Editor Pick: Fighting Saudi Inflation
Paul Gamble of SAMBA offers an explanation of the 400+% jump in Saudi Arabian annual average inflation from a stable ~0.5% between 2002-2005 to 2.3% in 2006. Like Sfakianakis of Saudi Arabian British Bank, he points to supply bottlenecks in the housing market as the largest contributor. Also like Sfakianakis, who formerly worked at SAMBA, he rejects currency revaluation as an appropriate inflation-fighting tool in the near-term on the grounds that it “would reduce competitiveness of non-oil exports and discourage foreign investment”.
Gamble weighs other policy options for containing inflation, ultimately favoring supply-side measures as the most likely course of policy even though they will have little immediate effect. Price controls and government spending cuts would be the most effective options for the short-term but the least viable for the long-term. A summary:
1) Interest rates – Raising interest rates dampens inflation by making borrowing more expensive, encouraging saving and increasing debt service costs. Low indebtedness and the exchange rate peg limit the ability to move interest rates.
2) Reduce commercial bank lending – Reducing the amount banks have available to lend will limit the expansion of the money supply. The downside is that it would undercut economic momentum. Also, bank lending is not currently a major contributor to inflation.
3) Reducing government spending or raising taxes can restrain economic activity, reducing demand and allowing bottlenecks to ease. The problem is, this approach will delay needed upgrades in human and physical infrastructure. Moreover, Saudi Arabia’s limited tax base renders tax increases ineffective.
4) Direct price controls – This can reduce inflation in the near-term but they create other economic distortions that may cause greater longer-term problems. This option should only be exercised as a last resort.
5) Supply-side measures – Addressing supply bottlenecks through market mechanisms is the most effective way to deal with the current bout of inflation. This will not show immediate results but will reduce price pressures over the longer term and prevent high inflation expectations from developing in the public mindset.
One Response to “Editor Pick: Fighting Saudi Inflation”
i would call it “fighting inflation with one hand tied behind your back” though. why rule out a revaluation?