Economics

[ram]

How is inflation affected by foreign trade?

 

[phillip1882]

hmm. this is a very good question. inflation has one of two definitions: a rise in the price of goods and services, or an increase of the money supply. (or possibly both as increasing money supply can defiinitly cause rising prices) foriegn trade increases the number of buyers and sellers in a paritucalar country by allowig other countries to buy and sell thier goods and services thus off setting inflation in general both by allowing greater distribution of currency (assuming the foriegn country accepts it) and by disstilling the impact of rising prices by allowing more competition.

[ram]

Thanks for the idea sir.. so meaning foreign trade will reduce inflation rate of a country by allowing more currency and more competition. Is there any negative impact of foreign trade to inflation or could it be worsen, sir?

Edited July 27, 2015 by ram

[Buffy]

It is important to understand here that while foreign trade can have an impact on inflation, it is not intrinsically linked: you could have either high or low foreign trade at the same time as you had high or low inflation. However changes in either can be a factor in changes in the other, just not the whole reason, and they could have no impact if the other related factors swamp them.

 

Similarly what philip said above about the money supply may or may not have an impact on inflation (that is, an increase in the money supply is not a "definition" of inflation).

 

Strictly speaking, inflation is an increase in the price of goods and services in an economy. It is usually measured by taking some standard bundle of goods and services and finding the average market price for those items and then comparing those prices to the same bundle of goods at an earlier time. There are usually different bundles measured that concentrate either on consumer goods or on raw materials used by industry, although measures that focus on the latter, also called the Consumer Price Index, are what are most commonly watched. Normally these statistics are gathered by a government agency, although there are many other less formal ones, like my favorite the Big Mac Index (although it's really mostly used to compare the relative strength of different currencies, it also produces inflation metrics). 

 

Now the level of trade for a country can have an impact on inflation, but it is not direct. If foreign trade increases, that may (but not always) result in an increase in the value of that country's currency on the world market. That increase in the "purchasing power" (see Big Mac Index), allows fewer units of that country's currency to purchase more of another country's goods, which is to say the price will be less for those goods, and thus it can provide a decrease in inflation in the short term. Unfortunately, that increase in the strength of the currency means that the goods of that country become more expensive to other countries so this will tend to *lower* foreign trade exports because the other countries can't afford as much.

 

This natural feedback loop, the lags involved due to economic "friction" mean that any of the stages in this cycle can be out of sync and the timing is uncertain: that is an increase in exports may be followed in the short term by increases in inflation due to other factors before the increase in exports has a chance to strengthen the currency and decrease inflation. This is precisely why people complain about China pegging the Yuan to the Dollar because it insulates them from the cycle and allows them to maintain an artificial advantage in maintaining high exports through artificially capped labor, capital and resource costs.

 

The most important thing though is that there are all kinds of other, more direct mechanisms which drive inflation compared to trade:

• Rapid changes in the availability of labor, capital or raw materials.
• Rapid changes in demand.
• Government expenditures either exceed government income without borrowing or under-spending. 
• Government monetary policy to manipulate the availability of money for lending.
• Internal or external government actions or events that cause price shocks.

There are endless examples of all of these, only the last one having to do with trade (e.g. the Arab Oil Embargo of the 1970s), and the normally completely dominate the effect of trade on the overall level of inflation.

 

One more thing: I always like to point out that people who have little familiarity with economics look at inflation like its some sort of hideous thing that should be vanquished, but in fact moderate inflation--due to the economic friction mentioned in passing above--is actually *necessary* to a growing economy. The point is that you want to keep inflation and growth in balance. If you have no inflation at all, your economy is likely not to grow, to grow at a slower pace than it could, or ultimately to create internal economic imbalances in distribution that will destabilize your political environment (with China being an example of the latter....take a look at their stock market).

 

There are lots of directions this discussion can go, but you need to specify more specifically what effects of trade you're interested in looking at.

 

 

When goods don’t cross borders, soldiers will, :phones:

Buffy

[ram]

@ Buffy,  Thank you very much for that great insights... It helps me a lot.

 

I was surprised when I read about China's Stock market crush. I think this is a very good example to my research work. Can you please help me understand the whole scenario. Why it happen to the world's second biggest stock owned? How it affect  china's economy and the world? When do you think it end? What do you think will happens next? Could it lead to war? as what you stated "When goods don’t cross borders, soldiers will"

Edited July 30, 2015 by ram