Deflation: Causes, Effects And Monetary Policy

Causes of deflation

Question:

1. The annualised rate of inflation in the euro area was estimated at 0.3% in September 2014, down from 3% in September 2011; in Greece, Italy and Spain it was negative (Eurostat October 2014). Discuss the reasons for this decline in inflation and explain why deflation is a concern and how this can occur after years of accommodative monetary policy.

2. Explain the various forms of non-tariff (and non-quota) trade protection and assess the economic and other reasons given for such protection.

3. Examine the structural and geographical pattern of Chinese outward foreign direct investment (FDI), including an assessment of how far traditional explanations of FDI can account for this pattern.    

4. New regulatory structures for the banking industry are being introduced around the world in an attempt to ensure a more robust international financial system. Examine the weaknesses that have existed in current systems and the challenges posed in building a new banking environment.

1) Introduction

Deflation means decrease in the price of inflation that slows down the rate in increase the price level of the good and services that helps in estimating the country’s gross domestic product. Deflation occurs only when there is increase in the price level of the consumer and it moves down as compares with the previous period where prices were increasing. There was huge consensus among the economists that inflation causes by enhancing the money supply that is available in the use of the economy of the country (Calvo, Celasun and Kumhof, 2003). The occurrence of the inflation is there when the economy burns due to the more demand is known as demand-pull inflation. It describes about the deflation in Europe.

The reasons of the deflation are all opposite from the inflation. These are either a reduction / decrease in the rate of the growth of the supply in money or the whole cycle of the business contradicts called as recession. If the central bank in the nation compress/ tights the monetary policies that states that government start selling off the country’s securities which reduce the money supply in an economy. The contradiction of the policy called as technique of tightening the quantity. When the securities are selling by the government in the market, the money supply comes down and the money became upscale with the constant demand for money. At the time of recession, among businesses competition arises and becomes more forceful among consumers. This affects the retail businesses where retailers now do not prefer to supply the good to the consumers at higher prices (Clarida, Galí and Gertler, 2002).

The main cause when the central bank opts for the contradictions of the monetary policy that is became costly to take over the money that rise in the decrease of the demand of goods and services. It affects the whole economy of the country. However, the demand of all the goods and the services decreases the supply of the commodities remains unchanged. Thus, a price falls in the upcoming period and leads the deflation.

Impact of deflation

In the early 1930, Panics among banks occurred due to the constraints in the central bank policy that imposes on the Gold Standard. It affects on the economy of the several countries with the Europe. Major panics were aroused due to the crisis in finance of banks. The major effect on such crisis was the debt deflation. The reason was an increase in the borrower’s insolvency and the real value of the nominal debts. Such situation creates the distress among the environment of the financial sector where it became tough for the people for taking new credit and the borrower’s incentives became unclear. However, fall in the price really effects. A comparative approach followed as the solution in evaluating the links between the deflation and the regression. Dummy data of variables had taken of all those different countries to analyze the reason of the bank’s crisis. The reason behind the panic among most of the countries was notices the harshness of huge deflation globally. Since the United States shares in the gold standard (monetary gold) remained constant at greater than 41% then the inflow in the France faced a great loss in the gold standard by the countries of Germany, Japan & the UK (United Kingdom). It was expect in France to increase the prices in the gold but because of various restrictions in the operations and policy choices the effects of the gold standard inflow on French prices was minimum.

Due to the deflation, the prices are constantly moving down. When the rate of growing unemployment is less than the normal rate of the growth that leads to the rise in the rate of increase in the price i.e. inflation but the rate of growing unemployment is above the general rate of growth , causes the slows down the rate of rise in prices i.e. inflation known as the deflation. This situation occurs because people are unemployed and they have small amount of money to spend that causes the reduction in the supply of the money (Waterloo, Zhang and Ottawa, 2006). Deflation is concern because there is the direct relation in between the deflation and the unemployment. The direct relation does not depend on the speed at which the deflation arises and it states simply that the rate of growth in prices or inflation can comes down only by raising the rate of jobless people at the lesser rate over the years. The most important constituent of deflation is the monetary policy as per the various scholars. They state that the belief of wages of the labor get affect if they personally feel that the central bank are committed themselves that they can reduce the rate of rise in prices. The procedure that follows in settle the wages as per the expectations can only change with the help of credibility. The view of the credibility is the fastest deflation that is more credible than the lesser deflation. Credibility slow down the cost of unemployment of deflation and central bank must go fast in speed for fast deflation. Monetary policy related with the rate of interest and the credit availability. Instruments of the monetary policy have involves the short-term rate of interest whereas the reserves of the central bank are based on monetary. Monetary policy depends on the relationship in between the economy’s interest rate. It is the price based on this money borrows and the total supply of it will be done (Guillermo and Carlos, 1999). The monetary policy uses the different tools to control any or both of these that influence the results like the growth of the economy, increase in prices, Rate of exchange of currency & unemployment. If the currency is under the issuance monopoly or under the authority of the regulatory framework through banks those are ties up with the central bank only. (Goodfriend and King, 2005). Signaling can use to slow down the expectations of the market for moving down the interest rates in an upcoming period. (Sullivan, Steven and Sheffrin, 2003)

Debt deflation

Conclusion

Arrangements regarding financial and the monetary were full of flaws and the major source was the decrease in the real output. Banking panics brought the impact of the deflation on the real output that contribute in creating more panic worldwide. Debt deflation was the probably a reason of deflation in the gold standard to the high / less degree. The monetary policy has the ability to change the supply of money. The other form of the monetary policy where the rate of the interest is near the 0% and the concern is all about the deflation, it is refers to the unconventional monetary policy. These unconventional policies involve the signaling, credibility, quantitative easing etc. In the credibility of an economy, central bank buys the assets of the private sector to increase the solvency and increases the access towards credit. Deflation can achieved fast by rising in the rate of jobless people at the fastest rate that spreads over the few years. The above project noticed when the total of the rate of unemployed people in the past years would be the constant. This explained with the help of point-year of excess unemployment.

Measure of Non- tariff involves policies those are applied by the countries to import and export their goods. Some of the non-tariff instruments use in the commercial trading are quotas, subsidies, export restrictions whereas others are the technical measures. The latter solves the purpose as these measures use in the concern of the food safety and protection of environment. Non-tariff protection measures are important in doing negotiations (Filanlyason and Zakher,1981). Hard core measures involves the controlling price and the quantity of goods, measures of threat with proper safeguards & other measures that have the power to distort an international trade whether the effects of the trade are protected or not example. Standards of the quality imposed without any intention of giving any protection, may be because of the reason having concern in all underdeveloped countries those who generally produces the non- equipped products complies with the policies response.

There are different forms of non-tariff trade protection depends on their scope. These are defines –

1. The technical and non-technical measures
2. Practice by customs
3. Licensing
4. Government Procurement

The above is not the alone problem whereas the Non-tariff measures are implemented with the intentions of giving protection to all failures of the market. These measures have an important effects those are restricted on an international trade. Technical measure means like labeling and protecting the quality standards, environment of the business and standards of technical condition.

Some of the measures relates with the inspection at the time of pre-shipment with other formalities of customs. Contingent measures leave the hard effect of imports in the market of the country where the goods are import. These measures involves with an objective of doing all fair transactions of trade. These measures follow all the procedures and fulfill the essential requirements of the market. Quotas, license and other measures those use to control the quantity use to limit the trade of quantity by doing a proper inspection through these. It also covers the prohibition on licenses and the import business activities. . Government procurement prefers towards the suppliers of their own domestic country such as tanks, airports etc Price control measures are implement to control the price of all goods those import in order to support the price of the various products in the domestic market when the price of import goods are lower. It also establish the price of own domestic products because of fluctuation arise in the prices in domestic markets or instability among prices in an international market or to enhance the save of revenue generated from tax (Mansfield and Busch, 1995).

Unconventional monetary policy

Reasons for trade Protection:

1. Infant Industry argument:
2. New Mercantilism:

Infant Industry argument is an influential idea that is a flourish industry may ask for the security until it gets started. It is associated with the mercantilism that is beneficial for the trade policy & import substitution. Scholars believe that Infant industry must protect with the purpose to give the permission to grow that can easily compete with the other established industries in abroad. Without protection, it is not possible. Whereas mercantilism was the economic theory that got started in Europe in 16^th to 18^th century that started the regulation by the government with the purposes or doing argument in favor of the state strengths at the expense of the rivalry power. It involves the national economic policy with the accumulated monetary reserves through the finished goods and accurate balance of trade. High Tariff on the production goods is the feature of the mercantilism policy.

The non-tariff measures are impactful on the consumer welfare in the analysis. The impact of such analysis done based on standard of quality of the seafood. In the industry of sea food these antibiotic use to save the animals from diseases but it is found to have toxic substance that leaves the impact on the health of the consumers. While the economic trade policies reports a negative effect on the business of imports. In most of the case, a rigid standard on quality is imposes on increasing the welfare of both domestic and the international. Therefore, the negative trade developments may outweighed by the positive effect on the welfare of the consumer.

An export measure applies on the export of the country that includes the export quotas, prohibitions on export business etc. There are various factors besides economic factors those gives the protection to the trade of imports and exports. It is clear from all of the above measures (Zhihao,2000).Reduction in the barriers of the non-tariff plays an essential part in liberalization. As much as the gain comes from deducting, the costs that imposes by the regulations as well as the trade under liberalization in services (Roorbach, 1993). There are economic benefits from liberalization of non-tariff hurdles but given the barriers in collection of data on these hurdles (Michalopoulos, 1999). The impact will be on the large scale at the time of removing these hurdles. Behind doing the above attempts, it tends to focus on any type of measure that underestimates the significance of these non-tariff hurdles and achieve gain from the removal. If the tariffs were removing then more than 50% of the benefit would expect to capture the emerging countries. Both agriculture and the industrial sector contribute in the overall gains or benefits in welfare that helps in reducing the tariffs. Under the liberalization, welfare gains of all developing countries comes from removal of distortions related with the tariffs majorly in three sectors- agriculture, clothing and motor vehicles (Oatley, 2007).          

All above measures creates the environment of the competition. Measures contribute the privilege to all limited groups acts as the economic operators and refers to the monopolistic measures such as the trading occurs within the state, single importing agency and national insurance.

Conclusion

Measures on investments on trade involves the restrictions on the investment by offering all local contents or requesting that in order to balance the business of the import investment should relate with the exports of the goods (Frieden and Lake,1995). At the time of imposing restrictions, restrictive measures are all relates with the distribution of imported goods within the domestic market. Some measures restrict the services on post sales like those that restrictions impose on the services of accessory. Subsidies impose on the goods affects the trade of the country adversely. Government also impose the restrictions considers as the bidders of the restrictions those tells about the details of selling the products such as when the goods should sell in an international market? Group restrictions are imposed those are all relate with the measures and the rights of intellectual property. An increase in the economic activities and its productivity will benefit the labor markets of the Europe and the United States in the terms of the wages of the labor and gives the new employment opportunities for less skilled labors. Displacement of labor will recover only with the good movements in the labor market and better economic trends. It shows that few of the labor shifts to the new jobs and move from one sector to another.

The Outward Direct Investment (ODI) is small in the terms especially if comparison done with the huge inward flow of investment. China’s overseas business gains the importance as the new source of the capital in an international market. The economy of the china continuously growing and became the economy free from the capital surplus. The policies of the china encourage the developments and the growth of the brands that treats like champions of the country. FDI (Foreign direct investment) originates from the country china has been growing constantly at the considerable rate (Al Nasser, 2007).

The outbound direct investment of the China reached at $ 16 billion in 2006 and more than 31.5 % in 2005 approximately. The outward direct investment of the country now considers as the fourth largest country and status of it changes from developing to the transition country. The United States considers the china’s foreign direct investment in other countries somewhere around of $ 61 billion with the 0.5% of the total world and 2.5% Gross domestic product of china. In 2006, China involves a large number of mergers and acquisitions made by their companies and financed outside the country. The outward investment of china has always underestimated. The outward direct investment has undergone through four development stages. In one of the stage, where the foreign trade was still under the monopoly of the state and the foreign investment was under the guidance by the state, only those corporations who were state-owned in trading as well as the local business firms regulated/ controlled by the state economic and the commission of the trade (Barrell and Pain,1998). They allowed making investments in overseas. The stage supports the local and the provincial businesses those do investments in abroad at national level where they support the outward direct investment at the local levels. The yearly outward direct investment reaches up to the $6.5 million around somewhere. This shows that the part of the outbound business involved in the rumor of the stock market & the real estate in the Hong Kong and its most of the branches in overseas had suffered heavy losses and featured by the management full of corruption. Whatever situation had face by the Beijing that was the serious loss of all assets and foreign currency of the country. It intends to execute with the promotion of all international business operations in form of Chinese with the picture of improving the allocation of resource and increasing the competitiveness in an international trade (Lecraw, 1993). The ministry of commerce is accountable in starting/ initiating with the coordination of strategy also, encourage the outward direct investment through the availability of an information about all the foreign locations, incentives granted and the slowly relaxations of all controls of the foreign exchange. It shows that the intersection of these measures with the success in the business of exports of Chinese manufactured products into the global market followed the outward direct investment. It results in enhancing the number of firms/ enterprises of china among the large number of MNC (Multinational companies) from all developing countries. Only seven enterprises of china in the terms of foreign assets were there among the top 50 largest multinational companies from developing countries/ economy (Poncet, 2007). This is the result of the year 1994 and by the year 2001, the seven enterprises got increased and reaches the number twelve (Hong, 2009). As many as six companies had foreign assets of approximately $1.5 billion. Now, the china has become the economy free from the surplus of capital and its investment in the overseas has increased the speed. They are now globally involved and changes into the huge variety of the sectors those includes banking, production and exploitation of all natural resources. The top sources of the outward foreign direct investment from china were all provinces and coastal areas of china specially Fujian, Guangdong, Shandong, Shanghai etc those accounted all together for 61.5% of china’s outward foreign direct investment. In terms of the country’s preferences, around 51% of Chinese foreign direct investment involved into the sector of service and 23% targeted for production with 21% in wholesale and the retail business and 16.5 % involved into the industries such as mining. Gradually demand of domestic business in china and excess of its productive capacity in industrial business especially in the electronic appliances and the machinery have encouraged the enterprises of the china to look forward for more growth opportunities in an international business (Dunning and Zhang, 2008).

The requirement behind securing the access into the market also promotes the enterprise of china those are exporting to serve their own markets through the foreign direct investment or to increase the presence of the market. Foreign Direct investment became the alternate channel to supply the products into the market. After following various strategies by the Chinese firms, they are buying the networks / channels of the local distribution of products and enhancing the economy of the nation. China’s success in attracting the flows of the foreign direct investment has the double impact (Dunning, 2008a). On the one hand, it involves in increasing the competition inside the country means among the domestic business enterprise and encourages own firms to visits abroad and adopts the diversified strategy in creating more incomes and expanding the country’s economy by transferring matured industries to low-revenue generated countries example. On the other hand, an exposure in an international business plays the role of encouraging enterprises of China to do business interactions in abroad through presentations and effects of the spillover on all domestic enterprise. Multinational companies in china began to capture the advantages relates with the trans-nationality means the knowledge of operating business activities/operations in the foreign country. Now, more enterprise of china are ready to become the players those plays their role globally (worldwide) in terms of operating businesses (Dunning, 1981).

All shareholding companies and the private ones within the china are entering into the investments of the large state owned firms accounts for making investments in the large volume. By the end of the year 2005, China’s cumulative investment in abroad such as foreign direct investment had increased until $ 56 billion and 81% was from the state- owned firms those directly controlled by the supervision of the state assets & administration commission. The effect of the outward foreign direct investment set another difference in making the comparison and assessing the outward foreign direct investment between the developing and developed economies whereas the loss of the employment was the concerned problem in all developing countries in 1970. It is because of various reasons-

• Absence of trade unions in all emerging countries
• Geographic distance have an adverse effects on the investment of china(Cheung and Qian, 2009)

A robustness check the geographic distance in between all significant cities and the population resides within these cities confirms the positive results.

Conclusion

The great effects on the Chinese outward foreign direct investment are from the companies and their natural resources. The bad environment of the host country attracts the foreign direct investment of china more by the natural resources of the country. In the result, this type of interaction fails to maintain the relationship in between the companies and the resources. By observing the previous comparative study of the years, it suggested that FDI outward is different from the FDI of other countries in attracting the governed countries those are rich in the natural resources. It reveals the characteristics of the Chinese economy for dominating the state ownership of international companies with the context of china. Aggregate FDI flows from China are different from the FDI’s of other countries. Example: The oil investment from China and the other countries driven by the similar causes and the data that was disaggregate the flow of the direct investment by both the location and the sector that is not available in most of the countries.

A new financial regulatory structure introduces to recognize the risks and improves the co-operation. An authority of the Federal Reserve supervise all the financial institutions those gives the threat to the stability of finance. Stronger standards of other financial banks and higher standards of some are all connect with each other. The supervisor of the new National Bank supervises all Federal chartered banks. International Financial System for the banking industry around the world helped in building the new environment for the banking system. All financial institutions as banks are crucial for the functioning of the market consider as the strong oversight. Any financial firm that poses the risk to the entire financial system weakly regulated. It is essential to clear the responsibility of the financial firms (Acemoglu, Ozdaglar and Tahbaz-Salehi, 2013).

Those years, which are leading with the present crisis of finance and built up the risk seriously in the financial system, increase the price of an assets especially housing loan and steals a sharp deterioration standard of underwriting for the procedure of loans. The largest financial banks those are highly leveraged became dependent on unreliable sources of funds those are for very short term. In most of the cases, Weaknesses in the financial banks current system are highly full of risks and left them unaware from the exposure of risks on and off their balance sheets. Taking access to the credit for short-term period granted and banks did not plan for the powerful factors those force their liquidity during the crisis. When the price of assets starts falling and freeze the liquidity of the market, banks pulled themselves back from lending. It leaves the limited scope for businesses and the households (Goldin and Mariathasan, 2014). Supervision plays an important role. Therefore, the most inter-connected advantages of financial institutions in the country were provide some supervision by the agency of the Federal Government but this type of supervision proved an inadequate or ineffective action. Liquidity and the capital needs of the banks were less and the regulators did not want them to hold the enough capital to replace the assets use in trading, risk on loans and without balance sheet commitments.

Regulators want them to hold the increasing capital in their best times to make themselves prepare for their bad times and meet their needs. They do not want the financial institutions to plan for such situation where the availability of the liquidity shortened. Regulators did not take the responsibility of any harm happened with any of the highly inter-connected and leveraged financial institutions that creates the risk on the entire financial system and on the economy of the country (Farhi, Gourinchas and Rey, 2011). The accountability for supervising all the operations of the financial banks/ institutions was break down among the federal agencies. Division of supervisory accountability and the drawbacks in the definition of the financial banks allowed the bank owners & the other depository institutions to hunt for the regulator of their own choice and selection. Investment banks have different scenario and they operate with the insufficient oversight of the government. Money mutual funds in the market were helpless to run or execute. Hedge funds and other private capital funds operate completely beyond the framework of the supervisory. By concluding all the above statements and the importance of the banking system with their operations and the consideration of the regulatory framework, the government has introduced the new regulation for all the financial institutions all over the world with the name of the Robust International and consistent regulatory standard (Dell’Erba and Reinhardt, 2013).

There are different types of financial crisis those occur after the long time of growth and creativity with innovation in the financial markets. New instruments of financial system permits the risk of credit to spread broadly and enable the investors to change their portfolios or scenario in the new different ways also, enables banks to remove exposures those are available on their financial statements such as balance sheet (De Larosiere, 2014). With the purpose of the security, mortgages has treated like the loans and sold to the large number of investors with their own preferences of risks. Banks can transfer their exposure in the credit loans to the third person/ party/ group through credit derivatives without selling the loans. It creates the huge risk and broadly perceives to reduce the burden of it after distributing the same. It is possible by using the appropriate resources at the perfect time with the promotion of efficiency. However, in place of risk distribution this process considers the risk as opaque and complex. Innovations occurs too fast for any financial banks/ institutions management handling risk for the infrastructure of the market like systems of settlement, payment system with the purpose of financial supervisor’s of the country (Bernanke, 2004).

Shadow-banking system comprises all non-depository banks. These banks serve as the mediators in between the investors and the borrowers. They provide the credit and capital to the investors from the arbitrage in the interest rates. In the down market of housing in 2008, the strategy followed by the shadow banking was borrowings of short term. They use these short-term borrowings for the long-term mortgages .When such market melted in the year then such shadow banking institutions no longer borrow sufficient funds to process (Roubini, 2012). The short-term borrowings dried up because lenders got scared from the credit risk. This results in collapsing investment because no fund borrows by the banks. This leads to the bankruptcy. A subsequent panic in the market of 2008 causes the recession and the crunch in the economy.

Credit ratings easily failed in describing the risk of products. In every case, the lack of clearness prevents the participants of the market from getting aware about the nature of the risks those were face by them (Berg and Krueger, 2003).

Risks build up in the derivative markets, which were thinking to dissolve the risks to those who are able to tackle it and became the big source of contamination through the financial aspects at the time of crisis. Proposal in bringing the market for all the assets based securities into the co-ordinate framework designed by regulatory that needs the transparency and improves the discipline of the market. This proposal imposes on keeping the records and reports all the needs on all derivatives. Propose to increase the prudential regulation of all the dealers in the derivative markets that reduce the risk of the market by acquiring all standard derivatives to execute in clear venues and through the medium counter parties. (Barr, Bush and Pienkowski, 2014). The growth of derivatives markets and the introduction of instruments of new derivatives brings into the limelight for noting the gaps and inappropriateness in the regulatory frameworks of all products.  

Conclusion

All financial institutions must face the same regulatory standards and the same supervisory with no loopholes for arbitrage. Proposal made for creating the council for the financial services and headed by the treasury to fill the gaps / loopholes in the supervision and co-ordinate policies to remove all disputes with the identification of risk in the market or financial system. This council involves the principal federal financial regulators and maintains the staff at treasury. The authority of Federal Reserve enhance over the market infrastructure to slow down the strengths for adjoining among all financial institutions in the market. Finally, tries to propose the regulatory and statutory regimes to get harmonize for the future securities whereas the differences in the regulatory of different markets are no longer continued and justified.

Reference

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