Subsidies, dollar pegs, and price controls

Two reports in the news today continue to make the case that this is no ordinary inflation problem that we're seeing around the world these days.

In a somewhat disturbing trend, more and more analysts are counting on a "good economic slowdown" to dampen global commodity prices that have now filtered into consumer prices across the globe, causing problems for many governments who previously thought they could combat "inflation" via subsidies and/or price controls.

Oh yeah, pegging your currency to the U.S. dollar seems to exacerbate the problem.

First, this story in The Economist:

Inflationary pressures are rising in the Middle East and North Africa (MENA) region, partly owing to exogenous factors such as high global commodity prices, but also fuelled by the predominance of currency pegs to the weakening US dollar and to the abundance of oil-related liquidity in the region.

While oil-exporting countries in the region are benefiting in terms of the huge fillip to growth and to their external balances provided by persistently high oil prices, the non oil-exporting countries and countries that import oil-related products despite being oil producers (such as Iran and Syria) have been suffering.
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Currency pegs are widespread across the region. While many North African countries operate pegs dominated by the euro, the Gulf Co-operation Council (GCC) countries are almost all pegged to the weakening US dollar. This has led to a rise in imported inflation and counter-cyclical interest-rate policies.

There was much debate over the course of 2007 about whether the GCC member states would chose to abandon their pegs to the US dollar given that they were contributing to already rising inflationary pressure. Speculation about a change in the prevailing exchange rate regimes reached fever point in the summer following the decision by the Kuwaiti central bank to drop the dinar's peg to the dollar in favour of a peg to a trade- and investment-weighted basket of currencies (albeit still dominated by the US dollar).
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In summary, it looks as though MENA governments, where they can, are partly choosing to live with higher rates of inflation or are choosing to dampen the impact of rising prices by continuing to subsidise goods or by inflating wages. Although these are by no means the textbook responses to inflationary pressures, it looks as though the authorities might succeed in managing expectations, helped by a less inflationary global environment. Our view is that global growth is set to slow in 2008-09 and that by 2009 global non-oil commodity prices and oil prices (to a lesser extent) will be falling, which should take some of the heat out of the regional economies.

Didn't they say that commodity prices would be falling back in 2005 and 2006?

Here it is 2008 and it's the same outlook.

They'll be right eventually...

And this report in the Wall Street Journal on price controls:

As food prices soar, more nations are falling back on an old -- and potentially hazardous -- response: price controls.

Last month, China said it would require producers of pork, eggs and other farm goods to seek government permission before raising prices. When producers do seek permission, it is denied, market participants say. Thailand is taking similar steps on instant noodles and cooking oil, while Russia is trying to cap prices on certain types of bread, eggs and milk.

Elsewhere, Mexico is trying to control the price of tortillas, and Venezuela is capping prices on staples including milk and sugar. Malaysia is setting up a National Price Council to monitor food costs and is planning stockpiles of major foods, as well as a 24-hour hot line for consumers to vent about spiraling food costs.

These measures reflect the mounting pressure on developing economies as food costs rise sharply. Food-price inflation is running at an 11% annual rate in major developing countries, up from about 4.5% in 2006, according to Bank of America Corp. The price rises partly reflect increased demand from emerging markets and higher oil prices, which drive up the cost of growing and transporting food.
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Economists warn that price controls encourage hoarding and can lead to supply shortfalls, fueling unrest. Faced with persistent food shortages, the government of Venezuela last week warned it could "expropriate" any food company necessary to ensure the nation's "food security and sovereignty."

Perhaps the biggest disadvantage of price controls, however, is that they short-circuit potential changes in behavior by producers and consumers that might damp the underlying causes of inflation. If price controls are kept in place too long, economists say, odds increase for a precipitous and destabilizing jump in prices later on.

If somehow they could dampen the real underlying cause of inflation - the creation of way too much money and credit in recent years - we'd all probably be better off in the long run.