Inflation is easing, but we still need to be on our guard

Food prices are rising in Bangladesh.

While that is good news for the farmers and those who supply our food, that is not so good for the rest of us.

However, when something happens, we have got to work out why it did so before we can try to craft solutions to this new problem. 

Getting the why wrong will mean that our answer will be the wrong one.

We can all observe that apples fall out of trees but the explanation “gravity” gives us different answers about how to get to the moon than the idea that apples just love the Earth and want to be closer to it.

So, it is with price changes -- we need to know why prices are changing before we can craft a solution. This is more important for food than it is for other items.

Firstly, and obviously, because food is vitally important to each of us and that in a very direct sense. “Vital” means necessary to life.

It is also true that food prices are more variable than those of most other parts of life. We can even see this in our national statistics.

We generally have two different measures of inflation, the regular one and the core one.

That core ignores changes in the price of fuel and food because we know that those prices bounce around a lot.

So, if we want to see the general change in prices, we should ignore those bouncings.

The reason food prices vary is that they are so often tied to seasons and how the latest crop has been doing.

We have had several worries about soaring onion prices in the last few years brought on just by the wrong sort of weather for onion growing.

These are problems that sort themselves out over the next growing season.

 

That this has been true does not though mean that all food price rises are such temporary phenomena.  

Which is what is the worry here and now -- this might not be just the normal variability of food prices; this might be a much more general event.

As reported, the prices of garlic, turmeric, ginger, have all risen between 5 per cent and 9 per cent.

Flour is up Tk 4 to Tk 32 in these past few weeks. There is no obvious connection to harvests with all of these items.

It is a reasonable assumption -- an assumption good enough at least to explore, even if then to reject -- that there is something else going on.

If all prices are rising then it is not actually the prices of goods that are changing.

It is the price of money that is falling. This might sound like a difference that is not worth pointing out but it does have significant implications for what we do next.

For the price of money falling -- each unit of money being able to purchase fewer goods and services -- has another name, inflation.

When the price of one good or another change, this is not, strictly, speaking, inflation. When all the prices are changing then that is indeed inflation.

The price of onions changing might be just because the fields were flooded at planting time. Or, when harvest time came around and they rotted. Or it was too dry for them to grow properly.

But when all prices are changing that is a monetary phenomenon. As Milton Friedman insists, inflation always was a monetary phenomenon.

We should also expect to be on our guard against inflation currently anyway.

One way that governments around the world have dealt with the costs of the coronavirus is simply to print more money to pay those costs. This can be called quantitative easing; some would call it a modern monetary theory.

 

It was also right that this was done because we did need the money to spend and a crisis is not quite the time to be raising taxes.

But there is the flip side to this, that making more money to chase the same amount of goods will lead to each piece of money buying fewer goods -- that is inflation.

Near all economists agree that this might or perhaps even is likely to happen. All the disagreements are about when it might and how much if it does.

In normal times we desire to, and try to, increase the money supply in line with the expansion of the economy plus inflation.

A larger economy just does need more money in it -- like a restaurant that used to serve 50 lunches now needs more plates and cutlery when it starts serving 100 lunches a day.

That would indicate that the Bangladeshi money supply should grow at perhaps 10 per cent a year.

That sort of amount, inflation plus economic growth, 5 per cent inflation plus 5 per cent to 7 per cent growth. These are rough numbers you understand.

However, we can go and look at the money supply figures and see that growth has been 20 per cent for M1 (one of the many different definitions of money supply and a useful one for us here).

In normal times we would expect -- even insist that it will -- this might lead to inflation, a general rise in the prices of goods or a general fall in the value of money.

These are not normal times, which is why the economists are not sure whether we will get inflation from QE.

To use that restaurant analogy, again it depends on the velocity of money -- it is possible to wash the plates faster or slower in order to feed more people, the speed with which we use money can change too.

The point here is that we need to find out which of the possible explanations this is.

 

Maybe food prices are just rising because there are problems with the harvest. The solution then is to wait for the next harvest most likely.

But perhaps this is the start of the inflation that might be caused by our printing all that more money. The answer then would be to stop printing the money.

For how we solve a problem depends, always, on our identifying what is causing the problem in the first place.

 

Tim Worstall is a senior fellow at the Adam Smith Institute in London

 

Source: Dhaka Tribune