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Wednesday, July 25, 2007

Caroline Baum: 'Imported' Inflation?

Caroline Baum on the source of inflation:

'Imported' Inflation? Try 'Made in the U.S.A.', by Caroline Baum, Bloomberg.com: For years globalization was touted ... in terms of the low prices it delivered to consumers. It was unqualified bad news only if you happened to be the fellow who made the goods now being produced in China.

Now the tide has turned. After more than a decade of ''exporting'' deflation, ... the ... price of Chinese imports to the U.S. has risen in the last few months, triggering predictable reactions based on faulty assumptions.

Specifically the question is, can one country import inflation from another? In the case of China and the U.S., it depends on whether one is flying from east to west or west to east. China pegs its currency to the U.S. dollar. ... If the U.S. inflates, China inflates, not the other way around. ...

The broader issue is whether a sovereign nation with an independent central bank can import inflation -- or deflation -- from overseas. ...

Forget about borders and exchange rates for a moment and think about individual prices in the domestic economy. Let's say the price of oil goes up because demand increases. Is that inflationary?

Former Federal Reserve Chairman Alan Greenspan used to explain to Congress that relative price changes are not inflationary per se. ... For a given stock of money, a rise in the price of oil may translate into a one-time rise in the price level. With time, the price of something else will fall as consumers cut back on non-oil purchases.

The same is true for the price of imports. If consumers have to pay more for items made in China, they will have less money to spend on domestic goods and services and other foreign imports --unless the central bank accommodates those higher prices by allowing the money supply to increase.

So it is always and everywhere the province of the central bank to determine its domestic inflation rate. ... As long as globalization doesn't mean one world central bank -- Trilateral Commission and Bilderberg Group conspiracy theorists, restrain yourselves -- ''flexible exchange rates give countries the independence to set their own inflation goals,'' Glassman says. ''That insulates everyone else from what you choose to do.''

And as for price shocks, the central bank has the ability to offset them, whether they occur at home or abroad. Inflation isn't transmitted via spores in the air. It's a monetary phenomenon, and as such, starts and ends on native shores. Globalization hasn't made central banks impotent. ...

Let me add a bit to the last paragraph. Inflation is caused by money growth and in the long-run inflation and money growth move together, but there can also be episodes of inflation in the short-run as relative prices adjust to oil price or other shocks. However, whether or not the movement of prices from one level to another in response to shocks should be called inflation is a matter of definition, some monetary economists reserve the term inflation for a continual run-up in the price level, not a one-time change to a new level, but whatever such movements in prices are called there's still a role for central banks to play in response to shocks that cause short-run movements in the price level.

    Posted by on Wednesday, July 25, 2007 at 02:16 AM in Economics, Inflation | Permalink  TrackBack (1)  Comments (7)


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