Welcome to Applied Macroeconomic Centre

A theory is appropriate as long as it fits into the fact; when a theory doesn't fit in the fact, it's wise to walk with the fact.

Thursday, February 27, 2014

Concerns on Recent High Inflation

Since FY09, average inflation (Base: 2005-06=100) remains high, at least above the 6.0%. In fact, since July 2008, monthly average inflation never came down to less than 6.0%. During this period, the highest monthly average inflation was 11.8%, observed in November 2011. Within a period of 6 consecutive FY, ranging inflation between 6.0% - 11.8% reflects significant volatility. At the same time, this also reveals, based on Bangladesh’s historical inflation record, a moderately high level of inflation period. In other words, since FY09, inflation remains unstable and high.

Two obvious questions arise when there is a consistently high inflation. One, why has the country been experiencing a high level of inflation for a longer period? Second, what are the costs of experiencing such high level of inflation?

Reasons: Data reveals that until early 2012, it was basically high food prices, which dominated the overall inflation, and started to decline in the latter period. However, prices of non-food commodities started striking when the pressures from food prices eased, which kept the average general inflation well above of 6.0%.

After first global food price shock in 2007-2008, there was second shock in 2011. As Bangladesh is not immune from global food price shock, it had to absorb its share from both shocks by experiencing higher inflation during those periods. Since FY09, the government, on couple of times, increased energy and electricity prices which had a direct and permanent effect on the general price level and consequential indirect effect on the prices of other commodities. Also, the government had to raise the wages of government employees, and set higher minimum wages for industrial workers. Wage adjustment in large sectors like government and industry have direct and upward effect on prices of commodities and wages of other sectors, basically due to speculation factors. Right after the stock market crash in late 2010, there was period when Taka depreciated sharply against the US$, although in the latter period, Taka appreciated again.   

For strange reasons, policymakers used monetary policy instruments to control inflation in Bangladesh. Despite having a pile of excess liquidity in the banking system, policymakers thought that inflation was driven by demand side factors, and still they are thinking in the same line. So they kept interest rate high for long period. Keeping interest rate high had twice effects: one, it helped raise the excess liquidity even more and second, the central bank had to allow domestic investors to take cheap credit from foreign sources. But inflation scenario wasn’t changed much; basically, average inflation has been roaming within a range between 6.0% - 11.8%. Then what’s the success of policies?

Judging policies is largely dependent on the expectation from policy adoption. Do you remember the last time you heard that the current inflation rate is less than 5.0%? One might ask that why an inflation of less than 5.0% is required for Bangladesh. Well, in a country where food commodities still dominate in the total food basket and even major non-food commodities are the basic consumer products, it’s the poor and middle-class who suffer the most from a higher level of inflation. Even when the inflation has been consistently high for a longer period, it is expected that the sufferings have been also lingering. Now if a policy/a set of policies can’t resist the sufferings of the mass, then should we call that as policy failure?

It seems that policymakers are not concerned enough to bring down the level of inflation rate, rather are quite happy for whatever their achievements are. Their recent concerns are to hold future inflation, without thinking to bring down the level of inflation even less. And again they feel to use monetary instruments. But as previously, they will be able to hold inflation volatility only, but not the inflation level. It seems they forgot one simple alternative. When demand management policies are not strong enough to bring down the inflation for easing the sufferings of the mass, then why not the authorities (same or other) try for supply management policies. Probably, policymakers forgot the fact that demand management policy is a short-term instrument to control inflation, but when inflation phenomenon is already a long-term one, they should think for long-term solution.

It’s not easy to formulate supply management policies. Improved governance is the most important factor for a successful supply management policy. A success in supply management policy requires strong commitment, good policy formulation and implementation skills. Above all, it needs committed governance, which is probably the missing area for which authorities had to use demand management policies.  

What policymakers should do? First, policymakers should consider the current period of high inflation as a long-run economic disruption. Second, policymakers should focus more on supply side of the economy to keep inflation at tolerable level in the long-run. They should recall the fact that demand management is effective in the short run, and they can’t use the same instrument for a longer period.  Third, it seems that policymakers are not interested to bring down the inflation at lower levels, say, below 5.0%. They seem more interested to keep the inflation around 7.0% along with a focus on controlling inflation volatility. But somehow they miss a point: it’s not easy to control inflation volatility without controlling the level of inflation. So, policymakers should focus on controlling high inflation, rather inflation volatility.

No comments:

Post a Comment