Inflation conundrum in Bangladesh
Saturday, 15 December 2007
Dr. Saadat Husain
WE were flummoxed when the Chicago trained teacher in Boston University told us that inflation at times may also be explained by sociological factors. It sounded like blasphemy on the part of a Chicago student whose article of faith was to be based on unadulterated monetarism. Inflation as Friedman taught us was a monetary phenomenon, it can be explained by the supply of, and demand for, money. In popular wisdom inflation occurs when too much money chases too few goods. The simple price equation will tell us the same thing. This holds true almost in any country and at point of time. An ardent student of economics will not like to deviate from this axiom. At the same time he may not disagree with the Boston University teacher who was referring to the social and political constraints that do not allow unfettered use of monetary instrument to bridle price spiral when it tends to explode through the roofs.
The dynamics behind the supply of money are convoluted. The monetary authority can tame inflation within a short time if that is the sole objective of the central bank and if it has the full freedom to take required measures to curb inflation at any cost. Addressing a single objective with a single instrument is a cinch in economic model building and it can be tried by any economist on demand from appropriate authority. Unfortunately such a situation does not exist in real life. Multiple objectives rather than single objective dominate the real world. The position is further compounded by abrasive juxtaposition of myriad constraints, at times drawing in opposite direction.
Neither the supply of money nor that of goods and services is an exogenous variable. The central bank does not control the supply of money by any magic wand; it has to follow some algorithmic mechanism. The result is visible usually with a time lag. The instruments used are interest rate, exchange rate, statutory liquidity reserve (SLR), cash reserve ratio (CRR), letters of credit (LC) margin, open market operation, sterilisation etc. Supply of goods is a real phenomenon which is affected by a host of factors like climate, technology, application of inputs, physical and financial infrastructure, availability of credit and availability of goods through import channel. Any shock, internal or external, may constrict the supply and spur the price movement upward, money supply remaining the same. If money supply is reduced pari passu there will be no effect on the price level.
This is usually not to be the case. First of all, the central bank may not decide to reduce the supply of money; even if it does it may not act so promptly and the result will be perceptible only with a lag. If taming inflation was the lone objective, the central bank would act to reduce the money supply. In a developing country like Bangladesh, the authority has to work with multiple objectives: employment generation, growth of GDP, export promotion, remittance facilitation and support deficit financing of the government. There is a trade off between the objectives. The central bank alone cannot fix its preference for a particular goal. The preference is reached by the complex interaction of various forces operating in the field. The preference is dynamic, it keeps on shifting. One can easily imagine how difficult it is for the central bank to use its instruments to curb inflation. It is hobbled up in many ways.
In Bangladesh prices have been spiraling for about two years. They exhibit seasonal variations. With the arrival of winter vegetables and increased catch of fish their prices come down in December and January. Harvesting of winter paddy ("aman") further eases the situation. The more perishable a product is the more difficult it is to control or restrict its supply by the producers or hoarders. Here we are confronted with the concept of market power. The new classical model of free market is built on the premises of perfect competition where there is no barrier to free entry and there is no room for oligopoly, cartel or collusion. There is strong regulatory framework to thwart any attempt at price manipulation through syndication. Market power, however, remains a recognised phenomenon; it is more than simple cartel or syndicates operating in the market. Astute operators use more than one way to wrestle market power and introduce a stilted price regime. Robin Maris and others dealt with the phenomenon of market power elaborately in their write-ups on market imperfection. The structure of market power is reticular, it is not very easy to dismantle it. It comes more within the remit of political economy rather than the fine contours of mathematical model building. Price gyration of imported onion and sugar in the recent past in Bangladesh testifies to the existence of market power in the current situation. Extortions at various points add to insurance and marketing costs which in turn stoke the price hike. This is not, however, an important factor in the power game of the market manipulators. Price increase in the international market is shown as the most evil variable for price spiral in the domestic market. It is only partially correct; it does not tell the whole truth. Price increase of some strategic commodities in the international market might have triggered the price hike of these commodities in the domestic market; that cannot, however, explain the appalling increase of general price level. It has been observed that prices of most domestic produces have also increased markedly. So either there was a supply shock or it is a problem of open economy exacerbated by the overly riveted globalised markets. As soon as the export opportunity opens up for a commodity, producers try to bring the domestic price at par with the international market irrespective of any price increase in the international market. This perspicuously explains staggering price hike of shrimps and prawns in the local market after liberation and the price hike of hilsha fish or potato in the recent past. The price of hilsha fish plummeted markedly with the imposition of export ban. Export ban on potato derivatives may have similar impact on the price. As a student of economics the author is conditioned to support open economy and export led growth, but as a government employee with a fixed salary he is adversely affected through consumption loss with the opening of export window for the domestic goods. Increased export helps create employment, but it reduces supply of domestic produce and increases money supply in the economy.
This brings us to the real problems that confront the monetary authority while they are trying to arrest the inflationary trend. The consumers will welcome an appreciation of domestic currency, the exporters and relatives of non-resident Bangladeshis will oppose the move because it stands to reduce their taka income. The surplus farmers are happy to see the price of agricultural commodities including rice increasing, the landless labourers, the fixed income groups, the deficit farmers and the business groups are unhappy at the price rise of agricultural commodities, a phenomenon they call "agflation". A rise in the interest rate on deposit will be blithely accepted by the non entrepreneur middle class who heavily depend on interest earning from the savings instruments. The industrialists and business people will decry such a move arguing that it will be pernicious for investment projects. One can see here a case of group struggle that goes on within the domain of political economy. Inflation, exchange rate depreciation, alteration of interest rate, wage or salary increase have divergent impact on different groups in the society. Within the same group, different layers feel the pinch differently depending on the level of their assets and income. For non-entrepreneur rich people with a fixed income, the effect of increase in food price is basically psychological, they feel bad but their consumption level is not lowered down. The lower middle class fixed income groups are really affected as their consumption level is drastically undermined. It may be appropriate at this stage to see how different strata of citizens have been affected by the currently raging inflation in the country. Citizens also experienced such a run away inflation in 1974-75. People were squeezed to the bone. Resources in the country were very limited and so was the income of people in general. Windows of opportunities and avenues of employment were few and far between. Poor and lower middle class people soon lost their entitlement to food and basic necessities of life. Middle class had also difficulties in seeing their both ends meet smoothly. A terrible famine ensued. The death toll was 27000 officially, actual figure may be much higher. Despite a high gradient monotonically increasing price curve the country did not see such a horrifying situation in the last two years. The overall resource position of the country and the income level of individuals have markedly improved compared to early seventies. Per capita availability of food, per capita income in dollar, employment level, export earnings, fish, meat and vegetable production have all increased. Hundreds of new employment avenues have been opened. Most important, about eight million Bangladeshis are engaged in overseas jobs and they remit huge amount of foreign currencies to their family members. If each overseas wage earner supports a five member family inside the country, it means foreign remittance take care of about 40 million people in the country, about 30% of total population.
The non-government organisations (NGOs) and micro credit organisations have, according to different reports covered about 70 million borrowers in their income generating programmes. Adjusting for duplications and overlapping, the net figure should not be less than 30 million. The beneficiaries from micro credit should add up to at least 90 million, it could be more. Taken as whole, almost every family has some cushion against their eroding purchasing power. Even if we leave aside thousands of additional employment opportunities and transfer windows, it can be logically surmised that at least about 70 to 80 per cent population of the country have entitlement to food and basic necessities of life. The spectacular growth of cell phone to about 30 million indicates the level of cash income available with common, people. The crunch is not that severe as in early seventies. They feel hurt but they are not down with hunger as one might perceive from the head-line index of inflation.
We are again back to the area of money supply. It is money that provides purchasing power to buyers in the market place. If there is a shortage of money supply goods and services will either remain unsold or sellers have to bring down their prices to clear their stock. Sellers will like to hold back if his cost of production is above the prices offered by buyers. How long they can hold back depends on the market power wielded by them which in turn hinges on their financial strength, the price elasticity, the cross elasticity and the perishableness of the goods and the expectation function of buyers. If market is cleared at a high price there is strong reason to suspect that the money supply is adequate to sustain the price hike. In Bangladesh supply of money has markedly increased in the last few years. In a recent article Faisal Salahuddin has shown the quantum of money supply has indeed increased markedly in the last two years and inferred that price spiral to a great extent may be attributed to enhanced money supply (The Daily Star June 14, 2007) It may be mentioned here that remittance in recent times has become an important source of increased money supply. Unless effectively sterilised using say Mundell's prescription increased remittance will not only add to foreign exchange reserve of the country, it will also be transmitted as cash money to the recipient consumers. A casual empiricism indicates that this might have happened in Bangladesh. Despite almost tripling of foreign exchange reserve, we could not benefit through currency appreciation against dollar, the weakest hard currency in the international market. Countries which appreciated their currency could partly offset the effect of the price rise in the international market. Increased earnings from export, unreported income, lax supervision by the regulatory authorities, deficit financing, income flow from easy credit policy and shoddy deals have conspired to increase money supply in the market place. Increase in price, be it driven from domestic or international source, was absorbed in the market with no perceptible impact on consumption level. Even the lower middle class had a cushion some where as distinct from the 74-75 situation. Only the fixed income group in the lower rung and the unemployed poor suffered badly. The wage earners have cushioned them through increasing their wage rate. Since the fixed income groups no more represent a big number the agitation due to price hike has not reached a high pitch in the last two years; the outburst remained confined to television talk show, seminar statements and press interviews of the political leaders and civil society personalities. It has not really shaken the political ground in the last two years.
Inflation, it appears, is a problem of income distribution and economic power game. Not all the groups are affected by inflation in the same manner, some groups like the surplus farmers, the stock holders, producers in some cases are benefited through inflation. Groups who have benefited from remittance, increased employment or participation, windfall gains, new opportunities and unabated entitlement are not really bothered about the scourge of inflation. They may at times express indignation as a conditioned response at the increase of price level. Many of them will, however, fiercely resist any move by the monetary authority to constrict the money supply in order to contain inflation. Their contention is that inflation has to be checked as if by faith healing without using any effective instrument. Containing inflation thus boils down to adjudicating a group conflict in which the affected groups, the beneficiary groups and the unaffected neutral groups struggle to protect their interest, if necessary at the cost of others. The monetary authority ultimately finds it a socio-political problem rather than a pure economic problem. How far and how effectively the problem of inflation can be tackled depends on the process and speed of resolving the socio-political problem.
WE were flummoxed when the Chicago trained teacher in Boston University told us that inflation at times may also be explained by sociological factors. It sounded like blasphemy on the part of a Chicago student whose article of faith was to be based on unadulterated monetarism. Inflation as Friedman taught us was a monetary phenomenon, it can be explained by the supply of, and demand for, money. In popular wisdom inflation occurs when too much money chases too few goods. The simple price equation will tell us the same thing. This holds true almost in any country and at point of time. An ardent student of economics will not like to deviate from this axiom. At the same time he may not disagree with the Boston University teacher who was referring to the social and political constraints that do not allow unfettered use of monetary instrument to bridle price spiral when it tends to explode through the roofs.
The dynamics behind the supply of money are convoluted. The monetary authority can tame inflation within a short time if that is the sole objective of the central bank and if it has the full freedom to take required measures to curb inflation at any cost. Addressing a single objective with a single instrument is a cinch in economic model building and it can be tried by any economist on demand from appropriate authority. Unfortunately such a situation does not exist in real life. Multiple objectives rather than single objective dominate the real world. The position is further compounded by abrasive juxtaposition of myriad constraints, at times drawing in opposite direction.
Neither the supply of money nor that of goods and services is an exogenous variable. The central bank does not control the supply of money by any magic wand; it has to follow some algorithmic mechanism. The result is visible usually with a time lag. The instruments used are interest rate, exchange rate, statutory liquidity reserve (SLR), cash reserve ratio (CRR), letters of credit (LC) margin, open market operation, sterilisation etc. Supply of goods is a real phenomenon which is affected by a host of factors like climate, technology, application of inputs, physical and financial infrastructure, availability of credit and availability of goods through import channel. Any shock, internal or external, may constrict the supply and spur the price movement upward, money supply remaining the same. If money supply is reduced pari passu there will be no effect on the price level.
This is usually not to be the case. First of all, the central bank may not decide to reduce the supply of money; even if it does it may not act so promptly and the result will be perceptible only with a lag. If taming inflation was the lone objective, the central bank would act to reduce the money supply. In a developing country like Bangladesh, the authority has to work with multiple objectives: employment generation, growth of GDP, export promotion, remittance facilitation and support deficit financing of the government. There is a trade off between the objectives. The central bank alone cannot fix its preference for a particular goal. The preference is reached by the complex interaction of various forces operating in the field. The preference is dynamic, it keeps on shifting. One can easily imagine how difficult it is for the central bank to use its instruments to curb inflation. It is hobbled up in many ways.
In Bangladesh prices have been spiraling for about two years. They exhibit seasonal variations. With the arrival of winter vegetables and increased catch of fish their prices come down in December and January. Harvesting of winter paddy ("aman") further eases the situation. The more perishable a product is the more difficult it is to control or restrict its supply by the producers or hoarders. Here we are confronted with the concept of market power. The new classical model of free market is built on the premises of perfect competition where there is no barrier to free entry and there is no room for oligopoly, cartel or collusion. There is strong regulatory framework to thwart any attempt at price manipulation through syndication. Market power, however, remains a recognised phenomenon; it is more than simple cartel or syndicates operating in the market. Astute operators use more than one way to wrestle market power and introduce a stilted price regime. Robin Maris and others dealt with the phenomenon of market power elaborately in their write-ups on market imperfection. The structure of market power is reticular, it is not very easy to dismantle it. It comes more within the remit of political economy rather than the fine contours of mathematical model building. Price gyration of imported onion and sugar in the recent past in Bangladesh testifies to the existence of market power in the current situation. Extortions at various points add to insurance and marketing costs which in turn stoke the price hike. This is not, however, an important factor in the power game of the market manipulators. Price increase in the international market is shown as the most evil variable for price spiral in the domestic market. It is only partially correct; it does not tell the whole truth. Price increase of some strategic commodities in the international market might have triggered the price hike of these commodities in the domestic market; that cannot, however, explain the appalling increase of general price level. It has been observed that prices of most domestic produces have also increased markedly. So either there was a supply shock or it is a problem of open economy exacerbated by the overly riveted globalised markets. As soon as the export opportunity opens up for a commodity, producers try to bring the domestic price at par with the international market irrespective of any price increase in the international market. This perspicuously explains staggering price hike of shrimps and prawns in the local market after liberation and the price hike of hilsha fish or potato in the recent past. The price of hilsha fish plummeted markedly with the imposition of export ban. Export ban on potato derivatives may have similar impact on the price. As a student of economics the author is conditioned to support open economy and export led growth, but as a government employee with a fixed salary he is adversely affected through consumption loss with the opening of export window for the domestic goods. Increased export helps create employment, but it reduces supply of domestic produce and increases money supply in the economy.
This brings us to the real problems that confront the monetary authority while they are trying to arrest the inflationary trend. The consumers will welcome an appreciation of domestic currency, the exporters and relatives of non-resident Bangladeshis will oppose the move because it stands to reduce their taka income. The surplus farmers are happy to see the price of agricultural commodities including rice increasing, the landless labourers, the fixed income groups, the deficit farmers and the business groups are unhappy at the price rise of agricultural commodities, a phenomenon they call "agflation". A rise in the interest rate on deposit will be blithely accepted by the non entrepreneur middle class who heavily depend on interest earning from the savings instruments. The industrialists and business people will decry such a move arguing that it will be pernicious for investment projects. One can see here a case of group struggle that goes on within the domain of political economy. Inflation, exchange rate depreciation, alteration of interest rate, wage or salary increase have divergent impact on different groups in the society. Within the same group, different layers feel the pinch differently depending on the level of their assets and income. For non-entrepreneur rich people with a fixed income, the effect of increase in food price is basically psychological, they feel bad but their consumption level is not lowered down. The lower middle class fixed income groups are really affected as their consumption level is drastically undermined. It may be appropriate at this stage to see how different strata of citizens have been affected by the currently raging inflation in the country. Citizens also experienced such a run away inflation in 1974-75. People were squeezed to the bone. Resources in the country were very limited and so was the income of people in general. Windows of opportunities and avenues of employment were few and far between. Poor and lower middle class people soon lost their entitlement to food and basic necessities of life. Middle class had also difficulties in seeing their both ends meet smoothly. A terrible famine ensued. The death toll was 27000 officially, actual figure may be much higher. Despite a high gradient monotonically increasing price curve the country did not see such a horrifying situation in the last two years. The overall resource position of the country and the income level of individuals have markedly improved compared to early seventies. Per capita availability of food, per capita income in dollar, employment level, export earnings, fish, meat and vegetable production have all increased. Hundreds of new employment avenues have been opened. Most important, about eight million Bangladeshis are engaged in overseas jobs and they remit huge amount of foreign currencies to their family members. If each overseas wage earner supports a five member family inside the country, it means foreign remittance take care of about 40 million people in the country, about 30% of total population.
The non-government organisations (NGOs) and micro credit organisations have, according to different reports covered about 70 million borrowers in their income generating programmes. Adjusting for duplications and overlapping, the net figure should not be less than 30 million. The beneficiaries from micro credit should add up to at least 90 million, it could be more. Taken as whole, almost every family has some cushion against their eroding purchasing power. Even if we leave aside thousands of additional employment opportunities and transfer windows, it can be logically surmised that at least about 70 to 80 per cent population of the country have entitlement to food and basic necessities of life. The spectacular growth of cell phone to about 30 million indicates the level of cash income available with common, people. The crunch is not that severe as in early seventies. They feel hurt but they are not down with hunger as one might perceive from the head-line index of inflation.
We are again back to the area of money supply. It is money that provides purchasing power to buyers in the market place. If there is a shortage of money supply goods and services will either remain unsold or sellers have to bring down their prices to clear their stock. Sellers will like to hold back if his cost of production is above the prices offered by buyers. How long they can hold back depends on the market power wielded by them which in turn hinges on their financial strength, the price elasticity, the cross elasticity and the perishableness of the goods and the expectation function of buyers. If market is cleared at a high price there is strong reason to suspect that the money supply is adequate to sustain the price hike. In Bangladesh supply of money has markedly increased in the last few years. In a recent article Faisal Salahuddin has shown the quantum of money supply has indeed increased markedly in the last two years and inferred that price spiral to a great extent may be attributed to enhanced money supply (The Daily Star June 14, 2007) It may be mentioned here that remittance in recent times has become an important source of increased money supply. Unless effectively sterilised using say Mundell's prescription increased remittance will not only add to foreign exchange reserve of the country, it will also be transmitted as cash money to the recipient consumers. A casual empiricism indicates that this might have happened in Bangladesh. Despite almost tripling of foreign exchange reserve, we could not benefit through currency appreciation against dollar, the weakest hard currency in the international market. Countries which appreciated their currency could partly offset the effect of the price rise in the international market. Increased earnings from export, unreported income, lax supervision by the regulatory authorities, deficit financing, income flow from easy credit policy and shoddy deals have conspired to increase money supply in the market place. Increase in price, be it driven from domestic or international source, was absorbed in the market with no perceptible impact on consumption level. Even the lower middle class had a cushion some where as distinct from the 74-75 situation. Only the fixed income group in the lower rung and the unemployed poor suffered badly. The wage earners have cushioned them through increasing their wage rate. Since the fixed income groups no more represent a big number the agitation due to price hike has not reached a high pitch in the last two years; the outburst remained confined to television talk show, seminar statements and press interviews of the political leaders and civil society personalities. It has not really shaken the political ground in the last two years.
Inflation, it appears, is a problem of income distribution and economic power game. Not all the groups are affected by inflation in the same manner, some groups like the surplus farmers, the stock holders, producers in some cases are benefited through inflation. Groups who have benefited from remittance, increased employment or participation, windfall gains, new opportunities and unabated entitlement are not really bothered about the scourge of inflation. They may at times express indignation as a conditioned response at the increase of price level. Many of them will, however, fiercely resist any move by the monetary authority to constrict the money supply in order to contain inflation. Their contention is that inflation has to be checked as if by faith healing without using any effective instrument. Containing inflation thus boils down to adjudicating a group conflict in which the affected groups, the beneficiary groups and the unaffected neutral groups struggle to protect their interest, if necessary at the cost of others. The monetary authority ultimately finds it a socio-political problem rather than a pure economic problem. How far and how effectively the problem of inflation can be tackled depends on the process and speed of resolving the socio-political problem.