Kose, who also serves as chief economist for the Prospects Group’s parent office, sees striking similarities between the current situation and the debt crises of the 1970s and ’80s as less-developed nations get squeezed by high debt, inflation and weak fiscal positions.

Kose also warns that higher commodity prices and pandemic-related disruptions could worsen supply chain snarls, weaken growth and send inflation higher, creating conditions for stagflation.

Edited excerpts from the interview follow.

Q: How do you assess the outlook for emerging markets?

A: One of the risks we look at is this higher-than-expected rise in interest rates – so, the much faster tightening of financial conditions.

The other risk we look at is the risk of commodity prices being higher, and the third important risk we analyse is the risk of further Covid disruptions, the types of disruptions we saw in the case of China. These disruptions are quite important because they translate into supply-side interruptions, weaker growth, as well as higher inflation.

If these risks materialise, (emerging-market/developing economies) growth would be lower: 1.2 percentage points in 2022, then 1.6 percentage points in 2023. Since our baseline forecast for this year is, for emerging/developing economies, 3.4, we might end up seeing growth slowing to 2.2 under the stress scenario. For the next year we have growth of 4.2 under our baseline forecast. That will be 2.6 under our stress scenario.

Q: What are the similarities and differences between now and the 1980s, when rising borrowing costs and currency depreciation triggered a financial crisis?

A: When you look at the 1970s and early 1980s and then compare that period to the 2010s and now the early 2020s, there are some important similarities. And these are the similarities we are really worried about.

When you look at the 1970s, you have these supply shocks after a prolonged period of monetary policy accommodation.

When you look at 2010, the interest rates were quite low. Real interest rates were negative, effectively, on average.

The other important similarity is how growth was weak in the 1970s and how it has been weak in the 2010s and, of course, we are expecting the 2020s. Potential growth slowed in the 1970s. We are seeing the same type of slowdown in potential growth.

When you look at emerging-market/developing economies, the big similarity is these debt dynamics. In the 1970s and early 1980s, very similar to now, you had high debt, elevated inflation and weak fiscal positions in many emerging-market/developing economies. These three factors made them very vulnerable to tightening financial conditions.

In 1982, there was the famous default of Mexico, and that marked the beginning of the Latin American debt crisis. When you look at the number of debt crises, in every decade, the 1980s stand out in terms of how many debt crises emerging-market/developing economies experience.

The challenge, in the case of emerging-market/developing economies, is that private-sector debt has risen significantly.

As much as there has been a strengthening of financial institutions around the world after the global financial crisis, there is this sovereign bank nexus we need to pay attention to, and how the debt dynamics can quickly get out of control.

Q: Do you think the Federal Reserve is being too hawkish?

A: I think the Fed is very clear about its desire to give priority to its inflation mandate, price stability mandate.

Stagflation, I think, is a bigger risk for advanced economies (than emerging markets), especially the euro area and the US, given how inflation quickly climbed up and growth prospects became weaker. That is why you see the US Fed stepped up its interest rate increases.

This is, I think, a step in the right direction.

We see inflationary pressures everywhere, and what we see in Japan is a manifestation of these inflationary pressures. But, at the same time, the Japanese structural factors keeping the inflation rate under control are still there and will be there for the foreseeable future.

The Bank of Japan and Japanese authorities have taken measures to control the inflation and make sure price stability is there. We have every confidence in the Japanese authorities to take the necessary measures going forward.

Q: What do you think about modern monetary theory – the idea that governments can spend free as long as inflation doesn’t become a problem? As central banks raise rates, pressure is mounting on governments to step in to help people get by.

A: Given these inflationary pressures, there are certain things central banks have to do to protect price stability, and there are certain things the government has to do.

If they spend more, it’s a peril to inflation.

In terms of today, what is critical now is to take the price stability mandate of the central bank very seriously and increase the interest rates to get ahead of these inflationary pressures. On the fiscal side, to have a well-defined medium-term plan to help the most vulnerable groups, while making sure that fiscal policy is not leading to inflationary pressures.

MMT, this idea that the governments can spend without thinking about the consequences, is not something we will take seriously in the context of emerging-market/developing economies. Then, we have this question about how in the ’70s and ’80s, because of these fiscal vulnerabilities we had all types of crises in emerging market/developing economies.

So, in this environment of tightening financing conditions, governments cannot afford to signal that they are willing to spend “at all cost”. There are consequences of that, and I think markets will punish those countries.