Don't expect prices to go down soon
It is crucial to maintain tight monetary and fiscal policies for some time to bring down inflation, says an IMF working paper
As the food inflation hit 12-year high last month, standing at 12.54%, the government abruptly moved last week to intervene in the market by capping the prices of egg, potato and onion, but the efforts fell flat offering consumers no relief from the exorbitant prices of those essentials.
The sudden jump in food inflation also made the policymakers worried about keeping the inflation under the target set for the current fiscal year at an average 6%.
The first month of the current fiscal year saw a slight fall in inflation, which has been hovering over 9% since last March. The inflation may increase further in the coming months as the election approaches amid a political crisis.
The continuing high level of inflation frustrated the government's set target of an average 7.5% last fiscal year.
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Inflation remains stubbornly high in the absence of a tight monetary policy, which has worked in other countries to tame inflation. A dollar crisis aggravated the situation as importers could not take the benefit of the price fall of some commodities in the global market. Inflation rates are volatile, due to the large share of food and imported products in the consumption basket.
Are the steps taken so far – monetary or fiscal – enough to keep prices in check?
The answer is a clear "no" for Bangladesh. Economists and analysts have repeatedly pointed out that monetary policy measures, as reflected in applying policy rate and exchange rate, did not work in taming inflation. Import curbs imposed by the central bank in terms of restricting opening of import letters of credit helped cut import bills significantly and ease pressure on foreign exchange reserves to some extent. But steep depreciation of taka and exchange rate distortions have made imported essential items pricier by at least 25% in the local market.
As a result, food inflation in Bangladesh hit a 12-year high in August when the global food market recorded a two-year low. Annualised average inflation crossed 9% in the last fiscal year ending in June and the government projects to bring it down to the pre-pandemic level of 5.4% in the next three years – a target that looks not an easy-go one if the findings of a recent IMF working paper are taken into account.
The paper, One Hundred Inflation Shocks: Seven Stylized Facts, released on 15 September, says some countries could bring inflation down to a reasonable level in three to five years through persistent policy of monetary tightening for a longer period and keeping currency depreciation at low – the two steps where Bangladesh has not fared well so far.
The IMF paper, authored by Anil Ari, Carlos Mulas-Granados, Victor Mylonas, Lev Ratnovski, and Wei Zhao, researched over 100 inflation shock episodes in 56 countries since the 1970s, including those linked to oil crises and financial crises.
"We document that only in 60 percent of the episodes was inflation brought back down (or "resolved") within 5 years, and that even in these "successful" cases resolving inflation took, on average, over 3 years," it reads.
Tighter monetary policy controls inflation
In some cases, inflation roared back after initial declines because of early easing of monetary tightening, it says, warning how "premature celebrations" of initial gains in inflation control backfired and led it to "plateau at an elevated level or re-accelerate."
"Сountries that resolved inflation had tighter monetary policy that was maintained more consistently over time, lower nominal wage growth, and less currency depreciation, compared to unresolved cases," says the IMF paper.
Based on the research findings, it concludes, today's economies may be in for a long inflation fighting period.
"It is crucial to maintain tight monetary and fiscal policies for some time. Policymakers should avoid loosening policy settings in response to emerging softer inflation readings," it says.
Dispelling the general perceptions that monetary tightening comes with growth slowdown and unemployment, the IMF research paper points out out-put losses were short-term in countries where inflation control measures succeeded.
BB maintained lending cap of 9%
While global central banks followed the US Fed in hiking their key policy rates as part of their inflation fighting steps, Bangladesh Bank maintained its lending cap at 9% until July, when it introduced a reference rate formula for bank loans and decided to adopt a unified and market-driven single exchange rate regime.
The central bank announced its new monetary policy in June with a goal to tighten money flow to the private sector as part of its steps to lower inflation to 6%. Bangladesh Bank Governor Abdur Rouf Talukder then noted that import restrictions did not help much due to the rate cap that kept loans cheaper and market-driven lending rates will make money expensive and help to check inflation.
But this did not happen. Though the inflation slightly eased in July, it surged again in the next month, proving the IMF paper's suggestion that ad hoc measures yielded short-lived relief in the past.
Countries seemed to have taken lessons from the past episodes of inflation shocks and shielded their people from prolonged hardships caused by inadequate policy responses.
France, Spain and Canada were among the economies which suffered from prolonged inflation as they loosened monetary policy after initial declines in inflation in the 1970s. Their growth slowed and unemployment peaked. Spain was one of the most extreme examples of how a large inflation spike coincided with looser policy paths. Inflation in Spain increased almost 20 percentage points between 1968 and 1978, while real interest rates declined by about 10 percentage points.
But these three economies have better managed inflation this time. Spain brought down inflation to 2.6% in August from over 10% in July last year, while inflation dropped to 4.8% in France in August from over 6% and to 3.3% in July from over 8% in Canada from a year-ago period.
Japan used "tighter-for-longer" policy
Japan stands out as one of the countries that successfully fought past inflation shocks by a "tighter-for-longer" policy mix. When Japan was hit by the second oil-shock, inflation doubled to 8% in 1980. Both monetary and fiscal policies responded with immediate tightening. As an immediate impact, GDP growth declined to 3 percent, but gradually picked up over the following years, while the unemployment rate remained stable.
Past experience has kept Japan better-placed this time as well, with inflation well under control at 3.3% in July, down from January peak of 4.4%.
As the world is fighting its worst inflation shocks in decades, countries' policy responses to inflation shocks varied: Some countries tightened policies, while others kept them looser; some remained committed to those tightening paths, while others loosened prematurely, likely anticipating that the inflation shock was already under control, the IMF research paper states. "Our case studies provide insights on the factors leading to differing policy paths, and their consequences," it states, leaving it to countries to decide how they will respond to similar or worse inflation shocks.
Some countries took lessons from their past experiences and handled the crisis better.
Is there any lesson for Bangladesh to learn here?
One thing the paper makes clear: taming inflation will take a longer period this time as well and loosening monetary policy sooner than required might risk further acceleration of inflation.
Monetary policy tightening does not necessarily mean a big loss in employment, production and workers' income, it reveals.
Bangladesh's monetary and fiscal policymakers may find some tips here while pursuing their inflation control measures.
The monetary policy stances so far taken could bring down inflation by 1 percentage point or so in a year from now. For a faster decline, Bangladesh needs to apply fiscal policies like slashing tariffs to give some instant relief for consumers, economist Dr Zaidi Sattar told The Business Standard last week.
Another IMF analysis in August shows how changes in the central bank's interest rate impact inflation. It finds an increase in the policy rate by 1 percentage point results in a decrease in the rate of inflation by 0.5 percentage point in the first year. And a 1 percentage point exchange rate appreciation results in a 0.3 percentage point decrease in inflation in the first year.
Persistent pressure
But some Central Asian countries are still facing persistent inflationary pressure despite raising interest rates by their central banks, the analysis says, identifying several structural factors that hamper effectiveness of monetary policy and limit the impact of interest rate changes on the economy.
To overcome such bottlenecks, it recommends some policy priorities – expanding central banks' operational independence, increasing exchange rate flexibility to cushion external shocks and help focus monetary policy on domestic needs, and enhancing central bank credibility by strengthening communication and transparency.
The success of Bangladesh's monetary policy will also depend on how all or some of these priorities are taken care of.
