Unfortunately, individuals from politicians to the public have little if any understanding of the causes of price inflation. Fortunately, the policy-makers at the Bangko Sentral ng Pilipinas fully understand the situation.
In a free market without regulatory pricing intervention, the demand and supply of goods determine the price. The exception is when a product or service is controlled by any sort of monopoly or cartel, such as in the case of utilities like electricity. In that case, government intervention on pricing and laws against price fixing are necessary.
If there is a balance in demand/supply, prices should be stable. Sellers want to receive the highest price. But every business owner knows that buyers determine the price. If buyers are not buying at a particular price, the seller lowers the price to create demand.
One type of price inflation is “demand pull” when demand increases against a stable or falling supply. People are willing to pay more for a variety of reasons to purchase a product. Some years back, when there was a scare about foot and mouth disease in pigs, chicken prices increased to keep supply/demand in balance to avoid chicken shortages. Buyers were willing to pay more. Likewise, pork prices decreased because there was more supply
than buyers.
In order to create more demand, notice that you can buy televisions and refrigerators on your credit card with zero interest. If suddenly there was a shortage of TVs and refs because everyone was using this “no/low interest” money to buy, it would be likely that the prices of these items would increase. Economists would then say that the TV/ref business was “overheating.” In order to bring back the demand/supply balance, credit-card interest rates would be raised.
That is why and how central banks use interest-rate increases to help mitigate demand-pull inflation. If “cheap” money is creating excessive demand and higher prices, then cheap money must be taken away.
The other type of inflation has nothing to do with the demand/supply equation. This is “cost push” inflation, when there is an increase in prices of inputs like labor, raw material, or any other cost increase that affects the final price.
It costs a poultry farmer P1 per chicken to transport the birds to market, which is included in the final price. But a new highway charges the farmer a toll fee of P2 per chicken. Therefore, the retail price must be adjusted higher. That is cost-push inflation.
The Philippines is currently experiencing cost-push inflation because of higher taxes and higher fuel costs in part because of the increased cost of crude oil. Therefore, increasing interest rates to stop cheap money is useless. Cheap money is not the cause of the current price increases.
In fact, increasing interest rates could increase inflation, since the cost of borrowing is part of the input cost of goods. If a company borrows money to buy raw materials to manufacture products, then an increase in interest rates will increase the final retail price just like for the chickens crossing the toll road.
It is unfortunate that the loudest voices are often the most ignorant. The next time a politician or commentator calls for an interest-rate increase, see if there is any analysis of how that will bring gasoline prices—or chicken prices for that matter—down. That may be difficult to find.