Why are the high growth countries so often the high inflation countries?

by on September 9, 2013 at 3:42 am in Data Source, Economics | Permalink

inflationindex

That is from this paper by Christopher Balding.  South Korea, by the way, during its years of most rapid growth, sometimes had inflation rates of over fifteen percent.  I might add that the slow growth countries often see deflation, or deflationary pressures, contrary to what a “naive” supply side model would suggest.

I can think of at least two mechanisms here.  First, when economic growth is high and wages are rising rapidly, there may be less public opposition to inflation.

Second, whenever there is lots of growth, markets are forward-looking and the supply of credit outraces the growth of the moment, a’la Long and Plosser (1983).  This leads to immediate inflationary pressures.

Of course these two options are not mutually exclusive.  In any case, low observed rates of price inflation do not militate against the relevance of supply-side “stagnation-like” shocks, in fact they may point to them.

Addendum: Interfluidity has some interesting speculations on demography and rates of price inflation.  Karl Smith offers related comment.

yo September 9, 2013 at 4:48 am

Perhaps the Latin American heterodox economists had it right after all.
The wages of people in the declining sectors go down quickly in real terms with inflation… causing potentially productive rent-seekers to move to more productive employment.

Larry September 9, 2013 at 12:27 pm

Exactly what I’m thinking, at least the first part. For the second part, there has to be real growth. High inflation does not imply that. Many more countries have high inflation than have rapid growth.

prior_approval September 9, 2013 at 5:20 am

Strange how (generally considered) high growth China and (the generally) not so considered high growth U.S. compare in terms of inflation – that is, basically identical.

JWatts September 9, 2013 at 12:11 pm

What? The US and Chinese inflation rates are not identical, even using official Chinese statistics.

JWatts September 9, 2013 at 12:17 pm

Sorry, the prior comment is not meant to critique your personal remark, but more at the silliness of that graph, which doesn’t seem to match the numbers reported elsewhere. This chart says that China had a 2.45% rate of inflation from 2000 to 2011. Hmmm, but there was deflation after the dot com bubble burst, so maybe that explains why the rate appears so low for China.

ChrisA September 9, 2013 at 5:44 am

Is this really a hard question? I mean a fast growing economy means that there are people consuming exponentially more and more goods each year (by definition). Increasing demand means higher prices (that’s very basic economics). It is a continual series of demand shocks in other words.

Additional factors, as the manufacturing side gets wealthier, Baumol’s cost disease occurs in the service industry, raising prices overall. Also, hi-growth countries are usually developing countries. Developing countries have less developed institutions, including central banks. Hence they have less control over monetary policy.

HM September 9, 2013 at 11:39 am

Growth means that production is going up exponentially by definition. The increase in demand isa consequence of this first fact.

Tom September 9, 2013 at 5:01 pm

Why would you invest to produce in the first place if there’s no demand?

Ironman September 9, 2013 at 8:26 am

We would say it’s the forward-looking aspect for consumption expectations, since it appears to be the net pace at which people enter into the workforce that drives subsequent inflation or deflation, which lags the entry/exit events.

TGGP September 9, 2013 at 9:06 am

Karl Smith does not appear in that last link.

Alex Godofsky September 9, 2013 at 10:42 am
Anders Larsen September 9, 2013 at 9:43 am

To me it looks like a spurious correlation. Developing countries have performed well recently, and at the same time those countries tend to have higher inflation rates. Is there anything I’m missing?

Brian Donohue September 9, 2013 at 10:17 am

I think it’s time for Mark Sadowski to get his own blog.

catbirdsouth September 9, 2013 at 10:24 am

Two comments. The inflation numbers for Argentina given in the chart are the official ones. The official numbers are widely accepted as being corrupted and a more accurate number would be 457 (2000 = 100). China isn’t the only country with data problems. Second, long run inflation (x axis) and real per capita output growth panel data give an inverted U shape with the peak in the 10 to 15% per year range. This result is pretty well known among monetary economists.

Patricia Mathews September 9, 2013 at 10:35 am

To my simple investor’s mind after 7 decades of seeing them come and go, I’d say “rapid growth + inflation” = *bubble* . And alarm bells go off.

R Richard Schweitzer September 9, 2013 at 10:35 am

While not stated, presumably the measure of “rate of growth” is determined as GDP.

If the GDP rate is largely determined by the expansion of “government” expenditures, then the efficiency of those expenditures and their tendency for inflationary impact are what should be examined if we are to find a reasonable answer.

Yancey Ward September 9, 2013 at 10:38 am

I might add that the slow growth countries often see deflation, or deflationary pressures

Ok, this is n of 1, right?

Z September 9, 2013 at 12:18 pm

I’ll just note that a significant portion of our economists see the correlation between inflation and growth in the same way Melanesians saw a correlation between certain practices and the flood of manufactured goods into their lands. If inflation and growth go hand in hand, printing money to create inflation will result in growth.

Brian A. Cobb September 9, 2013 at 12:24 pm

Is the author really asking that question?

What was the author doing during Econ 101?

Bob September 9, 2013 at 1:25 pm

How about the Sumner answer: Central banks are driving using the rear view mirrors, so monetary policy failures are as common when real growth is over trend than when it is under trend.

Barkley Rosser September 9, 2013 at 2:51 pm

While demography is certainly playing a role here, the data is also consistent with a downward sloping long run Phillips Curve.

Hazel Meade September 10, 2013 at 12:25 pm

Obvious answer:

If growth is export-led then domestic demand will rise faster than the supply of domestic goods (since they are being exported, dummy!) thus causing inflation.

Thomas Sewell September 10, 2013 at 4:33 pm

Ok, I’ll bite. How about, “When countries experience high growth, there is more opportunity for rent-seeking through monetary inflation because the growth rate hides more of the negative consequences from the public.”

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Tom September 12, 2013 at 9:42 am

Growth drives inflation partly because credit is a better deal in a growing economy, and partly because growth and supply constraints are always uneven across the economy.

Unfortunately many developed-world economists misunderstand the relationship and hope that by artificially goosing inflation we could goose growth. We’ve been trying it for five years already and we haven’t even managed to goose inflation. Turkey meanwhile has dramatically improved its control over inflation and is much healthier for it.

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