DHAKA TRIBUNE

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Sunday, February 2, 2014

The real record: Inflation

The economic and development records of the last 25 years. This is the third installment of the series

Mahmud Hossain Opu

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Chart 1: CPI inflation

Jyoti Rahman n

or those coming in late,even thoughinflation has risen under the current government(Chart 1),real GDP per capita has grownby around 4.5% a year under successivegovernments over the past decade. Over the last couple of weeks, I have had a bit of correspondence about inflation.

Source: IMF

The first question posed is: why is inflation a problem if income has risen fast enough to compensate for it? Recall, real GDP per capita that is, income after inflation is accounted for has been growing by4.5% a year. So, the question, what difference does it make if inflation is 5% or 10%? A simple answer is, inflation is a problem because people think its a problem. That might sound like a flippant answer, but its not. Inflation matters because it affects peoples decisions about the future. If inflation was steady at some rate, say 7%, and people knew that it was going to be

it steady. Thats why economists counsel low and steady inflation. And while there are many issues where the economists prescriptions can seem at odds with popular perception, or even common sense, when it comes to inflation, economic theory and the common sense are on the same side. There is another reason why high and unsteady inflation matters, even when real GDP growth remains steady. Whileeconomic growth can come about for many reasons, some (many) of which not having anything to do with government policies or actions, persistently high and unsteady inflation is almost always because of failures in economic policy making. Persistently high and unsteady inflation also puts the economy at risk of economic crises, with all the human costs such crises entail. Thats why, when comparing economic records of various governments, inflation is perhaps a more appropriate metric than economic growth. Note the qualifiers persistently high and unsteady and almost always its possible that sometimes a spike in inflation is beyond the control of any government. This leads to the second question I have been asked:how much of the recent inflation is because of global food prices? As Chart 2 shows, global food prices rose sharply in 2007-08, declined a bit in 2009, and then rose again in 2010. The 2007-08 global food price rises came as a surprise to most policymakers around the world, including Bangladesh. The causes of that rise wereprimarily global, as was the decline in 2009. That years fall in global food prices was a result of the Global Financial Crisis. As that crisis ended, it was predictable that food price would gradually return to pre-crisis levels. And thats what happened. Can the Bangladeshi policymakers be excused for not being prepared?

University professor and one of the best commentators on Bangladesh economy: Economic management is widely believed to be the weakest link of the government. However, the ineptness with which the electricity issue has been handled is simply mind-boggling. The government seemed to have embarked on the rental plant road without a clear idea about its finances, logistics and consequences. For example, the government now claims that the blowout in subsidy is due to unforeseen increases in the prices of petroleum products and not due to policy lapses. It seems absurd that the government could have planned (in 2009, say) on the basis of current prices, which were clearly very low in the aftermath of the most severe worldwide recession since the Great Depression (as the crude oil price chart shows). Even a cursory glance at the graph of the monthly crude oil price would have revealed that except for an abnormal period of about 18 months in 2008 and 2009, there was a clear upward trend since the beginning of the millennium. Interestingly, if one drew a trend line with the price data

Chart 4: Growth in private sector credit and money supply

Source: CEIC Asia and with full encouragement of the industry and finance ministers, Bangladesh Bank pursued an expansionary monetary policy in the first half of this governments term (Chart 4). Credit to private sector grew sharply in 2010-11. The thinking was that Bangladesh needed more private sector investment if economic growth cause inflation, but the Banks own policies contributed to it also. There is another way the Banks policy inactions contributed to inflation. As Ive said many times before,the taka-rupee exchange rate is a key determinant of rice pricesin Bangladesh. Bangladesh Bank and the government should have anticipatedthat as the Taka depreciated against the Rupee, rice prices would rebound in 2010. The policymakers proved to be oblivious about it. As it happened, inflation has subsided in the past year and a half even as the economy has continued to grow at a robust pace. This answers another question I have been asked does high inflation necessarily accompany fast growth? No, it doesnt. So, why has inflation subsided? Because, under the conditionalities of the$1bn IMF loan, the government has reigned in expenditure, and the Bangladesh Bank has curbed credit and money supply growth. The IMF prescriptions have tamed inflation, at least to some extent. One hears a lot about the spirit of independence these days. It seems to me that at least as far inflation under this government is concerned, our pro-independence policymakers proved to be pretty incompetent, and the IMF-dependent policies actually worked. So much for independence then. Jyoti Rahman is a political blogger. The previous part of the series was published on November 27, 2013.

World crude oil production and oil price

Not only did the Bangladesh Banks acquiescence to the governments faulty fiscal projections cause inflation, but the Banks own policies contributed to it also

Chart 2: FAO food and cereal price indices

steady at 7%, that would not be a problem. Whether its a firm deciding on a new investment, or workers negotiating payrise, or families deciding how much to save for childrens education if people knew that inflation would be 7% (or any other rate), they would make their decisions accordingly. The problem is, the higher the inflation is, the harder it is to keep

The 2010 rise in global food prices should have been anticipated by the government. Global oil prices too showed the same pattern, which should have also been anticipated when the government set theplans for the rental power plants. Evidently, this is clearly not something the government did. Let me quoteMA Taslim, a Dhaka

of 2002 to 2007 and then extended it up to 2012 to get the forecast value, he would have arrived at a number that is very close to the actual price. Hence, the future price increases should have been anticipated and hedged against. The governments electricity record is something Ill leave for another time. For now, lets accept that electricity is important, and put aside the question of whethersubsidies are appropriate. The relevant issue for us is, how the fiscal blowout caused by the mistaken fuel price assumption and the subsidies were paid for. In late 2011, when the full fiscal cost of the rental power plants was becoming apparent, thegovernment resorted to borrowing, includingfrom the Bangladesh Bank (Chart 3) that is, printing money. This directly pushed inflation up, and put Bangladeshat risk of a crisis. When a central bank ends up printing money to pay for ill-conceived government programmes, it means trouble. When Mr Atiur Rahman was appointed the Bangladesh Bank governor, I was one of the very few people who raised the risks of it through my blog. Its a callI would like to have gotten wrong. Under Mr Rahmans stewardship,

was to rise to 8% (from 6% pace we have had for a decade now). Right diagnosis. Wrong prescription. Private investment has been held back byinfrastructure bottlenecks and poor governance. Unless these issues are tackled, pumping credit and money into the economy would only push up prices of goods, as well as assets. That means, not only did the Bangladesh Banks acquiescence to the governments faulty fiscal projections

Chart 3: Growth in public sector credit

Source: CEIC Asia