Why worry about inflation

INFLATION affects everyone—rich, poor and the middle class— but it can be tamed.

A subject of great interest when this writer taught economics for more than 10 years at the postgraduate studies of the International Academy of Management and Economics, inflation means the general level of prices of goods and services is increasing. In other words, your peso buys less and less over time.

That’s why Bangko Sentral ng Pilipinas (BSP) Gov. Nestor A. Espenilla Jr. and his outstanding management team are always busy keeping inflation in check and stable, and making sure the economy grows and becomes sustainable.

The BSP is not only mandated to determine the nation’s monetary policy but it is also specifically tasked to closely monitor inflation and make sure it’s under control.

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The BSP also helps people spend wisely and draws up good business plans, as they do not have to worry that the purchasing power of their money would continuously drop.

Inflation can be divided into two broad areas: quality theories of inflation and quantity theories of inflation.

The quality theory of inflation rests on the expectation of a buyer accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer, while the quantity theory of inflation rests on the equation of the money supply, its velocity and exchanges.

The famous Scottish Economist Adam Smith (Wealth of Nation, 1976) and empiricist philosopher David Hume (1711-1776) were the ones who proposed a quantity theory of inflation for money, and a quality theory of inflation for production.

There are three main problems if inflation is high:

1. People on a fixed income (pensioners, wage-earners and students) will be worse off in real terms due to higher prices as this will lead to a reduction in the purchasing power of their income.

2. Labor unions will be encouraged to demand higher wages, and this can cause a wage spiral. If strikes occur, say, in an important food industry, the nation may see a serious reduction in productivity and unemployment.

3. Exports will become more expensive for other countries to buy, and this will create a deficit on the current account.

For laymen, a monetary policy means the actions taken by the BSP to influence the availability and cost of money, credit and interest rates affecting a range of economic variables, including input and output, employment, prices of goods and services.

In other words, the BSP must have the right combination of policy or policies to promote a low and stable inflation conducive to a balanced and sustainable economic growth.

The “Taylor Rule,” named after prominent economist Prof. John B. Taylor, of the Stanford University, is an excellent guide to assessing the proper stance of monetary policy. “It relates the setting of the currency rate to the primary objectives of monetary policy—that is, the extent to which inflation may be departing from something approximating price stability and the extent to which output and employment may be departing from their maximum sustainable levels.”

For example, “one version of the Rule calls for the money rate to be set equal to the rate thought to be consistent in the long run with the achievement of full employment and price stability plus a component based on the gap between current inflation and the inflation objective less a component based on the shortfall of actual output from the full-employment level.”

In his best-selling book, published by Amazon (ISBN-13:97802 26791258), Monetary Policy Rules- National Bureau of Economic Research Studies in Income and Wealth, Prof. Taylor prescribes the amount by which the money rate would need to be raised or, if output and employment are weakening, the amount by which it would need to be lowered. The specific parameters of the formula are set to describe actual monetary-policy behavior over a period when policy is thought to have been fairly successful in achieving its basic goals.

Economists have been suggesting a number of methods to stop inflation. For instance, high interest rates and a slow growth of the money supply are traditional approaches that most central banks throughout the world used to fight inflation.

However, some central banks view the means of controlling the inflation differently. For instance, some follow a symmetrical inflation target (SIT), while others only control inflation when it rises above a target, whether expressed or implied. SIT is a requirement placed on a central bank to respond when inflation is too low, as well as when inflation is too high.

 

To reach the writer, e-mail [email protected] gmail.com.

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BusinessMirror columnist Cecilio T. Arillo, a veteran author-journalist, was educated at the International Academy of Management and Economics (IAME) with a Ph.D. in Management; the Pacific Western University in LA with BSc in Mass Communications and Master’s Degree in Science, Major in Economics; the Harvard Law School-MIT-Tufts University (consortium) on Negotiation, Mediation and Conflict Management; and the Harvard Kennedy School of Government on effective Decision Making and Organizational Change for Senior Executives. He taught undergraduate and MBA interdisciplinary studies at IAME and was president of the Philcoman Council of Management and Research Institute. Arillo is a member of the American Economic Association, the American Sociological Association, American Association for the Advancement of Science, Philconsa and lifetime member of National Press Club.