Emerging inflation in emerging markets such as Thailand?:
Economist Paul Donovan of UBS AG analyzes the situation
By Jon Fernquest |
In an op-ed piece in the Bangkok Post today, Paul Donovan, deputy head of global economics for UBS Investment Bank, discusses the possibility of cost-push inflation and a wage-price spiral in Thailand.
What do Thai consumers and companies believe about future inflation?
What are their inflationary expectations?
As Paul Donovan observes: "In Thailand, data on inflation expectations is hard to come by."
Recent events in the news seem to indicate that inflationary expectations among consumers and firms are increasing: the recent minimum wage hike, cost of living allowance (COLA) increases at companies, the recent abandonment of informal price controls by the government (#1, #2), and price supports for a number of agricultural commodities, with some like rice, being well above market prices.
As Paul Donovan observes: "UBS believes that inflation will remain controlled in the [developed] OECD economies, but that it is a bigger problem in emerging markets."
Here is the article in full:
BY INVITATION
Great (inflation) expectations
PAUL DONOVANFriday June 27, 2008
All of a sudden, the world's central bankers are talking about inflation expectations. European Central Bank president Jean-Claude Trichet started the process by saying that he was "strongly determined" to anchor inflation expectations. US Federal Reserve chairman Ben Bernanke recently said that his central bank would "strongly resist" any erosion in price expectations. This led markets to contemplate the possibility of increasing interest rates.
So what are inflation expectations doing? In the OECD, companies' inflation expectations are stable. Companies do not believe that they can raise inflation in an environment of weakening growth, and reduced consumer credit.
For consumers in the OECD, there is a different story. Here price expectations have shot upwards. In the United States, consumers are expecting inflation to increase more than 7% year-on-year in the next 12 months. Inflation in America has not been more than 7% since 1982. Inflation expectations of European consumers are up significantly, at levels not seen since the introduction of the euro notes and coins.
So is there a problem? UBS research suggests that companies are generally good at predicting levels of core inflation. Corporate management is good at predicting future pricing power. Stable corporate price expectations suggest that central banks need not be concerned, and that inflation will be contained.
Consumers' price expectations, in contrast, are not very accurate. In fact, consumers are generally very bad at predicting inflation. Future expectations are strongly influenced by current perceptions. Current inflation perceptions, in turn, are influenced by the price of things bought on a daily basis - food, petrol, newspapers. While important items, these are only a part of the overall CPI basket, hence consumers' inaccuracy in predicting inflation. If consumers are bad at predicting inflation, and consumer expectations are the main area of increasing inflation expectations, why are central banks sounding worried?
The answer lies in what economists call "second-round effects". Consumers may not be accurate in their price expectations, but those expectations might influence the wage increases that they demand from their employers. Those wage increases in turn could influence broad price levels (labour costs are the most important part of inflation).
Central banks are looking for continued wage restraint in the face of higher food and energy prices. If there is no wage restraint then the risk is of a return to the 1970s - a wage price spiral. If there is wage restraint, then inflation is no threat. Indeed, if inflation expectations are not matched by wage growth, there is a risk that consumers will believe that their standard of living is being damaged. That causes consumer confidence to fall.
The cost of labour in the United States and in Europe does not suggest that wage restraint need be a problem. Inflation expectations for consumers are higher, but those consumers do not seem to be able to do much about it when it comes to wage demand. In the first quarter US unit labour costs at just 0.7% compared to the first quarter of 2007. In the euro area, negotiated wage settlements achieved a 0% increase year-on-year at the end of last year.
In Thailand, data on inflation expectations is hard to come by. However, the minimum wage deal earlier this year between employers, labour representatives and the government made it clear that inflation expectations have risen. Moreover, anecdotal evidence suggests that cost of living allowance increases are common in many private sector firms. And as the government allows further price increases for consumer goods on the basis of higher costs, it seems that "second-round effects" are coming to pass in Thailand.
UBS believes that inflation will remain controlled in the OECD economies, but that it is a bigger problem in emerging markets. For all the talk of concern about OECD inflation expectations and wages, there is no evidence that this is a problem yet. Raising interest rates in emerging markets seems a sensible strategy.
Paul Donovan is deputy head of global economics for UBS Investment Bank.
(Source: Bangkok Post, business, 27-06-08, page B4, Paul Donovan, temp-link)
Vocabulary:
inflation - when the general level of prices in the whole economy rises (See The Economist glossary and Wikipedia)
a wage price spiral - one cause of inflation, a cycle (or feedback loop or vicious circle) in which wage hikes due to inflation cause companies to raise prices, and those rising prices lead to demand by employees for further wage increases, which keeps the cycle going, or alternatively:
When there is inflation, employees will want to be compensated for the higher prices, as they want to buy the same things as they have always bought, so they push for higher wages, when they get the higher wages, this pushes up costs again for the firms, and so the firms increase prices again, if prices go up again, then people will demand higher wages, and so on indefintely. Higher wages push up prices, which in turn push up wages, which in turn push up prices, and so on.
This wage-price spiral can be very difficult to get rid of, as people quickly build the increased level of inflation into their expectations. That is why it is called a spiral as inflation spirals up and up fuelled by increased wages. (Source) (See Wikipedia, Paul Krugman New York Times editorial, and IMF paper)
cost-push inflation - when wage and raw material costs increase for a business, so the business increases its prices to maintain its level of profit, when all companies are doing this, the price level of the whole economy increases and their is inflation
A sustained rise in prices caused by businesses passing on increases in costs, especially labour costs, to purchasers.
Cost-push inflation is inflation that comes about costs increasing. When a cost of production (eg wages) increases, firms have to put up prices to ... (Source: Google Definitions and Wikipedia)
UBS Investment Bank - one of the business groups of the diversified global financial services company UBS AG, with its main headquarters in Basel & Zurich, Switzerland. It is(See Wikipedia on UBS AG)
hard to come by - hard to find
expectations - the beliefs that people have about the future, especially beliefs that are important for making decisions (See The Economist glossary)
inflation expectations - the expectations that consumers and firms have about future inflation
inflation expectations are stable - expectations about future inflation are not changing, not going up or down by very much
indicate that... - show that...
the minimum wage - the lowest amount of money that can legally be paid to someone everyday or per hour for their work
the cost of living - the amount of money spent daily by people for essentials such as food, transportation, housing, clothing, the cost of maintaining a certain standard of living (See Wikipedia)
Cost Of Living Allowance (COLA) - an addition to an employee's salary to help meet increased cost of living
informal price controls - when the government makes an informal agreement with companies to prevent their prices on some goods from increasing for a period of time
price supports - when the government purchases agricultural produce from farmers at a certain price, usually above market, so that the farmers do not suffer losses
emerging markets - when a country's economy is in the process of rapid industrialization, but not yet a fully developed industrialised nation (See Wikipedia)
OECD economies - an international organisation of thirty countries that accept the principles of representative democracy and free market economy: (See Wikipedia and list of members)
determined to X - have made a firm decision to do X, and nothing will stop you
anchor inflation expectations - prevent the public from changing their mind and expecting more inflation in the future
erosion - a gradual decrease, getting worse gradually
erosion in price expectations - the public is expecting inflation, more and more, gradually
contemplate - think about something (for example, about what might happen in the future, what you should do in a situation, etc)
led markets to contemplate the possibility of increasing interest rates -
core inflation - a measure of inflation excluding goods with volatile price movements, such as food and energy (See Wikipedia)
contained - control and prevent from increasing and spreading (for instance, the government managed to control the outbreak of Avian flue and prevented it from spreading)
inflation will be contained - inflation will be prevented from increasing
current perceptions - what people currently believe the situation to be like
consumer prices - the prices paid by people who buys goods in stores or as services (consumers), people usually think of this as inflation versus the prices paid by firms for raw materials, energy, and intermediate goods, components, and parts (factory prices) (See the Economist glossary)
Consumer Price Index (CPI) - an index number measuring the average price of consumer goods and services purchased by households (See Wikipedia)
a CPI basket of goods - the set of goods used to calculate the CPI above
restraint - preventing something from moving
wage restraint - preventing the wages from increasing (in the economy)
consumer confidence - the degree of optimism on the state of the economy that consumers are expressing, often shown through how much they are saving or spending (See The Economist glossary and Wikipedia on consumer confidence index)
negotiated wage settlements - when unions and companies have discussions and make an agreement about future wages
year-on-year changes - changes in levels expressed over the corresponding period (month or quarter in relation to the frequency of the data) of the previous year (SOurce: OECD glossary)
anecdotal evidence - based on stories that people tell (individual accounts), rather than reliable research or statistics, for this reason this evidence is often not valid (See Wikipedia)
a strategy - a long-term plan for success (in battle, in business, in a career...)
sensible - based on thinking not emotion
a sensible strategy - a strategy based on careful thought and analysis
