Fri, Jul 04, 2003 - Page 8 News List

Deflation is not the problem, intervention is

By Chang Ming-chung 張明宗

The central bank recently announced quarter-point interest-rate cuts for rediscount rates, rates on accommodations with collateral and short-term financing rates in order to ward off deflation. This has sent interest rates to an all-time low. The governor of the bank cited a research paper from the IMF at the press conference to announce the cuts, stressing that if a country is facing the risk of deflation, it must take precautions against it. But, is deflation really a problem?

The bank's worry about deflation is probably the result of the international media influence.

Japan began an economic decline 12 years ago. Its commodity prices began falling five years ago. Such a phenomenon has led to extensive international discussion about deflation in recent years.

Taiwan's consumer price index in 2001 registered year-on-year drops in four months. The wholesale price index fell in 10 months of the same year. Ever since then people have felt anxious about deflation.

To prove that the international worries over deflation are absurd, let's look at economic theory. From the viewpoint of microeconomics, deflation is actually a stupid problem.

On the basis of John Maynard Keynes' research, deflation might be a subject worthy of study. What requires our special attention, however, is that, as far as microeconomics is concerned, studying deflation is meaningless. The rise or fall of prices only mean that the market is changing the "signals" it sends out to reflect external changes. This couldn't be more natural.

For example, when the demand for a product falls, its price naturally drops, which can stimulate the demand and deliver a signal to manufacturers, informing them to reduce their supply.

In fact, it would deserve our concern if a worsening economy is not promptly followed by deflation. This situation would mean that the economic system might have become so numb that it could not appropriately respond to external changes.

If we assume that Taiwan started to enter an economic decline in 2000, then it has only taken little more than a year for the nation to see deflation. This is much faster than Japan's experience, where deflation began seven years after it entered economic decline. This is not necessarily bad news because the situation could mean that Taiwan's market functions are more apt to effectively respond to outside changes.

Of course, we have other reasons to support this explanation. With a system mainly built on small and medium-sized businesses, Taiwan is renowned for its quick response.

In contrast, Japan, with large enterprises as its mainstay, is more capable and likely to firmly hold on to the status quo for the sake of face and only accept failures after a longer period of time.

Microeconomics and the Keynesian school of economics hold diametrically opposite viewpoints because there is a fundamental difference in their research directions. Microeconomics takes a long-term view to analyze problems, but the Keynesian school focuses on the short-term.

Keynes had a famous quotation ridiculing the unrealistic long-term believers: "In the long run, we're all dead."

Our response to this quotation is: In the long run, we're all dead. But our posterity still has to face the difficult problems we leave behind.

This is why we should carefully map out policies from a long-term point of view.

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