The Required Balance between Inflation and Growth
Michel Morkos Al Hayat - 24/03/08//
Inflation is one of the most important components of the global economic crisis. It is linked to it as a reason that causes panic among the monetary policy supervisors in central banks. Inflation is the negative side of growth, even though it is a result of it in some way. Hence, central banks choose either to activate growth or curb inflation. Lowering key interest rates helps growth: it decreases pressure on investment and allows capital movement beyond the traditional economic sectors. However, adopting the best highest reference interest rate draws liquidity from markets, curbing high expenditure and shrinking inflation and its high rates.
Inflation bites out nominal growth rates; inflation rates are subtracted from growth rates to reach the actual growth rate. Therefore, inflation knocks off the effects of a real growth and throws the economy in a black hole eating itself from the inside.
Inflation, which spreads like a plague, is not only due to internal reasons; it is "globalized" and have external root causes. Global trade brings about inflation in producing and exporting countries as well as in importing and consumer countries. Any inflation in a producing and exporting country is reflected upon the importing country. This connection causes a change in the equations on which the global economy relied during past years, especially that the scope of the crisis's repercussions is on par - if not beyond - with the most important crises known in the 20th century.
The change in the equation starts with emerging countries. China and some Asian countries previously gained from an undervalued exchange rate to promote foreign demand for their products and increase export. The main motive for this behavior is to use their national labor force and cover the insufficiency of domestic demand. This voluntary policy helped them reach strong economic growth without initiating internal structural reforms, such as developing the financial or social services sectors. Asia exported recession (at inflation level), as the prices of its industrial products dropped in line with production growth and steady exchange rates against the dollar. Asian emerging countries ignored the economic growth's cyclic characteristics, and the countries receiving Asian products, especially from China and India, got used to the new economic pattern. Many multi-national enterprises moved to invest in Asia or Russia and Eastern Europe, in hundreds of thousands. Americans and Europeans thought that the world entered a new economic order so they pressured the Chinese authorities to reevaluate the Yuan against their currencies.
This new economic pattern led to stable inflation rates in Western countries, with the exception of a slight increase in salaries, and achieved some stability in certain countries. On the other side, it caused national enterprises to lose market share and closed some production sites, giving investors the upper hand over wage earners. As a result, the weak inflation level, resulting from the emerging countries' deep integration into world trade, preserved the purchasing power and helped wage earners to put up with what was known then as the new economic balance. However, the increase in prices of raw materials and the monetary mass growth disturbed this balance. After 5 years of growth exceeding 7 and 10 percent respectively, India and China witnessed an increase in their consumption of raw materials, which reached quarter of world consumption. The connection between the Chinese industrial production and oil prices, for example, has risen in 2000 from 0.8 to 2. To the inflation factor was added the rise in food products prices, some circumstantial and linked to weather or health conditions. The effect accompanying inflation sources, in the context of the strong growth of the monetary mass, causes concerns of long pressures on prices, salaries and production costs (Mathilde Lemoine - a member of France's National Economic Committee).
From now on, salary increase movement will begin in China. Salaries increased 30% on average in 2007, knowing that, on average, they did not increase more than 17% in the last 5 years. Salary increase movement can widen because of the labor force demands, which include improvements and special benefits. On January 1st, a work contract that provides for paid overtime hours and social security coverage was enforced.
During a forum held by Banque de France on March 7th, Yi Gang, Deputy Governor of the People's Bank of China, proclaimed that these pressures, noticeable in skilled and professional labor markets, could persist until 2010. Due to the price rise and production costs, the emerging countries will be forced to steer their economic policy towards absorbing inflationary pressures. Chinese Prime Minister Wen Jiabao said that he would let the Yuan self-evaluate faster while continuing to increase interest rates and reserve requirements. If inflation goes down, export prices will redeem themselves.
Emerging countries are exporting inflation now. Any decrease in inflation rates should therefore come from these same countries, unless the advanced economies recover. Such a development, even if circumstantial, requires an emergency reinvestment. In addition, advanced countries must aid the sectors they are trying to reclaim, provide them with the possibilities to achieve competitiveness and support their productivity with investments. Because the new situation continuously pushes consumer products prices upwards, horizontal industrial policy making must be sped up. These policies must back innovation, help rehabilitate wage earners and develop the infrastructure of small and medium-sized enterprises.
Will the world be able to rebalance its economy?
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