GIVEN the global meltdown in the equities and bond markets, coupled with the weakening of all currencies against the US dollar—which was caused by the US Fed increasing interest rates to bring down inflation, you might be wondering if this course of action is the right solution. Inflation is the rate of increase in prices of goods and services over a given period of time; and there are three major causes of this.
The three major causes of this are demand-pull inflation, cost-pull or supply side inflation and built-in inflation. Demand-pull inflation occurs when the overall demand for goods and services increases more rapidly than the economy’s production capacity. Naturally if you have more demand than the available supply, this will cause prices to increase. What causes this increase in demand? A low interest rate makes consumer credit cheaper and attracts more people to buy goods and services.
An increase in the money supply or the total amount of money in circulation will also increase demand, since the people now have more money. How does this happen? Generally, this happens when there is more government spending, such as the stimulus checks or “ayuda” given during the lockdowns. Perhaps restraining the money supply is a better alternative to increasing interest rates to dampen consumer demand, since a higher interest rates creates many unwanted side effects such as a global recession.
Cost-pull or supply side inflation happens when the increase in prices of goods and services goes up due to their rising costs. The war in Ukraine and the sanctions against Russia caused disruptions in the supply of certain goods such as oil and gas products, grains and other raw materials. This is on top of the disruptions due to Covid-19 lockdowns and restrictions that choked production and disrupted the global supply chain. It is also interesting to note that increasing interest rates to dampen consumer demand to bring down inflation, also increases the borrowing cost on the supply side, since they will now have to pay a higher interest rate, which is ultimately passed on to consumers through higher prices.
Built-in inflation occurs when workers demand their wages to increase when prices of goods and services go up, to maintain their standard of living. This is really a double-edged sword, since laborers demand higher pay, the cost of production increases, which in turn raises the cost of living. This death spiral can easily get out of control and actually cause more pain for the laborers. In 2022, 25 states and the District of Columbia increased the minimum wage to at least $10 an hour. In February 2020, the US unemployment rate fell to 3.5 percent, its lowest level since 1969 and is forecasted to hit 4.0 percent in 2023.
We can only hope that history teaches us a lesson to avoid going through the same pain needlessly and have the right people in the right place to lead and guide us through these difficult times.
The views and comments of Dr. George S. Chua are his own and not of the newspaper or the Financial Executives Institute of the Philippines (Finex). Chua, 2016 Finex president, is currently a professorial lecturer at the University of the Philippines Diliman and BGC campuses. He is also an active entrepreneur. Comments may be sent to email@example.com.