Monday, August 18, 2008

The Wrong Kind of Inflation

A few winters ago, British Rail explained the late arrival of trains because of the the 'wrong kind of snow'. Presumably they were hoping for the kind of snow, that cleans the tracks before obligingly melting away. With global inflation increasing, many are talking of the 'wrong kind of inflation' This is because the inflation is cost push. It increases living costs (aggregate supply shifts to the left) and discourages consumer spending. The other type of inflation is demand pull (e.g. growth too high). With demand pull inflation, consumers are spending. It is easier to control because when growth is too fast, Monetary policy can be used to slow down consumer spending.

However, for central Banks, this wrong kind of inflation presents a difficult dilemma. They are faced with inflation rising and economic growth falling. Using interest rates they can't deal with both problems. Therefore, they are forced to either target inflation or help growth; it is not possible to solve both at once simultaneously. The ECB and UK central Bank are currently caught in the middle and are keeping rates stagnant in the hope that the problem will dissipate.

Japan Deflation and The Wrong Kind of Inflation

For a whole decade of in the 1990s and early 2000s, the Japanese economy suffered damaging periods of deflation, which discouraged consumer spending and led to stagnant or falling growth. Here the deflation was very damaging for the economy - nobody wanted to spend with prices falling. The government tried very hard to increase the money supply - interest rates of 0%, and fiscal expansion. Many argued that what Japan needed was a bit of inflation. (BTW- This is why Central Banks target inflation at 2% and not 0%)

Currently, Japan is experiencing inflation (it is only 2%), but, it is of no relief for the economy. The inflation is created by rising commodity prices, chiefly food and oil. It is a story repeated in many countries. But, this rising inflation is discouraging consumer spending. Nominal wage growth in Japan is low. In fact, in firms of more than 30 workers, nominal wage growth fell 0.6% last year. With costs of living rising, Japanese consumers are having their disposable income squeezed.

Combined with slowing exports, rising unemployment and general economic uncertainty the Japanese economy is facing another contraction. This time it is not alone and the causes are primarily global. But, it has come at a bad time. - Just when the sickly Japanese economy was looking to be making a fresh start along comes a supply side shock, leaving policy makers little room for manoeuvre.

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1 comment:

Anonymous said...

hi boy
this is amin askari from iran
i am interested about uk economy
can you help me?
can i have a look to your article?