Earthquakes and monetary policy

China Financial Markets looks at the monetary implications of the earthquakes. Economics does not stand still.

The devastating earthquake is also bad for monetary policy [China Financial Markets]

This has been a sad week for China, and it has certainly not been easy to watch on television the heartbreaking scenes of the effect of Monday’s earthquake. Sichuan is a heavily populated province, and many of my students have friends and family in the affected areas, so the disaster has hit us very hard. The fact that so many of the victims were schoolchildren makes it all the more horrifying. Bless China, as my student Gao Ming wrote me earlier today, a phrase many worried and dismayed students around campus have been repeating. Next week my friends and I will organize a concert to raise money for the earthquake victims. It’s not much, but everyone feels helpless and wants to do something to help, however small.

Unfortunately the earthquake and its corresponding devastation are almost certainly going to complicate matters horribly for the PBoC in its attempt to manage monetary policy and fight inflation.

Things are likely to get very tricky indeed.

Clearly the earthquake in Sichuan will not only impact agricultural production and the ability to deliver products to the market, but its reconstruction will fuel a boom in demand for energy, materials, and a wide variety of related goods and services. Recognition of the impact of the earthquake both on loosening monetary policy and on increasing the demand for a variety of goods seems to have powered the stock market today. It closed up 2.73% today, driven by smelters and banks.

The government’s automatic response to this potential surge in demand is to clamp down even tighter on price increases, but this cannot possibly have any but the most adverse effect. After all it is one thing to freeze prices in order to drive out inflationary expectations, but the earthquake has caused a real increase in demand and a real decrease in supply – and the stock market immediately recognized that fact. How can price freezes possibly eliminate the disequilibrium?

In fact yesterday’s China Daily had a very long article on the difficulty of maintaining existing price freezes. The article is called “To raise oil prices or not, that is the question” and starts out very bluntly with: “Diesel sold out. This notice can be seen at many gas stations in the country.” It explores both the difficulty of keeping prices at current levels – shortages and an increasing fiscal subsidy – and the difficulty of letting prices rise – the inflationary impact. People like me of course will point out that price freezes simply convert inflation from one kind, the kind that’s measured in CPI, to another, the kind that shows up as shortages and higher taxes, but the idea that China does not have monetary inflation, simply a temporary food-supply problem, has become so ingrained in policy, even though fewer and fewer people believe it, that its impact will stay with us for a while.

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