Inflation has taken the world by storm, as rises in oil prices, agriculture goods and energy costs over the past month fed through to consumer prices. In the UK, it has reached its highest level in Britain in 11 years; the pound sterling is declining as inflation accelerates. "the pound losses could signal markets are shifting from single-minded focus on higher inflation and beginning to look toward the potentially deleterious impact of higher rates, inflation and slower growth,'' Citigroup Inc. analysts including Tom Fitzpatrick, New York-based global head of currency strategy, wrote in a client note.
"Selling pressure seemed to ease after the State Bank of Vietnam raised an interest rate last week to 14 per cent from 12 per cent, its second rate rise in three weeks, as part of an increasingly aggressive monetary tightening." The Financial Times (19th June 2008) reports. Inflation in Vietnam has hit a record-high 25 per cent at the end of May, the highest level since 1993. This sudden rise threatens to hurt expansion in the region's second fastest growing economy.
A sudden surge in inflation is adverse for the economy; it brings economic growth to a stand-still, and a stagnant economy leads to lower wages and mass unemployment. Many governments take on an aggressive approach with their monetary policy to curb inflation, eg drastically raising interest rates. However, the question is: Is raising interest rates a misguided policy prescription to counter inflation?
Chik A5
3 comments:
1. A coin has 2 sides and so does this problem. UK is facing what seems to be an increasing evident case of stagflation, i.e. stagnant economy and increasing inflation.
2. To counter inflation in the short run, the government chooses between either demand management, Fiscal policy or the Monetary Policy.
3. UK has an increasing public sector deficit and therefore has little or no power over the Fiscal policy to manipulate situation.
4. The Government can choose to cut domestic spending, but that would contradict any political motives. Should Gordon Brown move to cut welfare benefits/government spending on public staff, it would further cement disapprovement of him as PM among British citizens.
5. That leaves UK with the Monetary Policy. The surest way to counter inflation is to raise interest rates. But the UK housing market has most of its mortgage tied to variable interest rates.
6. The housing market is an integral part to the UK financial sector. Increase of interest rates would lead to default of loans. Basic demand and supply laws would dictate prices of houses to fall. Overinflated current prices would cause houses to fall into negative equity.
7. If there is no intervention, the "housing bubble would burst". Effectively, this could lead to a downward spiral.
8. Supply side shocks of increasing oil prices and slowdown of the economy of major trading partners such as USA and the EU would have minimal effect on a cyclical growth to save the UK.
http://news.bbc.co.uk/1/hi/business/7457886.stm
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