Pages

Saturday, June 25, 2022

Tackling inflation will be painful



Tackling inflation will be painful

By Dr Carmelo Ferlito - June 25, 2022 @ 5:00pm


It is important to clarify that there is a difference between price increases and inflation. - File pic


IT is important to clarify that there is a difference between price increases and inflation.

First, we must distinguish between one-time jump in most prices without a continuing rise (which is not inflation) and inflation, which usually means a continuing general rise in most prices.

The difference is important because they are caused by different events.

The first one can be caused by demand pressures or supply-chain shocks (wars and lockdowns; these events are usually temporary).


However, the necessary and sufficient condition for a persisting, increasing price level is that the quantity of money is increasing relative to the stock of real goods and services.


That and only that is the source of a persisting inflation, said American economist Armen Alchian.

Nobel economics laureate F.A. Hayek said: "A general rise in prices, for instance one brought about by a shortage of food caused by bad harvests, is not inflation.

"Nor could we properly call 'inflation' a general rise in prices caused by a shortage of oil and other sources of energy that led to an absolute reduction of consumption, unless this shortage had been the pretext for a further increase in the quantity of money."

Inflation's "original and proper meaning is an excessive increase in the quantity of money, leading in turn to an increase in prices".

Nobel economics laureate Milton Friedman said inflation is produced by "a more rapid increase in the quantity of money than in the quantity of goods and services available for purchase, and such an increase raises prices in terms of that money".

Therefore, inflation "is always and everywhere a monetary phenomenon in the sense that it is, and can be, produced only by a more rapid increase in the quantity of money than in output".

In a nutshell, if chicken prices go up because supply cannot temporarily cope with the increase in demand, this is not inflation.

The situation can be addressed by letting prices temporarily go high for supply to step up and bring about a market adjustment, which will bring down prices.

Which kind of phenomenon are we are experiencing in Malaysia?

Actually, both of them. And both can be traced back to painful and prolonged lockdowns, which, while did not contribute "to break the chain of infections", were extremely costly and are now affecting the public.

Movement restrictions worldwide altered the supply chain structure, distorting supply and demand.

A process of gradual readjustment can emerge only if market forces are let free to operate.

Governments tried to patch up lockdown holes with expansive fiscal and monetary policies that made the quantity of money grow faster than the output.

In 2020 and last year, Malaysia's gross domestic product cumulatively lost 2.67 per cent, M1 grew by almost 28 per cent and M2 by more than 11 per cent.

(M2 is a calculation of the money supply that includes all elements of M1 as well as 'near money'. M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, and other time deposits).

This dichotomy between output decline and increasing quantity of money is inflation, which leads to a price increase.

This dichotomy can distort growth, creating artificial demand and artificial jobs, planting the seeds for a boom-and-bust cycle.

Can the government provide cash aid to the people in these troubled times?

While it seems reasonable to expect that the government wants to help the poor, we must wonder if the proposed cure may be worse than the disease.

Here's a rhetorical question: if money creation is the source of inflation, can more money creation cure inflation?

In fact, what could happen with more cash aid is that people would have more money in hand, but what that money can buy would remain the same or even become less.

This is what happened over the past two years: people had more financial resources to compensate for their loss of income.

But the actual value of that resources was lower because it did not have a counterpart in the real economy.

This means that it was not accompanied by the creation of goods and services: more money chasing fewer goods.

Unfortunately, there is no easy way out of inflation.

The only way out of inflation is deflation, and not without pain.

The long-term measures that need to be implemented are:

1. Productivity growth deflation by nurturing an environment conducive to innovation

2. Cash-building deflation, as savings will boost growth

3. Reducing (rather than increasing) government spending to reduce the quantity of money in circulation

4. Reinstating the primacy of balanced budgets



The writer is chief executive officer at the Center for Market Education, Malaysia


No comments:

Post a Comment