Twin Stability Problem: Joint Issue of High Current Account Deficit and High Inflation
11 Pages Posted: 3 Dec 2016
Date Written: November 2016
Abstract
The low level of global interest rates and the high liquidity resulting from the quantitative easing policies adopted by advanced countries in the wake of the global financial crisis of 2007–09 bolstered capital flows to emerging market economies. However, the uncertainties relating to the future path of global monetary policies and the prospects for economic recovery led to high volatility in risk appetite, capital flows and exchange rates. In the process, emerging market economies with higher current account deficits faced larger currency depreciations and, consequently, higher cumulative increases in consumer prices. High current account deficits combined with strong inflationary pressures created a twin problem of financial and price stability. Exchange rate pass-through turned out to be an important parameter of this twin problem with a high degree of pass-through amplifying the relationship between current account deficits and inflationary pressures. Moreover, the twin problem created significant constraints for monetary policy and necessitate d the use of complementary macroprudential (and other) policy tools.
Full Publication: Inflation Mechanisms, Expectations and Monetary Policy
Keywords: Financial stability, price stability, current account balance, inflation, exchange rate pass-through
JEL Classification: E31; E44; F32
Suggested Citation: Suggested Citation