Contractionary policy is a useful tool to reduce inflation and cool an overheated economy, said Pouya Jabal-Ameli, an economist, in a write-up for the Persian economic daily Donya-e-Eqtesad.
A translation of the text follows:
Economists who advocate contractionary monetary policies are often being criticized by inflationists for ignoring production and economic growth.
Inflationists seek to solve manufacturing problems by extending cheap loans, although they know runaway inflation has become a permanent feature of Iran’s economy for decades now. They need to know that contractionary policies do reduce inflation and, unlike what people think, also have positive effects on national production.
Risk reduction and economic predictability are positive aspects of controlling inflation, which can impact investment decisions and economic growth, but another aspect of low inflation has been neglected.
Chronic, double-digit inflation has resulted in the redistribution of resources among inefficient enterprises that wield strong bargaining power instead of efficient enterprises, which reduces productivity.
Inflationists seek to solve manufacturing problems by extending cheap loans, although they know runaway inflation has turned into a permanent feature of Iran’s economy for decades now
How does inflation disrupt the structure of manufacturing in favor of inefficient enterprises?
Imagine there are two groups of producers: A and B. Group A enterprises are in need of loans due to their inefficiency, yet they enjoy high lobbying power for receiving credit from the system. Group B includes enterprises that don’t seek loans, thanks to their efficiency; they lack the lobbying power of Group A.
Money supply increases by offering loans to Group A. When they receive and spend these loans, costs are based on old rates. With the injection of this money into the economy, prices start going up. The effects of the new money on prices become completely evident in six months. If Group B makes purchases in the third month of receiving the loan, prices have already increased by 50% and consequently the power of this group has decreased compared with Group A.
After six months, both groups are facing total price increases due to the new credit but during the process, enterprises of Group A, which were the gateway to new credits, have access to more resources than Group B. In other words, inflation has shifted the structure of manufacturing in favor of Group A, the inefficient group.
You might say the process will reverse when Group B receives loans. But we know Group A typically receives more loans than Group B, that’s why the redistribution of inflation-inducing new credits is constantly being shifted from efficient enterprises to inefficient ones, particularly when inflation becomes chronic over a long period of time.
Anti-inflationary contractionary policies stop the change in production restructuring and make industries more productive. An increase in productivity means that the same resources yield more fruits and create growth and welfare.
However, many believe that they can help production by lending and credit creation. If we look at this phenomenon from a panoramic perspective, we’ll find that contractionary monetary policies that prioritize controlling inflation can be more useful, though to the chagrin of select few.
