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