Headquarters of Bangladesh Bank in Dhaka —FE File Photo After years of fiscal profligacy, monetary policy came to the forefront as the saviour of the economy in a large swath of the world. From the financial crisis of 2008 to the Covid pandemic, loose fiscal policy was found to be the easy way out of the recessionary prospect that loomed in many countries' economic horizon. With most advanced countries experiencing anaemic growth, recovering from 2007 financial crisis, their central banks were forced to move from conventional monetary policy -- reducing policy rates (open market purchase of short term government bonds ) -- to a range of unconventional policies that included purchase of long term government bonds (quantitative easing), credit easing (CE) etc.. The outcome of this spendthrift period was ballooning inflation in developed, emerging and developing countries, all alike. For the first time in three decades inflation, fuelled by unconventional monetary policy, hovered around double digit, making cost of living unbearable for many with fixed incomes. As tight monetary policy was pressed into service to rein in runaway inflation in the wake of economic recovery in the developed countries the consumer price index gradually began to climb down.
Monetary policy has been found effective in both situations of robust growth and economic slowdowns, though Keynesians would like to give exclusive role to fiscal policy in respect of the latter. Though, historically, economic upturns have been associated with low unemployment and creeping inflation, encapsulated by Philip's Curve, central banks have not always been correct in making forecasts about its trajectory. In a review of recent inflation in America and Europe, Ben Barnanke, the former chairman of Federal Reserve Bank of America (Fed), remarked:'....the surge in inflation that began in mid-2021 was largely, though not entirely, unanticipated by central banks.' The IMF's decomposition of recent inflation in the United States (US), Eurozone and the United Kingdom (UK) in the latest World Economic Outlook (2023) gives further support to this view.
In a recent speech at the International Monetary Fund (IMF), Christian Lagarde, the chairman of European Central Bank (ECB), said: 'A century ago central bankers learnt the hard way that pegging the currency to gold and fixed exchange rates was not robust in times of profound structural change. Today, the central banks' tools for preserving price stability have proved effective'. She pointed to the quick fall in inflation once central banks started to raise policy rates in 2022. Consumer prices had shot up following a surge in post-pandemic demand, global supply chain disruptions and big rise in energy prices after war broke out in Ukraine. Inflation rose to 7 per cent in US, 12 per cent in the UK and 10.6 per cent in eurozone countries by the last quarter of 2022. In Bangladesh, inflation rose from 6.5 per cent in 2022 to 9.5 in 2023, shooting to 11. 50 per cent in the last quarter of fiscal FY24.
To contain inflation, the Fed made aggressive use of policy rate, raising it to 4.75 per cent from zero over a period of a year and a half. After increasing the rate steadily at quarter percentage points in almost every quarter, the Fed cut policy rate at half (0.5) percentage point in September this year. The drastic rate cut followed the decline of inflation from 7 per cent in 2022 to 2.5 per cent last August in America.
By comparison with the US, the rurozone is in a far more economically weak state, with GDP expanding by just 0.2 per cent (3 per cent in US) in the second quarter of 2024. But as a result of tight monetary policy, eurozone inflation has fallen from 10.6 per cent in 2022 to 2.20 per cent in September this year, over a period of 18 months. As in America, the decrease in the rate of inflation has been a 'soft landing' (a goldilock situation), with low inflation conflated with low level of unemployment. According to analysts, the fact that ECB could raise interest rates by an unprecedented 450 basis points in 18 months without a hard landing (recession) shows the strength of monetary policy in addressing crisis of a heated economy.
In the UK, the Bank of England (BOE) has eased monetary policy more cautiously. It made a single quarter-point reduction last August, after a year of no change. It took a tentative step towards forecasts for future cuts, signalling that gradual reductions in policy rates will depend on whether there are unexpected shocks to the economy.
As central banks contemplate how far rates will fall, key question confronting them is where the so called 'neutral' level of interest rate lies -- a theoretical rate that is not onerous (deflationary) for the economy, but does not stimulate it either with inflationary pressure. Fed officials had long estimated the neutral rate to be 2.5 per cent or lower. Policymakers now argue that neutral rate has risen in the face of a range of factors including higher debt burden and supply chain disruptions.
Meanwhile, top central bankers in America and Europe have moved closer to declaring victory over the biggest inflation surge for a generation.
In Japan, the world's third largest economy, monetary policy has been used for a different purpose since 2007 viz to fight deflation. The Bank of Japan (BoJ) turned to negative interest rates in 2016 as it tried to encourage banks to lend more in order to generate consumer spending. Negative rates helped stave off deflationary threats, but increased costs for the banks and allowed near bankrupt companies to survive. The BoJ ended an era of negative interest rates in March this year, raising borrowing costs for the first time since 2007 in a historic shift as the country put decades of deflation behind. The policy shift by BoJ is likely over time to trigger shifts in global investment flows and signals broader change in Japanese economy.
In the second largest global economy, Chain's leaders have changed their stance on monetary policy to 'moderately loose' from 'prudent' for the first time in 14 years, sending stocks and bond prices higher as investors bet policymakers were taking monetary policy more seriously. China, last adopted a 'moderately loose' monetary stance in late 2008 after the global financial crisis and ended it in late 2010. The Chinese economy has been dogged by deflationary pressures for months on the back of a property slump, prompting the government to announce a monetary stimulus in September last, mainly targeting local government debt.
BANGLADESH CASE: After years of freewheeling accommodative monetary policy (euphemism for loose money) regime, the Bangladesh Bank (BB) sought to contain inflation with a contractionary monetary policy. With headline inflation moving stubbornly northward across double digit number, BB has tried to implement a number of monetary policy initiatives. It raised policy rate by 350 basis points since May, 2022, including a 200 basis point increase in the second half of FY24. After the interim government took over in August this year the new BB governor disclosed the desperate remedy for the desperate situation to combat the current inflation above 10 per cent. He promised to double down on policy rate by hike twice in quick succession. This policy statement was carried out in August 25 when the policy rate was raised by 50 basis points to 9.0 per cent. The new governor expressed his optimism about bringing down the inflationary pressure in a few months. But the regulatory somersault over a moratorium on printed money to rescue sick banks appeared to compromised the avowed policy towards contractionary monetary policy. The BB pumped liquidity support to six struggling banks amounting to Tk 225 billion in the last week of November. To stem the tide of inflation, the BB has announced a policy to mop up new money injected by printing through issuing various types of BB bills. The response of the money market to BB's liquidity support to the sick banks has been positive as the inter-bank call money rate has eased bringing it to 9.96 per cent compared to 10.10 per cent recorded before the bailout announcement. On the other hand, austerity in public spending by the new government aimed at pegging bank borrowing target within Tk 850 billion from previously projected Tk 1.37 trillion is expected to help curtail broad money supply in the market.
As in the developed countries in recent months, the goal of monetary policy pursued by Bangladesh Bank is to bring back inflation to the targeted level (5.5 per cent for Bangladesh). In the past the BB obliged the government by making money available even through printing money, exacerbating the inflationary situation. Now the central bank has embarked seriously on a campaign to combat double digit inflation with its contractionary monetary policy. The future course of the economy depends on the success of this policy.
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