Monday, June 30, 2008

Multilateral Institutions Stress Warnings Over Global Inflation

"BIS Seeks Higher World Interest Rates"
"IMF Warns of Rising Inflation Risk in Latin America"
"Eurozone Inflation Soars to New High"
"Brazil Raises Interest Rates Again"

Multilateral financial institutions have begun to express their concerns and possible solutions to the threat of global inflation. The Bank for International Settlements (BIS) announced on Monday that inflation is a clear and present threat to the global economy. The BIS oversees central banks and banking regulators around the world. The organization pointed to excessive credit growth and low interest rates over the last decade as a possible cause of the current inflation worries along with the present rising food and oil costs. To combat the inflation risks, the BIS has been pushing central banks to tighten their money supply by raising interest rates.

Last week, the International Monetary Fund (IMF) stated that the macroeconomic credibility built up in Latin America countries could be jeopardized by the rising inflation. The strong increase in domestic demand in Latin America combined with the sudden increase of global food and oil prices have contributed to the inflation concern. The IMF Managing Director, Dominique Strauss-Kahn, stated that current economic policies in Latin America tend to amplify price shocks and these countries need to act quickly and decisively to stem inflation and the high social costs of adjustment. The IMF has pledged to provide financial support to the countries most affected along with adapting lessons learned from the current credit crisis to developing countries.

The concerns over inflation have started to materialize with countries starting to report inflation numbers that greatly exceed targets. The Eurostat announced on Monday that inflation in the Eurozone has risen 4% in the last year, twice the amount of the European Central Bank’s (ECB) targeted amount. In response, the ECB is expected to raise interest rates by twenty-five basis points on July 3rd. Brazil has already taken action to prevent higher inflation by raising interest rates, starting in April, to cool down an overheated economy. Market economists expect Brazil’s inflation rate to reach 5.48% by year end, almost a full percentage point above the government’s target rate of 4%.

1) Has the systematic risk created by the globalization of the world’s financial markets been the driving force behind the current inflation crisis or rather can the crisis be blamed on the sudden increased price of staples like oil and food that every country consumes?
2) How much should the central banks of the world factor in global inflation worries when deciding whether to tighten local monetary policy by raising interest rates? Should international regulators require global inflation to be taken into account? If yes, then how should the appropriate regulations be designed?

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