Why inflationary situation remains worrying
Friday, 27 July 2007
Anas Ibrahim
THE approaches to inflation differ widely between developing and developed countries. According to Friedman's quantity theory of money, there is a general agreement that growth in the quantity of money is the primary determinant of the inflation rate (Mankiew, 1997:156). In developing countries, in contrast, inflation is not a purely monetary phenomenon, but is often linked with fiscal imbalances and deficiencies in sound internal economic policies (Mortaza, 2006). If we want to see the nature and causes of inflation in Bangladesh on the perspective of economics rather than on the popular and frequently-read newspaper's points of view, there are several researches that have been conducted since independence.
Taslim (1982) with the data from FY60 to FY80 analysed the inflationary process of Bangladesh. He pointed out that any devaluation of the domestic currency is followed by an almost equal proportionate increase in the rate of inflation, while an increase in money supply does not induce an equal proportionate increase in the inflation rate.
Begum (1991) found both the existence of demand-pull factors (import bottlenecks, government expenditures, wage, expected inflation) and cost-push factors (agricultural bottlenecks, rate of interest and credit) as the causes for inflation.
Aktaruzzaman (2005) studied on the period 1973-2002. The paper observes that there is a negative relation between real income and inflation. Besides, the level and the rate of devaluation of exchange rate, growth of money supply and deposit rate are statistically significantly related with inflation.
In financial year from 2001 to 2006, our economy experienced comparatively low average inflation rates compared to that in the '90s. In FY03 to FY06, we got a higher upside trend. In FY06, the rate was 7.16 per cent. We introduced flexible exchange rate from May 2003. So exchange rate may be a strong factor behind the inflation in recent years after initiating the flexible exchange rate regime in Bangladesh.
Mortaza (2006) conducted the most recent observation on inflation generating process in Bangladesh. His key findings were: money supply growth is the important explanatory factor of inflation in our country. The channel may be through the effects of money supply on GDP or on exchange rates. The deposit rate of interest is found to be a weak determinant of inflation.
The findings note the demand-side management for Bangladesh in controlling inflation. Prudent monetary policy on a continuous basis is needed. Besides, many developing countries have experienced inflationary pressure in the initial period of introduction of flexible exchange rate regime. As we entered into this regime in 2003 and are passing the very initial period, we have also to concentrate on stabilising the foreign exchange market to slow down the pressure.
Anti-inflationary measures in the budget:
1. Complete withdrawal of customs duty on some commodities (edible oil, lentils).
2. Distribution of 1.0 million (10 lakh) metric tonnes (MT) of foodgrains through safety net programme.
3. Continuing the duty free imports of essential commodities, including rice, wheat, onion, etc.
4. Establishing four wholesale markets at four corners of the city.
5. Government itself will import 0.8 million (8.0 lakh) MT of foodgrains, in addition to private sector import.
Besides, under the budget for the current fiscal, the safety net is targeted for widening its operation. It will help the poor to be safe from shocks from inflationary pressure.
Will inflation be really kept in wallet?: Recently the policy has been announced for shrinking money supply to curb the inflationary pressure. But there is a huge smoke of doubt about this initiative.
Before getting some satisfactory answer, let us think about what measures are really needed for tackling inflation. According to studies of Taslim (1982), Begum (1991), Aktaruzzaman (2005) and Mortaza (2006), exchange rate, government expenditure, import, wage, expected inflation, agriculture, rate of interest, credit and finally and, most importantly money supply, are the significant factors influencing inflation.
In agriculture, there will be both diesel and fertiliser subsidies, involving a substantial amount of money.
About import, we have noted that the sufficient amount of foodgrains will be imported by the government to help curb inflationary pressure. Also tariff has been withdrawn, in the case of import of some essential goods.
About interest rate, it is to be pointed out that the lending rate increased to 12..71 per cent in May 2007 from 11.01 per cent in June 2004. As the central bank is determined to continue tightening its monetary policy, the interest rate will continue to maintain an upward trend.
Meanwhile, with a flexible exchange rate regime, coupled with export-oriented policy, we can expect that taka will continue to be devalued.
Will inflationary pressure continue, even after the above-mentioned measures?
Some points may be considered here.
1. One of the distinguishing features of the current fiscal's budget is that the government has set a large deficit, which is 5.6% (excluding grants) or 4.82% (including grants) of the GDP. An expansionary budgetary measure with the central bank's tightening monetary policy will create a negative impact on output and employment generation in the private sector. The shortage of output will not help in controlling inflation.
2. Of the total deficit Tk 255.81 billion (25581 crore), some 75.35% of the budget deficit would be financed through domestic borrowing whereas the rest of the amount will be met through external borrowing.
This clearly indicates the dominance of the fiscal authority on monetary authority. But we clearly know that the monetary measures are the most important ones for controlling inflation. The government will pursue the central bank to finance its deficit through creating demand for its bonds. As a result, the central bank will require to create extra money for financing the government budget deficit. In this context, the monetary policy in tackling inflation will be less powerful by the dominance of fiscal policy set out under the budget for the current fiscal.
3. Moreover, the government has to repay a huge principal amount with interest. This will require additional creation of money. Ultimately, we will have more undesired inflation level. The size and magnitude of this additional amount of money will depend on the rate of interest on public borrowings and also on the rate of the growth of the economy. If the rate of the former goes faster than the rate of growth of the GDP, it will soon create more inflationary pressure.
4. What will be the impact of slashing down import duties on essential commodities? Experience suggests that it will be a temporary solution. The price would decrease very marginally. This will tend to be gradually adjusted as the taka continues to depreciate against dollar as well as with increasing domestic cost of production.
So we can conclude at least that the budgetary measures as well as the tightening monetary policy will not be able to control the inflationary pressure. Our poor citizens have to tighten their belt more if they have any!
The writer is in Economics Department, University of Dhaka and can be reached at e-mail: [email protected]
THE approaches to inflation differ widely between developing and developed countries. According to Friedman's quantity theory of money, there is a general agreement that growth in the quantity of money is the primary determinant of the inflation rate (Mankiew, 1997:156). In developing countries, in contrast, inflation is not a purely monetary phenomenon, but is often linked with fiscal imbalances and deficiencies in sound internal economic policies (Mortaza, 2006). If we want to see the nature and causes of inflation in Bangladesh on the perspective of economics rather than on the popular and frequently-read newspaper's points of view, there are several researches that have been conducted since independence.
Taslim (1982) with the data from FY60 to FY80 analysed the inflationary process of Bangladesh. He pointed out that any devaluation of the domestic currency is followed by an almost equal proportionate increase in the rate of inflation, while an increase in money supply does not induce an equal proportionate increase in the inflation rate.
Begum (1991) found both the existence of demand-pull factors (import bottlenecks, government expenditures, wage, expected inflation) and cost-push factors (agricultural bottlenecks, rate of interest and credit) as the causes for inflation.
Aktaruzzaman (2005) studied on the period 1973-2002. The paper observes that there is a negative relation between real income and inflation. Besides, the level and the rate of devaluation of exchange rate, growth of money supply and deposit rate are statistically significantly related with inflation.
In financial year from 2001 to 2006, our economy experienced comparatively low average inflation rates compared to that in the '90s. In FY03 to FY06, we got a higher upside trend. In FY06, the rate was 7.16 per cent. We introduced flexible exchange rate from May 2003. So exchange rate may be a strong factor behind the inflation in recent years after initiating the flexible exchange rate regime in Bangladesh.
Mortaza (2006) conducted the most recent observation on inflation generating process in Bangladesh. His key findings were: money supply growth is the important explanatory factor of inflation in our country. The channel may be through the effects of money supply on GDP or on exchange rates. The deposit rate of interest is found to be a weak determinant of inflation.
The findings note the demand-side management for Bangladesh in controlling inflation. Prudent monetary policy on a continuous basis is needed. Besides, many developing countries have experienced inflationary pressure in the initial period of introduction of flexible exchange rate regime. As we entered into this regime in 2003 and are passing the very initial period, we have also to concentrate on stabilising the foreign exchange market to slow down the pressure.
Anti-inflationary measures in the budget:
1. Complete withdrawal of customs duty on some commodities (edible oil, lentils).
2. Distribution of 1.0 million (10 lakh) metric tonnes (MT) of foodgrains through safety net programme.
3. Continuing the duty free imports of essential commodities, including rice, wheat, onion, etc.
4. Establishing four wholesale markets at four corners of the city.
5. Government itself will import 0.8 million (8.0 lakh) MT of foodgrains, in addition to private sector import.
Besides, under the budget for the current fiscal, the safety net is targeted for widening its operation. It will help the poor to be safe from shocks from inflationary pressure.
Will inflation be really kept in wallet?: Recently the policy has been announced for shrinking money supply to curb the inflationary pressure. But there is a huge smoke of doubt about this initiative.
Before getting some satisfactory answer, let us think about what measures are really needed for tackling inflation. According to studies of Taslim (1982), Begum (1991), Aktaruzzaman (2005) and Mortaza (2006), exchange rate, government expenditure, import, wage, expected inflation, agriculture, rate of interest, credit and finally and, most importantly money supply, are the significant factors influencing inflation.
In agriculture, there will be both diesel and fertiliser subsidies, involving a substantial amount of money.
About import, we have noted that the sufficient amount of foodgrains will be imported by the government to help curb inflationary pressure. Also tariff has been withdrawn, in the case of import of some essential goods.
About interest rate, it is to be pointed out that the lending rate increased to 12..71 per cent in May 2007 from 11.01 per cent in June 2004. As the central bank is determined to continue tightening its monetary policy, the interest rate will continue to maintain an upward trend.
Meanwhile, with a flexible exchange rate regime, coupled with export-oriented policy, we can expect that taka will continue to be devalued.
Will inflationary pressure continue, even after the above-mentioned measures?
Some points may be considered here.
1. One of the distinguishing features of the current fiscal's budget is that the government has set a large deficit, which is 5.6% (excluding grants) or 4.82% (including grants) of the GDP. An expansionary budgetary measure with the central bank's tightening monetary policy will create a negative impact on output and employment generation in the private sector. The shortage of output will not help in controlling inflation.
2. Of the total deficit Tk 255.81 billion (25581 crore), some 75.35% of the budget deficit would be financed through domestic borrowing whereas the rest of the amount will be met through external borrowing.
This clearly indicates the dominance of the fiscal authority on monetary authority. But we clearly know that the monetary measures are the most important ones for controlling inflation. The government will pursue the central bank to finance its deficit through creating demand for its bonds. As a result, the central bank will require to create extra money for financing the government budget deficit. In this context, the monetary policy in tackling inflation will be less powerful by the dominance of fiscal policy set out under the budget for the current fiscal.
3. Moreover, the government has to repay a huge principal amount with interest. This will require additional creation of money. Ultimately, we will have more undesired inflation level. The size and magnitude of this additional amount of money will depend on the rate of interest on public borrowings and also on the rate of the growth of the economy. If the rate of the former goes faster than the rate of growth of the GDP, it will soon create more inflationary pressure.
4. What will be the impact of slashing down import duties on essential commodities? Experience suggests that it will be a temporary solution. The price would decrease very marginally. This will tend to be gradually adjusted as the taka continues to depreciate against dollar as well as with increasing domestic cost of production.
So we can conclude at least that the budgetary measures as well as the tightening monetary policy will not be able to control the inflationary pressure. Our poor citizens have to tighten their belt more if they have any!
The writer is in Economics Department, University of Dhaka and can be reached at e-mail: [email protected]