Tuesday, June 17, 2008

Current Issues: Inflation

Normally Central Banks would use its 'tools' to counter inflation, ie raising interest rate. Why?
Higher interest rate would dampen investment and the demand for money. People and businesses would simply park their money in the bank and earn interest instead of borrowing money from the bank to invest in economic enterprise, like starting a small business or venture. So the theory goes, with less investment, there will be less demand for goods which leads to lower inflation in the near term.
M3, the money in circulation would also contract. People would feel less rich, and hence spend less. This would dampen GDP growth, and sometime may lead to economic contraction (recession).

Is inflation that bad? What does inflation means to ordinary people, and to businesses?
To ordinary people, inflation means rising prices, caused by high demand for goods with limited supply. To businesses, inflation means passing on the cost and higher profit figures.

Inflation dangers 'threaten Asia'

Rising food prices could lead to spiralling inflation in Asia
The threat of high inflation remains a major worry for Asia, and could undo the progress made in the past 20 years, the Asian Development Bank (ADB) says.

ADB managing director Rajat M Nag said inflation in 2008 would exceed the 5.1% annual figure predicted in April.

Rising fuel and food prices were the chief dangers behind inflation that affected Asia "good growth story".

Rising inflation could also hit investment and corporate earnings, and destabilise governments in the region.

In Asia, roughly about a billion people are vulnerable to the food and fuel price increases

Rajat M Nag, Asian Development Bank

On Friday India said its inflation had risen at its fastest rate in seven years. And earlier in June South Korea said its inflation had hit a seven-year high as a result of rising energy and food costs.

In Vietnam inflation is more than 25% and the government has said the issue is the biggest challenge it faces.

Singapore, Thailand, and the Philippines and Indonesia are facing inflation rates of between 7.5% and 11%.

'Regressive' taxation

The ADB has forecast 7.6% growth for the region in 2008, down from 8.7% in 2007, which was the highest in two decades.

Mr Nag said Asian monetary and fiscal authorities should "recognise inflation as a very major concern" and indicated that raising interest rates could be one solution.

Inflation "can endanger growth in Asia," he said, adding that "central banks should take all steps, including looking at rates as what India has done quite appropriately."

On Wednesday India's central bank raised a key short-term borrowing rate by a quarter percentage point to 8.0%.

Rising food prices have been spurred by rising fuel costs that have increased production and transport costs.

Loans offered

Asian nations such as India, Malaysia and Indonesia recently cut fuel subsidies in the face of rising world oil prices, which may send inflation even higher.

"Inflation is the most regressive form of taxation and it hits the poor most. In Asia, roughly about a billion people are vulnerable to the food and fuel price increases," Mr Nag said.

He said governments had to ensure "targeted cash support" for the poor to protect them from the price increases, he said.

Asia is home to two-thirds of the world's poor. It cut its poverty rate to about 19% from 33% in 1990, but Mr Nag said this improvement was under threat because of inflation.

In April the Asian Development Bank offered to support countries dealing with the effects of rising food prices.

It said loans could be made available to countries so that they can subsidise the price of staples to help the poor.

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