Professor Barry Eichengreen (left) and
In a recent IMF Staff position note Olivier Blanchard and Gian Maria Milesi-Ferretti provide a useful classification of current account imbalances. They argue that deficits and surpluses on current accounts are "good" if they reflect optimal allocation of capital across time and space. That is the case, for example, when savings ratios differ across countries because of different ageing profiles or when investment ratios differ because of different productivity trends.
Oscar Wilde, suspecting that the relationship between price and value hides reasons that reason itself ignores, observes in the Lady Windermere’s Fan that a cynic is “a man who knows the price of everything and the value of nothing”. The economist will laugh at Wilde’s one-liner. But after a brief moment, she would protest. Theory tells her that value and price is one and the same thing. And she will insist that what matters for South Asians today is the difference between an increase in the price level and an increase in the inflation rate.
The price level increases when there is a supply shock, such as an increase in food and fuel prices. The initial increase in the price level tends to transmit itself to other prices when the economy operates close to capacity. If the price increase is accommodated by monetary policy, the supply shock transforms itself in a spiral of prices and wages and inflation goes up. Monetary authorities do right by not tightening monetary policy in response to the primary impact of supply shocks, but have to be attentive in case the increase in food prices begins to encourage secondary inflationary effects.