Intro: High inflation is a common feature of emerging markets. Even when real GDP growth is positive and monetary and fiscal policies are prudent, the lack of willingness to hold local currency as a store of wealth typically results in higher inflation rates relative to developed markets.
As explained in Strong Growth and Low Unemployment are Deflationary Forces, the stronger a country’s real GDP growth is, the more of a deflationary force it exhibit as inflation results from too much money chasing too few goods. However, when we look at emerging market economies we more often than not find higher rates of inflation.
One possible explanation is that emerging market economies have higher rates of money supply growth and bond issuance owing to large fiscal deficits. However, over recent years it is developed market economies that have seen the most aggressive fiscal deficit and debt monetisation efforts, yet inflation rates have remained far lower than their emerging market counterparts.
With this in mind the only possible conclusion to draw is that emerging markets have experienced lower demand for their currencies, for whatever reason. Historically high levels of inflation are often ingrained in the minds of citizens of emerging markets, meaning that there is much less of a tendency for them to hold their currency as a store of value. Rather, they have a strong tendency to either convert their savings into dollars or gold, or simply bring forward their purchases of goods and services in anticipation of higher prices, thus resulting in higher inflation. In contrast, developed market citizens have been more than happy to hoard the large amounts of money and bonds created by their central banks and finance ministries over the past decade.
This is not only true at the individual level but also at the policy level. Central banks across emerging economies continue to accumulate dollars and other reserve currencies as way of preventing appreciatory pressure on their currencies and building up a defense against future economic shocks. In doing so they are effectively importing inflation from developed market economies.
