(c)
3.
If world prices, expressed in US dollars, rise, this will be transmitted into Hong Kong prices much more rapidly through a fixed link. This could occur either because of a rapid rise in average world prices, or because of a fall in the value of the US dollar against other currencies.
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Inflation can only really be said to be "imported" in case (c), and that has not been happening recently Hong Kong's inflation rate is much higher than elsewhere, even in dollar terms and hence allowing for the recent depreciation in the US dollar.
4. In fact, is pretty clear that Hong Kong's recent inflation has been home grown. It arises very largely because the pressure of demand, particularly in the labour market, exceeds the economy's productive capacity. Evidence for this is the very low unemployment rate, and the fact that prices of non-traded goods have been rising considerably faster than those of traded goods. That this has been occurring at much er growth rates than we have seen in earlier years is the sequence of slow growth in productive capacity rather than a boom in demand. Growth in the labour force has slowed down, both because immigration has stopped and because emigration, particularly of highly skilled labour, has increased. Investment has been faltering. The latter two factors may be the result, in part, of the erosion of confidence as a result of political uncertainty. Shortage of land has also been an important constraint.
5. I disagree profoundly with Professor Chen's assertion that this is not demand pull inflation, although I agree that trying to improve productive capacity may be just as important for relieving excess demand as measures to reduce demand.
6. One of the results of this inflationary process is that production of non-traded goods will become more profitable and traded goods less, with the result that resources will shift from the production of the latter. In due course, the excess demand will be relieved by a combination of reduced exports, higher imports, a higher tax take, and monetary contraction resulting from the balance of payments deficit. But the process may be protracted and uncomfortable.
7.
Two questions arise from this. First, does the inflation matter? Second, are any policy measures available to mitigate it or its effects?
8. To some extent, Hong Kong should live with inflation above world levels, as a necessary part of the adjustment process. The argument by Gledhill et al that it is making Hong Kong uncompetitive is valid only insofar as it eventually results in higher unemployment and lower growth than might
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