Syndicate content

Add new comment

Dan, It is good that you bring this up. The view that prices are determined by money supply is one of the most widely held in economics. In my view, it is also one of the most misleading ones. Bernanke et al wrote in their textbook about a link [read link in italics] between money and prices. However, in economics many things are linked. They did not write that prices are determined by money. Moreover, the institution headed by Bernanke--the US FED--,as well as most other major central banks have in recent decades stopped looking much at money as a determinant of inflation. That is because empirical research in recent decades has shown that the causal link from money to prices is very complex and indirect at best, especially in anything but the very long term. Thus, if you look at FED reports of the last 10 years, there are virtually no references of the words M1 or M2 close to inflation. Instead, output gaps and capacity utilization feature as the dominant drivers. I agree with most major central banks who have concluded that prices are basically determined by supply and demand on the markets for goods and services. In the case of China, M2 and credit grew by 30 % last year and are set to grow by another 18 % or so this year. However, as long as demand in China's real economy will not exceed supply by a large margin this year, inflation is unlikely to exceed 4 %. China's real economy is fairly well integrated in the world economy via trade channels. That is why we see global price developments reflected in China. That is true for raw commodity price movements and prices of manufactured products. China is lucky at the moment. There is not a lot of spare capacity in its own economy, but there is a lot of spare capacity in the world economy. That global spare capacity is containing price pressures at the moment, globally and in China. But, you are right, in any economy there are non-tradables, whose prices are little if at all affected by global prices. Houses and housing costs are a prime examply. These prices can rise in China even in a context of downward price pressures globally. Indeed, this is why, while I have remained quite sanguine about goods inflation in China amidst the dramatic increase in M2, I have been concerned about the impact of all that liquidity on asset prices, notably house prices.