Unit 7 Macroeconomic policy in the global economy

7.11 Application: Quality of governance and inflation

We have argued that inflation often results from crises, which in turn may reflect failures of governments to prioritize the best interests of their citizens. In this application, we assess whether the data supports this claim.

Measuring the quality of government is far from straightforward, but that does not stop economists and statisticians from trying. The World Bank produces a ranking of countries on a range of different criteria intended to capture the quality of governance, namely:

• control of corruption
• rule of law
• regulatory quality
• political stability and absence of violence/terrorism
• government effectiveness
• voice and accountability.

These measures are quite strongly correlated across countries: countries that are ranked low in terms of (for example) control of corruption, also tend to be ranked low on other criteria. To simplify things, for each country we just take an average of all six rankings. Therefore, the lower the value of this average for any country, the lower is our estimate of the quality of its governance. We then express the figure as a percentile ranking among all the 167 countries in our sample: thus a number that runs between 0 and 100%.

Figure 7.23 then shows a scatterplot comparing our measure of the quality of governance with the average inflation rate over the period 2012–2022.

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https://www.core-econ.org/macroeconomics/07-macroeconomic-policy-global-economy-11-application-quality-of-governance-and-inflation.html#figure-7-23

Figure 7.23 Quality of governance and average inflation (2012–2022).

Worldwide Governance Indicators: a global compilation of data capturing household, business, and citizen perceptions of the quality of governance in more than 200 economies; WDI (for CPI inflation).

As is often the case with such scatterplots, the picture is not straightforward, but two messages do emerge:

• The lower the ranking of the country’s governance, the more likely it is that the country will have high inflation. This relationship is not universal: there are some countries with low-ranked governance that still manage to maintain relatively low inflation but as you move left in the diagram, the spread of the dots gets increasingly wide.
• Conversely, as you move to the right in the diagram, the points become increasingly concentrated. If you focus only on the top 50% of countries ranked by quality of governance, there are no countries with average inflation above 10%, and the great majority had inflation in low single figures.