Policy coordination to attack the inflation problem

Due to present sky-high oil prices, all countries are in double jeopardy; not only do they face slowing economic growth, but there will also be a significant increase in their consumer price index, the so-called inflation.

Though these threatening situations have not predicted a crisis yet, they present economists and policymakers with a policy dilemma, as any fiscal or monetary policy which aims to attack a problem will exacerbate another.

Each time an inflation problem occurs, the people will call on the Ministry of Commerce to launch some commodity price curbing measure. However, in my opinion, the Ministry of Commerce should not be the sole organization responsible for the inflation problem. Furthermore, inflation policy should not be spearheaded by the Ministry of Commerce.

According to macroeconomic theory, inflation may be caused by excessive money supply or by aggregate demand. Therefore, those organizations that are able to solve the inflation problem are likely either to be the Bank of Thailand, or else the Ministry of Public Finance. However, since current inflation is obviously caused by an increase in oil prices, in principle, it should be the Ministry of Energy that takes responsibility for the current inflation problem, carrying as it does suitable policy instruments to manage those oil prices.

Nevertheless, the Ministry of Public Finance and the Ministry of Energy have no commitment to solve the inflation problem, while the Ministry of Commerce, which has no efficient policy instruments, is in charge of it. Consequently, the Minister of Commerce has to “do something”, under his own policy instruments, in order to moderate public fury.

Unfortunately, that “something” that the Minister of Commerce does, may not be “the best thing.” Due to a scarcity of policy instruments, the Ministry of Commerce, from the past until now, has adopted price control measures; although, historically, it has always failed to tackle the root of the inflation problem.

There are many ways to control prices. Sometimes the Ministry of Commerce may ask producers to cut their prices, which does not seem to work due to the profit-maximizing nature of business. Compulsory price control is considered to be market distortion. Because of compulsory price control, producers will restrain their production level, causing consumers to suffer supply shortage, followed by the birth of the “black market,” a situation in which consumers are unable to find controlled price goods and must then buy goods at a higher price than those at a controlled level.

Thus, policy coordination is necessary to attack the inflation problem efficiently, because other ministries have more efficient policy instruments and cooperation will make policy congruence between each ministry.

In fact, policy coordination is really not a brand new idea. In Thailand, this concept was initiated by Dr Puey Ungpakorn when he founded the Fiscal Policy Office, officially functioning to form policy coordination among organizations having different goals. Regretfully, macroeconomic policymakers after Dr Puey’s time did not concentrate on this function.

In my article, I will now propose some practical examples of policy coordination that is able to attack the inflation problem. These plans lie in the adoption of Public Finance Ministry policy instruments, of which there are many efficient policy instruments.

The first policy instrument of the Ministry of Public Finance is tariffs, which play a major role to maintain the gap between local price and world price. Where local price is high, a decreased tariff rate will lead to the decreased price of imported goods. As a result, local producers must cut their prices. Moreover, where tariff rates are reduced on imported goods which are raw materials or on intermediate goods of a local kind, the production cost of those local goods will decrease and, consequently, their prices will decrease.

Nonetheless, the Thai government must think prudently before changing tariff rates because this will affect the benefit distribution among interest groups. For example, when the government waived four percent of import tariffs on soybean meal (SBM), the beneficiaries were the local animal feed producers. However, with the decreased price of imported SBM, soybean oil producers had to cut their SBM selling price accordingly. Eventually, consumers were possibly able to benefit from the lower price of pork, but it may have been offset by soybean oil producers turning to make a soybean oil profit by raising prices to compensate for their profit loss from lower SBM prices. The government also lost a tariff revenue from SBM.

Negative tax is another measure able to alleviate the effects of inflation, as I mentioned last week. Besides being an economic stimulus, negative tax also supports the poor during time of hardship. In practice, the government may consider raising the value of tax refunds to the poor, so that they are able to pay for their daily necessities.

While increasing private sector money will truly raise aggregate demand and, consequently, increase the inflation rate, if the Ministry of Public Finance has good policy management, the inflation problem may not deteriorate much. Tax refunds should be paid only to low-income groups or to people with many dependants, but not to all. The tax refund should not support the full burden of inflation; but its recipients must bear part of the burden. Thus, negative tax measures will not so greatly increase the aggregate demand that significantly impairs the inflation problem.

In addition, additional tax refunds should be paid only if people suffer from severe inflation. As long as the government does not adopt this measure regularly, producers will not raise their prices since they will expect the permanent income of consumers to be still unchanged. Thus, I believe that the negative tax measure will likely be more effective in tackling inflation than will the price control measure.

Besides tackling the inflation problem, however, the Thai government should initiate policy coordination to regulate other macroeconomic goals also. I somehow wish that macroeconomic organizations could reach agreement on the desirable picture of Thailand’s economy, before then jointly taking responsibility for each goal and formulating more harmonious policies.

Dr Kriengsak Chareonwongsak
Senior Fellow, Harvard Kennedy School , Harvard University
kriengsak@kriengsak.com, kriengsak.com, drdancando.com