Tuesday, July 22, 2008

How did Germany avoid great inflation in 1979? � Mostly Economics

How did Germany avoid great inflation in 1979? Mostly Economics
Amol Agarwal points to interesting paper relating to German experience with inflation during the 1979 slowdown. Broadly the learning implies controlling the money supply using predictable medium term targets.

I do not believe at this stage simple controlling will help. This might result in excess money, accumulated in one part of the system (or big money), broadcasting it into the broader system. This permeation will absolutely guarantee high inflation. Conversely, less painful (for the masses) solution may be to keep excess money localized and slowly suck it out of the system.

In the US/UK today, the excess money has already permeated through the system. Increased debt burden and consumption triggered by rising house prices have already spread the excess money deep and wide. Hence a monetary tightening at this stage will have high adverse impact on US/UK population. More money in the system and alive and kicking employment alone could have been a solution if it weren't for the high household debt. Household debt burden simply inflates if value of money goes down. Hence bankruptcy laws and loop-holes therein are most critical. Prof. Elizabeth Warren realizes this and hence her strong emphasis on modification to bankruptcy laws. I understand South Korea, Australia and EU are in same situation as US/UK.

In the rest of the world, the money has not permeated as well. Sovereign funds, reserves and to some extent big money have limited the spread. In any case situation is better than US/UK. Here monetary tightening might be a useful tool. Emerging markets and other countries could do better than emulate the west in this regard.

The future is tough! Let us just hope we don't forget the lesson this time!