Friday, August 10, 2007

Food prices increases and inflation (II)

What make inflationary expectations control so important?. First of all Central Banks are in charge of Monetary Policy, which means that they are responsible for keeping inflation stable. Each Central Bank has autonomy to do its job, although it might have different complementary macro variables aside from price stability itself, to focus on. It follows that monetary policy as the main tool to get inflation under control ,it is not that much applied in a kind of homogeneous textbook style. Some Central Banks keeps focus also on growth and employment, another Central Banks keeps focus just on inflation , and others keeps its focus also on price expectation .-
Inflationary expectations are an important component of economic information, as part of the decision making process to allocate resources. Economic agents ,want to know in advance what the inflationary trend looks like , to avoid being caught in the middle of a transition from low inflation to high inflation ,or the opposite. Either way mean both efficiency and welfare looses. Consumers and producers makes their decisions on the basis of the best information available including expectations. Inflationary expectations by itself, might validate an higher inflation rate, whether the monetary policy is not credible enough to convince consumers and producer, “not to take inflation on their own hands” by charging in advance higher prices .-
Thus, food prices increases might imply higher price expectations, as long as demand expansion goes along with it, because in such case all prices moves upward.. It follows that to keep control of aggregate demand expansion, and effective GDP(Gross domestic product) and potential GDP gap, is a necessary condition to keep inflationary expectation under control. A second condition is to have credible monetary policies.-
A different questions arise again and again: Why is it so important to keep inflation under control, even up to the point of keeping attention upon the price expectations?. The economy needs information to allocate resources(right prices) ,and inflation means a distortion in that process ,because it changes prices signalling ,it give a higher price to activities based on rents, specially those best protected against price fluctuations (real state) , and away from productive ones such as investment. Nobody want to risk huge amount of resources which are going to be devaluated by inflation.
On the other hand , inflation means a tax which is paid specially for low income people who are badly protected from inflation .In other words ,inflation has negative social effects because it affects stability at society level. In Latin America, very much of its economy instability in the past has, been strongly related to inflation and its consequences. In advanced economies high GDP volatility because of inflation , also have welfare effects. Therefore, inflation hit the rich and poor economies.
These days monetary policy has made a lot of progress to confront inflationary pressure coming from different sources and its associated risks. Inflation has become less volatile ,so it has the GDP and economic growth has become more stable and persistent in time as well . Monetary policy Rules have allowed to have a more effective tools to fight against inflation. So, the fact of the matter is that these days in the global economy, for any inflationary pressures there are better monetary policy instruments available.-

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