What is the best way to reduce inflation in a developing country?

My answer on Quora:

There are many ways to try to fight high inflation in developing countries because there can be many sources of high inflation.

Ultimately, the key differences between developed and developing economies in the context of fighting high inflation often deal with the effectiveness of monetary policy and any reliance on imports for staple and basic goods due to inadequate domestic production.

If the country depends on importing food and/or other necessary goods, high inflation can come from rising world prices or a depreciating exchange rate (where now it needs more of its currency to be the same amount of, say, wheat that is priced in dollars). If the country has enough monetary policy space, it can prop up its currency. If there is enough fiscal policy space, it can subsidize the domestic price of the imported goods. Both of these responses, however, are temporary in nature and must be a part of a broader policy framework. If the reliance on imports is persistent and structural, a more durable and longer-term approach would be to pursue policies that support import substitution, where the domestic economy develops the capacity to produce the imported goods itself.

If the country is experiencing high inflation from excessive credit or a fast growing money supply (let’s say the government decides to pay off all its debt by printing, instead of “earning” more money), tightening monetary policy by reducing credit growth, raising bank reserve requirements, or lifting interest rates are possible responses. The effectiveness of these policies in reducing or controlling high inflation depend on how strong, linked, or deep the banking system in that country and on who the borrowers are (households? real estate developers? corporations? If so, how are they investing? If investments are speculative, for example, that raises the likelihood that faster credit growth is indeed inflationary).

If the country is experiencing high inflation after a natural disaster destroyed factories, inventories, farm crops and critical infrastructure, then emergency measures would need to be taken that would involve direct public intervention including public provision of basic goods, price controls, support from the international community, and a clear roadmap on how the government plans to respond. In this example, a government can try to mitigate the effects of the shock if you can (price controls, international emergency aid, strong policy anchors) but that’s cerainly a not a fight to win! Just an example of one source of high inflation, and the types of responses within a governments scope.

I’ll stop here, but the list does go on… !


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