Monday, October 20, 2008

Inflation or Deflation?

By definition, the money supply decides inflation or deflation. CPI is NOT the index of inflation. It has been proven in the last few years: while US was expanding on credits, it benefited from the cheap production cost from China. Yet it was reflected on commodity price.

The current policy makers, in order to avoid liquidity trap as shown on Japan, have supplied money to the intermediates (banks and financial institutions) to encourage loans. Yet, without reliable and highly potential projects, bankers invest on nowhere. Besides, as the borrowing cost is low, it does not matter for them to re-invest back to the government for a low yield rate.

The control of banks by government may alter the appetite of bankers by orders.

Meanwhile government needs to "create" beneficiary of the "mandatory loans". Government projects will be one of the obvious most ways; subsidies from government on "coporate participants" for creating projects and jobs will be another.

Depending on the strength of will of maintaining a certain level of salary by labour through their representatives as well as the economic conditions, the degree of divergence of salary from actual labour market determines the stickiness of salary - the essence of Keynesian school. Government will be easily tempted to please their electors by altering the actual demand and supply on labour market.

If that appears, inflation will also come back.

Possible scenario, then, will be: first deflation due to credit crunch; then hyper-inflation due to un-disciplined government spending. But if the government refuses to directly spend money and level up labour salary, deflation continues and will also harm the global economy completely.

1 comment:

Felix Kan said...

Well, it appears that ALL governments will soon run out of tricks to boost its own economy or keeping up with enough jobs for their citizens. Last resort would be resume Keynesian practice.

If we put ourselves into their shoes we would've made the same decision...

- why not spend more money (that can be printed) to keep the voters happy?
- why not print more money when every other nations around globe is doing so?