The International Monetary Fund (IMF) has released new research indicating that sharp spikes in food and energy prices are likely to become more common, driving inflation expectations higher for longer and worsening poverty. According to the IMF, such crises threaten economic stability, particularly for poorer households that spend a larger share of their budgets on daily necessities. The research examined three decades of strategies used by governments to mitigate price surges and introduced a new economic model that accounts for the higher inflation experienced by poorer households.
The IMF's new economic model revealed a 0.8 percentage point gap to the standard inflation measure, suggesting that 23 million more people fell below the extreme poverty line from 2021 to 2024 than previously calculated. Chiara Maggi, the IMF economist who co-led the research, stated that cost-of-living crises impact price stability, reduce living standards, and worsen inequality. The research was published as Chapter 2 of the forthcoming World Economic Outlook, which will be released next week.
Large surges in prices of everyday necessities have been infrequent historically, especially at the global level, but they have been a recurring source of economic and social stress over the past five years. This is attributed to Russia's invasion of Ukraine in 2022 and this year's war in the Middle East. The IMF noted that near- and medium-term inflation expectations increased significantly during cost-of-living crises and remained significantly above their pre-crisis level even three years after the onset of a crisis.
The IMF's data showed that five-year-ahead inflation expectations increased modestly initially but remained elevated even three years after a crisis. This could result in interest rate increases. The IMF recommended targeted transfers as the best way for countries to protect the most vulnerable while preserving price signals. Actions aimed at suppressing prices, including price controls and lower consumption taxes, could cost governments three to six times more money to implement.
The IMF also found that producer subsidies, often favored by developing countries, were particularly inefficient. These subsidies could lower costs for goods that were then exported, leaving domestic taxpayers to essentially subsidize consumers abroad. According to Maggi, producer subsidies could cost 22 times as much to roll out. Broad measures could also become less effective if many countries implemented subsidies at the same time.
Shantayanan Devarajan, a Georgetown University professor and former World Bank economist, noted that developing countries faced a serious crisis given the combined impact of higher oil prices, high debt levels, increased borrowing costs, and the expected impact of this year's super El Niño weather pattern. He stated that growth has slowed down tremendously in low-income countries, which were already experiencing an all-time low in overall growth.
Some countries, including Egypt and Indonesia, have begun to shift away from broad subsidies towards targeted cash transfers. Devarajan urged countries to implement reforms aimed at boosting growth and limiting damage from the Middle East war. He emphasized the importance of preparing for crises, saying, "Fix your roof when the sun is shining," as introducing measures during a crisis can be too late and face huge resistance.
Key points
- Poorer households experience higher inflation rates due to increased spending on necessities.
- Targeted transfers are recommended to protect the most vulnerable while preserving price signals.
- Producer subsidies can be particularly inefficient and costly to implement.
