Over the last few days, I’ve been reading several articles about the GDP growth rate and inflation and balancing the two by means of monetary policy and all that.
Now, aren’t GDP growth rate and inflation extremely highly inter-related? Unless the country has a massive trade imbalance?
Let us take the simplistic case of no foreign trade. Now, the GDP is the total value of goods and services produced in the country. So GDP growth rate is the growth in this total value of goods and services. Now, how does growth in GDP happen? One of 2 things must happen – more goods and services must be produced and sold, or the existing goods and services will become more expensive – in other words, prices go up – in other words inflation happens.
What about the other case, where production goes up? Let us assume that there’s no change to inventory, so what is produced gets consumed. Is it possible for consumption to go up without a corresponding increase in price? Shouldn’t the price change at least in lag? Doesn’t that contribute to inflation? And if suddenly more things are being purchased, doesn’t that mean money supply has gone up? Which implies inflation?
Now, bring back foreign trade and let’s assume the country is an exporter. Then, yeah, one could make more money by increasing prices abroad for all products, and thus improve the GDP growth without affecting domestic inflation. BUT, if there is free flow of capital, there are likely to be inflows, which will put upward pressure on the currency (which will put downward pressure on growth) and consequently on interest rates which will normalize and so on…
Tell me if i’ve got something wrong here… ??