For the past year, rising prices of imported oil and commodities have become the primary cause of imported inflation. Regardless of whether it results from monetary or fiscal policies, there is no way to fight this kind of cost push inflation. Macroeconomic principles tell us that monetary and fiscal policies can only manage demand and address factors resulting from demand-side fluctuations. If demand-tightening measures such as raising interest rates or cutting fiscal spending are adopted, a slight decrease in commodity prices may result, but the price of economic recession must also be paid.
When policymakers face these kinds of dilemmas, all they can do is choose the lesser of two evils. US Federal Reserve Chairman Ben Bernanke therefore continued to decrease interest rates in order to accomplish the main goal of preventing the US economy from slipping into recession. The European Central Bank, on the other hand, held firm on interest rate adjustment as its first priority was fighting inflation.
In addition to monetary and fiscal policies, exchange rate policies can also serve as an imperfect tool for fighting commodity price inflation. Because the price of crude oil, gold and bulk commodities such as grain, cotton and soybeans is denominated in US dollars on the international market, most purchases are paid in that currency. With the ongoing and visible depreciation of the dollar in recent years, the rise of commodity prices that was already taking place as a result of supply-demand imbalance intensified.
In other words, if a nation’s currency is able to appreciate considerably against the US dollar, the impact of the imported inflation mentioned above would actually be softened.
However, an exchange rate policy can be a two-edged sword. Although substantial appreciation of a currency can reduce import costs, it also increases the relative price of the nation’s exports, which decreases product competitiveness. Even more serious is that when the nation’s currency appreciates against the US dollar, government and private assets denominated in US dollars suffer from exchange loss with their decrease in value.
Taiwan is facing this dilemma. To fight commodity price inflation as well as avoid triggering a recession, the central bank has very careful applied a slight interest rate increase to reach its goal of preventing the real interest rate on deposits from going negative.
The central bank has also already allowed for the limited appreciation of the New Taiwan dollar. This has caused the currency to appreciate by more than 6 percent in the past year, partially offsetting the rising costs of imports.
Furthermore, the Cabinet froze gas and electricity prices prior to the presidential election to avoid angering the public. After the election, however, they announced that the price freeze would remain in place until May 20.
Basically, we recommend returning to market mechanisms in determining prices because the imposition of price limits will only address the symptoms of the problem rather than the root causes. The late US president Richard Nixon imposed price controls on three separate occasions while he was in office. The first time, no acute price increases occurred after controls were lifted because the inflation was not generated by the supply side. However, the second and third price control impositions took place right in the midst of the energy crisis, which caused cost push inflation. When price controls were lifted, large-scale price inflation was the result.
We therefore call for a decrease in the interference of market mechanisms and for allowing gas and electricity prices to fully reflect their costs.
Once this is achieved, the economic burden on the middle and lower-classes will grow heavier, which means that income policies must also be changed. This way, the government can respect market price mechanisms while also caring for disadvantaged members of society. Subsidies can be allotted to citizens according to their income levels.
For example, the lower a driver’s income, the higher the gas subsidy he would be entitled to.
Low-income families could also be entitled to receive higher electricity subsidies so as to decrease the burden of paying for rising electricity prices. Conversely, high-income families would not receive any subsidies. A tax could even be levied on high-income owners of gas-guzzling vehicles with the proceeds partially funding government subsidies for low-income consumers.
Since domestic gasoline products are solely provided by CPC Corp, Taiwan and Formosa Petrochemical Corp, the government must find a way to prevent price fixing — real or imagined — from occurring. The Fair Trade Commission should keep a close eye on these two companies and keep them from gouging the public in the name of market mechanisms. Furthermore, the legislature should follow the US Congress’ example and enact a law to levy a tax on oil companies that engage in profiteering. The proceeds from the tax could serve as another source of subsidies for middle and low-income gas consumers. If electricity prices rise too quickly, similar measures could also be implemented.
If exposure to rising prices is to be reduced, people should address the problem at its source by adopting a simple lifestyle, cutting down on excessive consumption and using the money saved to pay for the higher costs of basic energy and material needs. The government could also promote polices with a focus on energy conservation.
Tsai Tzong-rong and Chen Bih-shiow are Associate Professors of economics at Soochow University.
Translated by James Chen
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