Inflation: monetary phenomenon?

Inflation is an inevitable phenomenon, with income varying over time. In the same passage of time, the price of commodities jumps higher relative to changes in income. It seems to increase in the same way as human age increases. On the other hand, technological development drives down the price. Age increases with time travel theory. At the same time, medical science is providing anti-aging solutions. Therefore, inflation is similar to the growing trend of aging and non-inflation to anti-aging.

However, inflation is about to change the price of basic necessities more or less in monetary form. Money supply is claimed to be the cause of inflation which leads to an increase in the price level. “Too much money chases too few goods” is demand-driven inflation. But too much money relative to production can create excess demand. It is, in another sense, a situation where too much money is in circulation.

Production proportionate to a given demand does not lead to a change in the price level. But it is not easy to distinguish between a surge in demand and a monetary phenomenon. In practice, excess demand is expected to produce additional production. The position then becomes sequestered, no one is to blame. Therefore, the question arises as to when demand-driven inflation exists. This happens due to supply shocks.

From the end of 2019 to 2021, the world is almost in lockdown due to a small virus. The normal production process becomes hampered. Governments of different countries are declaring stimulus packages in form of transfer payments under fiscal policy and easy money in form of loans through monetary framework. Fiscal supports work better and help eliminate accumulated assets in the markets. But easy money cannot produce results as expected. Coming out of a pandemic situation, economies shift gears with excess demand, but production cannot sustain demand. Supply shocks lead to inflation exceeding 3.0% to 8.0% globally.

There are few countries known as bamboo economies that are not dependent on others. This means they don’t need to import goods. But economies like ours must depend on external sectors for goods ranging from consumer goods to input content. Shocks in global commodity markets lead to imports of inflation. To contain prices at a reasonable level, the market policy for certain products is dictated by price fixing. There is a side effect of such an imposition, the market becomes drier.

The situation creates a parallel market where goods are traded at prices higher than fixed prices. With regard to the foreign exchange market, the exchange rate for import payments is set by the central bank. But banks do not sell foreign currency at the dictated rate. Importers are then forced to purchase foreign currency from other banks at a higher price for import payments. So the market does not support fixation, flexibility works better here. During supply shocks, the price level moves to a higher level, but the income level does not go into that range.

With prices remaining at a higher level, central banks are busy fine-tuning monetary policy. Under the program, central banks simulate the money supply, which results in higher interest rates. The foreign exchange market is supported by the supply of foreign currency to the markets. These tools are also drying up local currency markets and fueling rising interest rates. Loans at individual levels are not intended for the purchase of consumer goods, but rather for major purchases. Loans are particularly used to meet business needs. Rising interest rates make loans expensive, discourage additional investment and result in loss of production. Therefore, political tools make money scarce in the market, which leads to other negative impacts.

The current monetary system is based on fiduciary money. It is not backed by gold or other stable currencies. As such, it is not sound money. It is always subject to inflation. The sterilization mechanism keeps the monetary base fixed. But this is not always possible. Market intervention by foreign currency brings local currency into central banks. This leads to a decrease in foreign assets and a shortage of local currencies, leading to a reduction in the monetary base. Under the system, foreign currency crosses the border against imports, the money market is in short supply as far as possible. On the other hand, the reduction in the monetary base of the central banks destroys the funds loanable to the multiples.

Consumer credit can fuel demand and lead to inflation. This situation may be necessary to promote production. The proposition is not feasible if the input supply chain is facing shocks. Whatever the situation, access to financing by companies must be fluid in all cases. Shocks in the global supply chain may require foreign currency support from central banks. But the impact resulting from the return of the national currency to central banks increases the cost of loanable funds.

There is no scope or hedging mechanism to remove the import price. It becomes inevitable. But the price in domestic markets must be reasonable without administrative intervention. It is easy to talk about, but the implementation is not so easy. The change in the price level due to supply shocks is not easily manageable. Coordinated efforts are needed. From a monetary point of view, liquidity must be injected into the markets. But it takes a process to get there. There are various tools through which central banks monitor the banking system. These are the advance deposit rate, reserve requirements, etc. Relaxing some parameters can help achieve the goal. Otherwise, a mechanism for extending special liquidity support should be designed by central banks. Import of finished goods may be allowed under buyer’s credit, which may loosen the forex market at the moment. In this case, an external credit for six months should be authorized with local credit support for the same duration.

At the end of the tax point, import taxes should be reduced as much as possible, including exemption from value-added tax for a certain period. There is an opportunity cost to the government for tax exemption. In this case, the government must tighten tax regulations. But he is not expected to follow austerity measures. As stated earlier, the pricing measure is not feasible as it dries up the markets with the creation of parallel markets with higher prices. To contain this situation, in-kind tax assistance can be extended to vulnerable groups. Under the program, vulnerable people are expected to receive consumer goods at a subsidized price. It is an alternative to the pricing mechanism.

Supply shocks caused panic. This is done by devolved wards. To keep the markets at a stable price level, rumors should be approached with caution. Without adopting inward looking programs like price fixing, fixed cost of money, exchange rate sensing, etc. ; the application of different proposals can bring fruitful results.

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