At a time of financial turmoil in advanced countries, emerging economies have provided a welcome measure of resilience, but this has also set the stage for inflation, mainly from rising fuel and food prices.
Even as global activity slows, consumer prices are rising at an annual pace of nearly 5½ per cent, compared with less than 4 per cent in recent years. Much of this pressure is concentrated in emerging economies, where inflation has spiked to 7 per cent, after years of moderation.
This development is part of the changing dynamics of the global business cycle. Strong internal growth momentum in emerging and developing economies is providing a valuable global trade shock-absorber.
The US downturn would be a lot steeper if not for the support being provided by its export sector trading with faster-growing economies around the globe. Financial shock absorbers are working too - through new channels as emerging economies as a group have shifted to being a net source of global savings as sovereign wealth funds are helping to recapitalise ailing banks.
But the commodity price shock absorber is no longer working as it did in the past. Moderating demand in advanced economies has not led to the usual softening of commodity prices that would boost purchasing power.
This is because demand for energy and commodities has remained robust, largely reflecting the strong growth in emerging economies, led by China and India. Growth in these economies is more energy- and commodity-intensive than that in advanced economies.
Moreover, many emerging and developing countries hinder the full pass-through of international prices to domestic consumers by subsidising or capping fuel prices. Of a sample of 43 emerging and developing economies, fewer than half allowed full pass-through of the increase in international prices in 2007 compared with three-quarters in 2006.
In fact, emerging and developing economies as a group have accounted for about 95 per cent of the growth in oil demand since 2003 and two-thirds of growth in demand for the major food crops (the remainder being due to biofuels).
At the same time, the supply response to rising commodity prices has been disappointing. Oil supply projections, particularly for non-OPEC oil producers, have routinely been revised downwardsd in recent years.
Costs associated with investment in new capacity have increased sharply - it is estimated that average field exploration and development costs have doubled, from $5 a barrel in 2000 to $10 a barrel in 2007.
As spare capacity and inventories have dwindled, the oil market has become highly sensitive to news of supply disruptions and geopolitical events, pushing oil prices to all-time highs both in real and nominal terms.
In agriculture too, the supply response has been limited, partly due to years of policy neglect. Infrastructure has not been developed, governments still intrude in distribution and marketing, and trade barriers remain an obstacle to investment.
In recent months, financial factors may also have played a role in the volatility of oil and other commodity prices. Investment inflows into commodity assets have surged, as the combination of US dollar depreciation, falling short-term real interest rates, and rising credit risk in advanced economies has made oil and other storable commodities more attractive alternative assets.
It is, however, hard to find solid evidence that speculation is the main driving force behind recent commodity prices increases. For example, we do not see the build-up in inventories that would be the counterpart of rising speculative activity.
How can demand and supply be rebalanced to reduce the level and volatility of commodity prices? Given that some portion of the latest increases in oil prices appears to be durable, allowing a demand response to the reality of higher oil prices will be crucial.
Indeed, the pass-through of changes in international oil prices to domestic prices, along with well-targeted policy supports to protect the most vulnerable segments of society, would help promote an inevitable demand response to changing market conditions and encourage conservation.
Several emerging economies, including China, India, Indonesia, and Malaysia, have recently increased domestic prices. Similarly, more open and realistic biofuels policies in advanced economies, as well the removal of market-distorting protectionist policies, would help to reduce pressures on food prices.
At the same time, to stimulate a supply response, policies are needed to foster investment in the oil sector and in energy resources more generally. These include efforts by oil producers - particularly those in emerging and developing countries - to ensure that investment regimes are stable and predictable.
There should be greater cooperation and synergies between national and international oil companies through well-designed partnerships. Similarly, removing supply-side constraints to agricultural production in emerging and developing economies, including by improving infrastructure and removing price distortions, should help reduce food price pressures over the medium term.
Advanced economies could support this process by opening up their own agricultural markets to foster cost-effective production at the global level.
How can the inflationary pressures from fuel and food prices be contained? The trick is to allow the inevitable adjustment in relative prices to occur without spilling into higher inflation of non-food and non-fuel products or wages.
The challenge is greatest in emerging market countries, where hard-won gains in combating inflation are at risk of being eroded without decisive policy action. In these countries, the risk that increases in food and fuel prices have second-round effects is raised by the large share of these products in consumption baskets (25-40 per cent compared to 10-15 per cent in the advanced economies) and the fact that many of these economies are already overheating.
Indeed, central banks across a broad range of countries, including Brazil, China, India and Russia, to name just a few, have appropriately increased policy rates, but policies may have fallen "behind the curve," in the sense that the rise in inflation has been greater than the increase in policy rates.
In fact, real policy rates are low and have become quite negative in several emerging economies, notably in the context of tightly managed exchange rates, and there is a risk that inflation objectives are likely to be missed in several of these countries.
A move towards greater appreciation of exchange rates could provide further scope for effective and stabilising monetary policy action.
The global economy is wedged between slowing growth and rising inflation. While risks of the return to the widespread stagflation of the 1970s appear to be modest for most countries, we could instead be faced by a similarly challenging phenomenon: stagflation or at least low growth in the advanced economies and inflation in the emerging economies.
With dynamics of global inflation changing, policymakers in emerging economies will need to play their part in ensuring that we avoid a repeat of the 1970s - keeping domestic inflation under control, but also ensuring policies for robust demand and supply responses to rising commodity prices.
Charles Collyns is Deputy Director and Krishna Srinivasan an Advisor in the Research Department of the International Monetary Fund