Monday, 28 March 2011

Japan earthquake: a supply shock and another aftershock

Last week, Caroline Baum said that the earthquake in Japan represents a supply shock that could raise inflation pressures around the world.

There’s one economic aspect of Japan’s earthquake, tsunami and nuclear disaster that seems to be getting lost in the rubble, and that’s the effect on prices.

Yes, prices. Remember them? You’d never know it from the analysis of what Japan’s triple-whammy means for the domestic and global economy.

A natural disaster qualifies as a supply shock. For the graphically inclined, this is represented by an inward shift, to the left, of the supply curve. It describes what happens when producers provide fewer goods at any given price than they did before. The result is lower output and higher prices.

Baum said that there is little that central banks can do to mitigate the impact on output.

The problem isn’t weak demand; it’s reduced supply. Central banks manufacture one thing: money. They can’t produce computer chips, electronic components or automobiles.

In other words, they can’t make up for the lost supply. All they can do is print money so that more money chases fewer goods and services, which is the definition of inflation.

And if the initial earthquake did not do enough damage to Japan, there are the aftershocks, of which another came on Monday, to add to the ongoing nuclear crisis that just refuses to go away. Reuters reports some the latest developments:

Japan appeared resigned on Monday to a long fight to contain the world's most dangerous atomic crisis in 25 years after high radiation levels complicated work at its crippled nuclear plant.

Engineers have been battling to control the six-reactor Fukushima complex since it was damaged by a March 11 earthquake and tsunami that also left more than 27,000 people dead or missing across Japan's devastated northeast.

A magnitude 6.5 earthquake rocked the region on Monday, the latest in a series of aftershocks, and officials warned it would trigger a 50-cm (two feet) tsunami wave.

Radiation at the nuclear plant has soared in recent days. Latest readings on Sunday showed contamination 100,000 times normal in water at reactor No. 2 and 1,850 times normal in the nearby sea.

Those were the most alarming levels since the crisis began.

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