Stiglitz: stop trying to beat inflation? by mattsteinglass
May 19, 2008, 9:31 pm
Filed under: Economics, Vietnam | Tags: , ,

So Vietnam is flirting with 20% inflation, and every foreign economist (and, yes, even The Economist) is fervently trying to persuade the government that it has to get serious about cutting non-essential expenditures, stopping sweetheart loans to inefficient state-owned companies for projects that have nothing to do with their core businesses, allow the dong to rise against the dollar, raise interest rates to some approximation of the rate of inflation, and so on, or they’re going to severely undermine that dazzling economy they’ve been boasting about for years. There are even a couple of contrarian Vietnamese economists at the Fulbright Economic Training Program in HCMC who think the country should be discouraging portfolio investment because that influx of $7 billion last year in non-productive foreign currency is part of what’s driving inflation (as the government tries to sterilize it and maintain the exchange rate). Though the HCMC Stock Exchange seems to be doing a pretty good job of discouraging foreign investment lately by losing 70% of its value.

Anyway, now along comes Joseph Stiglitz to make the ultimate contrarian case that countries shouldn’t worry so much about inflation — more specifically, that they should abandon “inflation targeting” policies put into place over the past 30 years. The current bout of inflation, he says, is not driven by monetary issues, as Friedmanite orthodoxy would have it. Instead, it is driven by real excesses of demand over supplies of commodities, chiefly fuel and food. Trying to beat back inflation driven by shortages through contracting the money supply won’t work:

Raising interest rates can reduce aggregate demand, which can slow the economy and tame increases in prices of some goods and services, especially non-traded goods and services. But, unless taken to an intolerable level, these measures by themselves cannot bring inflation down to the targeted levels.

For example, even if global energy and food prices increase at a more moderate rate than now – for example, 20% per year – and get reflected in domestic prices, bringing the overall inflation rate to, say, 3% would require markedly falling prices elsewhere.

That would almost surely entail a marked economic slowdown and high unemployment. The cure would be worse than the disease.

This certainly sounds logical to me, though as a non-economist, most things proposed by staggeringly brilliant economists tend to sound logical to me. But it sounds intuitively correct that a country that imports all of its gasoline can’t keep gas prices down by shrinking the money supply, or that if it did, that monetary policy would have to be deflationary in every other area, and thus ruinous. And, obviously, gas prices tend to get passed through to the rest of the economy.

On the other hand, Vietnam’s inflation problem isn’t driven solely by rising commodity prices, but also by a vast influx of investment currency over the past 2 years which has created tremendous upward pressure on the dong. As the government tries to hold down the dong to safeguard exports from getting more expensive, it has to basically increase the supply of dong, which creates inflation. And this is exacerbated as the dollar is falling against other currencies, as well as against oil, which is still Vietnam’s biggest export. The advice of most economists has been that this is untenable, and they’ll have to let the dong rise against the dollar somewhat to alleviate inflation.

Still, Stiglitz’s point seems very solid, right? The current situation does seem to indicate that inflation isn’t, in the old Friedmanite formulation, always and everywhere a monetary problem. Then again, wouldn’t this have already been discovered in 1974? What was the economists’ position then?


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[…] getting more expensive, it has to basically increase the supply of dong, which creates inflation.” Stiglitz: stop trying to beat inflation? ACCUMULATING PERIPHERALS __________________ Islam delenda […]

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