Saturday, January 25, 2014

Raghuram Rajan Calls Inflation a Disease and Creates Some More of It!!!


RBI governor Dr. Raghuram Rajan a day before yesterday described Inflation as a destructive disease. This is his exact statement as reported by the newspapers:
“Inflation is a destructive disease. Industrialists complain about high interest rate and when inflation is high at 8 per cent, citizens want to have their savings earning 10 per cent interest to marginally beat inflation. Industrialists want an interest rate of about 5 per cent. Both cannot be satisfied. The mismatch is because of inflation.’’
Delivering the 8th R. N. Kao Memorial Lecture, organised by the Research and Analysis Wing (RAW), here, he said that a long time could be spent in debating the sources of inflation but ultimately inflation came from demand exceeding supply. “It can be curtailed only by bringing both in balance. We need to reduce demand somewhat without having serious adverse effects on investment and supply’’ (here).
Let’s analyze his statements.  First, as usual, his mainstream definition of inflation as a rise in the general price level itself is faulty, resulting in faulty analysis and policy stances. As the old and true definition of inflation shows, inflation is an increase in the supply of money and credit, period. Rajan is saying, that the high price is a result of demand exceeding supply, but the relevant question is, why is the demand exceeding supply in the first place? Is it possible that somehow demand will exceed supply? Any sound understanding of the functioning of the market economy will make one thing clear that such demand supply mismatch is simply not possible. In fact, absent RBI’s own loose monetary policy, demand can never exceed supply. Say’s Law of Markets states this very clearly:
Say’s Law or Say’s Law of Markets is a principle attributed to French businessman and economist Jean-Baptiste Say, stating that there can be no demand without supply. He theorized that the activity of production opens a demand for the products produced. Thus the mere creation of one product immediately opens an avenue for other products. To put it another way, Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my nonlabor assets. The higher or lower that productivity is, the higher or lower is my power to demand other goods and services. (here).
As Say said, without supply, there can be no demand. Demand can rise only by that much amount by which supply has risen. The problem here is not economic goods’ demand exceeding its supply, but too much money chasing too few economic goods. And for this phenomena RBI’s own money printing monetary policy is wholly responsible. So, in fact, Rajan first creates the destructive disease of inflation and then cries fowl about it! Who is he trying to fool hmm?

He is also saying, that we have to reduce demand somewhat without having serious adverse effects on investment and supply. This can easily be done if RBI stops printing any new money immediately, and allow the market to cleanse itself of prior malinvestments. Rajan instead of fighting deflation should be embracing it as a cure of inflation and its boom bust consequences' remedy. As long as he is printing money things will never change for better.

Those statements by Rajan only exhibit his complete lack of understanding of sound economics. He is totally clueless about the economy’s capital and production structure. He has no idea of how various prices like the market rate of interest are formed by the market forces of demand and supply. He has no idea of what inflation actually is and what are its destructive consequences. Basically, he is creating the same inflation monster which he is allegedly trying to fight and conquer.  

2 comments:

  1. very nice and clear explanation. Thanks and keep it up.

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  2. Well said! Supply and demand reveal themselves via demonstrated preference. Thus, statements like "supply is exceeding demand" are completely unfounded. The simple fact is that if you increase the money supply, the purchasing power of money will decrease and the first one's to get the new money will make a fool out of the rest.

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