Cooling down overheated economies, Booz and Company reports (page 1 of 5)

While inflation has been increasingly pervasive in the G7 as well as in emerging economies, the very highest jumps in the rate of inflation have been registered in the hydrocarbon rich economies of the GCC.

Inflation makes the GCC extremely vulnerable to economic shocks. While the GCC region has been flourishing with economic expansion, surging oil revenues and an influx of foreign capital, in the event of a sharp and substantial drop in oil prices or a global credit crunch coupled with sustained contagion effects- the GCC's economies could contract very swiftly and likely stay constricted for some time. Additionally, inflationary threats are likely to be exacerbated as policymakers rally to prevent prolonged downturns by adopting expansionary macroeconomic policies.

Rabih Abouchakra, a partner at Booz & Company, remarked:

"Countries that choose a sustainable development growth model, and who thereby manage inflation and overall macroeconomic stability, typically have an easier time sustaining real GDP growth and can recover far more quickly from contractions."

The goal, then, for any country is to structure an economy so it can perform well and recover swiftly no matter what happens. This article examines the root causes of inflation and proposes a holistic approach to policy making that can ultimately help stabilize economies under any circumstances.

The worldwide question is what to do about inflation: developed and emerging economic powerhouses—including the U.K., EU, China, India, and Russia—have all failed to meet their target inflation rates earlier this year. Now is the time for policymakers in countries that don't have strong inflation-fighting and macroeconomic stability systems to develop them.

"The GCC must move from a model characterized by overheated economic growth to one that emphasizes growth through sustainable development beginning with fighting inflation comprehensively," explained Richard Shediac, a partner at Booz & Company. It must examine the ways governments can influence inflation, including through monetary, fiscal, and exchange rate policy, and trade/market intervention policy. In so doing they can create a holistic policy framework to fight inflation— a macroeconomic stability framework.

Global and Regional Approaches to Measuring Inflation

Measuring inflation is an inexact science. Countries that meticulously measure inflation know that different evaluations work best at different points in the economic cycle. The producer price index, a measure of average changes in prices received by domestic producers for their output, can be an important leading indicator of other types of inflation, as can certain commodities futures price indexes. Commodities futures price indices tend to be imperfect because their components may not fully capture the inputs and real dynamics relevant to any given region.

Other indicators lag inflation. The GDP deflator is calculated by dividing nominal GDP by real GDP. While the GDP deflator provides a holistic view of price rises, it is not easy for consumers to interpret. The CPI, another lagging indicator, is more intuitive—measuring a fixed and weighted basket of goods in areas like housing, transportation, food and clothing.