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How to control rising inflation – by Alok Sheel
Inflation is fast becoming an 'internationally tradable virtual commodity' over which nation states and their central banks are losing control.
According to monetarists, inflation is primarily - in Milton Friedman's extreme formulation "everywhere and always"- a monetary phenomenon. Their logic goes something like this: if money supply were constant, and the price of a particular good, service or asset, were to rise, a fall in the demand for, and hence price of, other goods, services and assets would take place to compensate for the relative rise in demand for steel. Ceteris paribus, the rate of inflation would remain constant, because aggregate monetary demand and supply tend to equate in a market economy.
This logic however works only in a closed economy. While economies were never fully closed, goods and services are now increasingly tradable across borders. External demand and supply pulls are therefore becoming stronger. The price of tradable goods in which there is a global demand-supply imbalance could still rise despite domestic money supply remaining unchanged or even declining. The money supply adjustment would be in the non-tradable sector, which would see a decline in prices. Conversely, excess money supply is likely to inflate the price of non-tradables, especially assets like stocks and real estate, rather than the basket of tradables comprising the consumer price index.
As global trade or GDP ratios rise sharply, the price of the tradable goods is increasingly determined by international, rather than domestic, demand and supply. Most of the inflation in tradable goods over the past year, in India and abroad, has been in oil, commodities and food marked by global demand-supply imbalances. Prices of most other tradable goods are still relatively stable on account of the efficiency effects of globalisation. While the world economy taken together can be seen as closed, the role of...
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