resources may be used in circumstances requiring structural adjustments in a member’s economy.
The Fund maintains a surveillance over exchange rates and exchange rate policies of members. A very important aspect of this function of surveillance is to point out to members how these policies inhibit or facilitate the adjustments that other members need to make. This effort to promote the mutual consistency of policies is concerned with the effects of industrial countries’ policies on developing countries as well as with the interactions of industrial countries among themselves. It is the Fund’s purpose to promote a viable structure of payments and associated exchange rates in the world as a whole.
Goldstein, Morris, and Mohsin S.Khan,Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, IMF Occasional Paper No. 12 (Washington, August1982).
Goldstein, Morris, and Mohsin S.Khan,Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, IMF Occasional Paper No. 12 (Washington, August1982).)| false
The discussion focused on inflation: its causes, its effects on growth and employment, and policies to combat it. Inflation in the industrial countries was emphasized, although the possible transmission of inflation from the industrial to the developing countries was also discussed.
The rise in inflation in the industrial countries from the mid-1960s through the 1970s was attributed to a variety of causes. Several participants cited policies adopted in these countries, including overly expansionary fiscal and monetary policies, and structural imbalances affecting the patterns of expenditure, output, and incomes. Reference was also made to the possibility that the emergence of high inflation and its coexistence with high unemployment could be due to fundamental weaknesses in the market-oriented economies of Western countries.
The Fund staff agreed that expansionary fiscal policies accompanied by relatively loose monetary policies had been a major cause of the high inflation in the industrial countries. They noted that the ratio of budget expenditure and budget deficit to gross national product (GNP) had risen appreciably in most of these countries and that this rise was associated in part with growing expenditure on social security and other entitlement programs. Other contributing factors included the rise in grain prices in the early 1970s resulting from widespread crop failures and the increases in oil prices in 1973–74 and 1978–79.
The Fund staff attributed the intractability of inflation to strong expectations, especially among trade unions and enterprises, of continued large price increases. Once unions started to expect, partly because of their recent experience, that inflation would remain high during the periods covered by upcoming wage contracts, they began to demand wage increases that would protect the real income of their members from the effects of this anticipated inflation. Enterprises, which had formed similar expectations for largely the same reasons, were willing to meet these wage demands, as long as they felt they could pass on the increased costs in higher prices. But, in due time, these higher costs and the higher interest rates associated with inflation discouraged capital spending. This effect, combined with poorer export sales, the inability of consumers to maintain spending in real terms, and official policy constraints on spending, eventually led to unemployment and excess capacity. Lately, these effects had in their turn begun to moderate inflationary expectations, and the year-to-year rise in consumer prices in the industrial countries as a group declined from slightly more than 12 percent in March 1980 to about 7 percent in September 1982.
The participants showed considerable interest in the effects of lending through the Euromarkets on world inflation. It was suggested that the effects might be positive, since the Euromarkets would facilitate the transmission of inflationary impulses from countries that were net lenders in the markets, including many industrial countries, to countries that were net borrowers, most of which were developing countries. It was also suggested that the inflationary effects might be quite large, since outstanding loans made through the Euromarkets were more than US$2,000 billion, or about one sixth of world GNP. The Fund staff argued that the Euromarkets did not initiate inflation, but they agreed that they might provide a channel for its transfer from one country to another. They cautioned, however, against exaggerating the importance of such transfers, noting that about two thirds of outstanding claims in the market were interbank and that the expansion of nonbank claims relative to the total demand of countries that borrowed in the markets had not been unduly large.
Participants also discussed the possible beneficial effects associated with inflation. It was argued that expansionary fiscal and monetary policies that gave rise to inflation might, at the same time, provide a boost to growth and employment. It was also suggested that, by reducing the real cost of borrowing, inflation directly encouraged investment, again contributing to higher growth and employment. However, other participants, including the Fund staff, claimed that any such beneficial effects would be short-lived because of the adverse effects of inflation on wage costs, on the confidence attached to estimates of returns to investment, and on the pattern of resource allocation.
The discussion of policies to combat inflation centered on the effectiveness of specific policies and on the importance of the policy mix. Some participants believed that the experience of the industrial countries during the 1970s demonstrated the inability of supply-side and monetary policies to achieve reasonable stability of prices. Others argued that both sets of policies had important contributions to make. Supply-side policies directed at providing appropriate incentives fostered increased supplies of labor and savings, as well as more efficient patterns of investment and production, and thus contributed to the moderation of inflation by increasing the supply of goods and services. Policies aimed at restricting the supply and/or increasing the cost of money tackled inflation by containing the growth of aggregate demand for goods and services. The decline in inflation in the United States in the last few years could be attributed largely to the tight money policy introduced in 1979.
Nevertheless, there was widespread agreement that neither supply-side policies nor monetary policies should be relied on exclusively to combat inflation. What was needed, the Fund staff suggested, was a mix of policies aimed at increasing supply through the provision of adequate incentives, restricting the growth of aggregate demand through fiscal as well as monetary policies, and restraining wage and profit claims through incomes policies. With respect to the last, incomes policies that were implemented through edicts would probably not be effective, but those based on a cooperative approach among representatives of government, unions, and enterprises could play an important complementary role in combating inflation.
The importance of the fiscal-monetary policy mix was also emphasized. It was noted that, in order to dampen inflationary expectations, it was essential that both the fiscal situation and the rate of monetary expansion be well controlled, both in fact and in the eyes of the community. Doubts as to the willingness of the authorities to firmly manage one of these policies could reduce the effectiveness of the other policy.