Today the worldwide economic scenario presents contrasting look with USA &European Union grappling with falling output, low levels of demand and record levels of unemployment. Opposite is the case with emerging nations including INDIA, CHINA, etc. where prices are sky high threatening their long yearning dream of making 21st century as ASIAN CENTURY. In nutshell, west is being haunted by deflation having its roots in recession of 2007 and east is down with inflation.
Current events like USA debt-ceiling crisis, its downgrading by S&P(STANDARD & POOR) and countries like SPAIN, ITALY,GREECE giving out grim look on economic front, it’s evident that world economy is reeling under the burden of rising burden of government debt in OECD countries. Policymakers, across the globe, are vouching for different measures ranging from cutting public spending to raising taxes.
Although a seemingly paradox, INFLATION can prove to be the cure for this debt addiction of big economies. Inflation erodes the real value of outstanding debt. It is a tax by another name that helps governments balance budgets. It is unpopular, but right now spending cuts and tax increases look even more unpopular. In cases of political gridlock, inflation can be an unwitting solution because it can happen without explicit government action.
We will see how it happens through a simple illustration. Take the case of USA. As is the situation, US govt. need to repay the debt to other sovereign bond holders not in terms of dollar but in the form of foreign currency. Here comes the role of foreign exchange market.
Let the general price level in USA be PA and the general price level in foreign country is Pf .Exchange rate between these two nations in its simplest form would be determined as:
EXCHANGE RATE, FX=Pf/PA ;
Here FX is the effective price that USA will pay for the debt. As the price level in USA will rise, a sort of inflation which is, it will pay fewer amounts in real terms.
Mathematically, if PA goes up, FX would fall; keeping Pf constant.
Neither massive stimuli (as in the US) nor austerity budgets (as in the UK, Greece, Portugal, Ireland and Spain) look like producing much-needed growth. Without growth, the debt/GDP ratios of these countries will keep worsening. The limits of Keynesian economics have been exposed cruelly. Big stimuli can get you out of a recession, but cannot guarantee that growth will be fast enough to automatically tame burgeoning debt. Keynes formulated his theories in the context of a closed economy. But today OECD (organization for economic co-operation & development) economies are open, so fiscal and monetary stimuli can leak out. If you stimulate consumer spending through tax cuts, you may simply stimulate imports rather than domestic production. A monetary stimulus may mean that cheap money is used to invest in other countries, not your own. This partly explains why huge stimuli in OECD countries have fuelled growth in emerging markets and commodity producers rather than in the OECD.
Inflation will enable the OECD to strike back. It will erode the real value of huge foreign exchange reserves – and private holdings of OECD gilts (govt. bonds) and corporate bonds – held by developing countries, and thus amount to a massive write-down of OECD debt. Developing countries will want to diversify out of OECD gilts (bonds), but there are no comparable adequate alternatives.
SO what we hear every day that everything is relative and not absolute comes true for Inflation. Rising prices do burn big holes in our pocket but in the context of USA & European Union, it could well prove to be a blessing in disguise.
- Kumar Ashutosh
simpleashu441@yahoo.in
No comments:
Post a Comment