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7/28/2019 Price Inflation in Bangladesh
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Introduction:
In mainstream economics, the word inflation refers to a general rise in prices measured
against a standard level of purchasing power. Previously the term was used to refer to an
increase in the money supply, which is now referred to as expansionary monetary policy
or monetary inflation. Inflation is measured by comparing two sets of goods at two points
in time, and computing the increase in cost not reflected by an increase in quality. There
are, therefore, many measures of inflation depending on the specific circumstances.
The most well known are the CPI which measures consumer prices, and the GDP
deflator, which measures inflation in the whole of the domestic economy. The prevailing
view in mainstream economics is that inflation is caused by the interaction of the supply
of money with output and interest rates. Mainstream economist views can be broadly
divided into two camps: the "monetarists" who believe that monetary effects dominate all
others in setting the rate of inflation, and the "Keynesians" who believe that the
interaction of money, interest and output dominate over other effects. Other theories,
such as those of the Austrian school of economics, believe that an inflation of overall
prices is a result from an increase in the supply of money by central banking authorities.
Till now, no concerted strategy has been adopted in Bangladesh in view of the ongoing
global economic crisis. This owes partly to the fact that the (negative) impacts are yet
be visible in the economy. Performance of Bangladesh in such areas as export,
remittance, share market, and aid has been along historical trends during the July-
December 2008 period. However, some of the early disquieting developments are
starting to emerge in some sectors (banking and finance, import duties). Government of
Bangladesh has set up a technical committee and The Central Bank (Bangladesh Bank) as
taken some precautionary measures through its monetary policy and has set up taskForce to review and monitor the situation.
In the following sections, under some broad headings, a number of initiatives
which concern the relevant areas, have been highlighted. However, as was pointed out
earlier, any of these initiatives that were taken in the recent past were not directly
related to e causes or consequences of the global financial crisis, and are in many
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instances, coincidental. Nevertheless, some of the very recent initiatives
(encouraging higher remittance, banking sector practices, reserve management)
appear to be inferred by concerns about possible impacts and consequences.
What is Inflation?
Inflation is the rise in general level of prices of goods and services. It can be said in other
ways that inflation is the decrease in value of money. It means that
each dollar can purchase fewer amounts of goods and service then previous.
It reduces the purchasing power of the currency.
Inflation does not mean that all prices are increasing, even during period of rapid
inflation; some prices may be relatively constant while others are falling.
The troublesome aspect of inflation is that prices rise unevenly, some raises sharply,
some slowly and some dont rise at all.
The main measure of inflation is the consumer price index.
Inflation in Bangladesh:
As we know Bangladesh is a country of middle income. Nearly 65% of total population
income is less than $1. Bangladesh is primarily an agrarian economy. 66% of in
Bangladesh people are work in agriculture sector. Nowadays price hike is one of the main
concerns of Bangladeshi people. Though their income is not increase as much as need but
their expenses are increases day by day. As a result people consume more than theirincome. And poor people are getting poorer day by day. Government has taken some
short-term policies but those are not paying off.
In this report we try to understand that why price hike in Bangladesh, what is the reason
behind it an, what consequent are arises among Bangladesh people for these
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unsustainable price hike in consumption goods and what are the initiative measures
government can take to at least make the price level sustainable.
Inflation rate Rural Urban
Food 8.79 9.44
Non-food 7.83 6.09
Background:
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Bangladesh suffered from inflationary pressures starting in 2007 due primarily to
domestic supply shocks originating from two rounds of flood and the destructions
caused by the cyclone Sidr. If we compare the inflation chart with that of commodity
prices, it is clear that the first round of inflationary pressure in Bangladesh starting in
2007 was not linked with global commodity price developments. In the period
immediately preceding the global commodity price shock, inflation in both India and
China were moderate despite some inflationary undercurrents originating from
strong domestic demand.
Commodity prices started its surge in early 2008 and the global index for commodity
prices reached its peak in July 2008, coinciding with the inflation rates recording
their peaks in Bangladesh, India and China. Thereafter, as the commodity prices
declined by 53 per cent during the July-January period, inflationary pressures also
receded rapidly in all economies across the globe. In India the inflation rate declined
from its peak of more than 12 per cent to 4.39 per cent by January 2009 and
thereafter further to 2.43 per cent by end-February. In China, the inflation rate
dropped to the negative territory -1.6 per cent and is likely to remain negative in the
near term. In contrast, although inflation in Bangladesh declined initially (during
August-October 2008), it stabilized at more than 6.0 per cent level during November-
January.
Can the differences in traditional macroeconomic indicators like monetary and credit
expansion or the stance of fiscal policy explain the difference in inflationary
behavior? A cursory review of the usual culprits however cannot help explain this
relatively lesser decline in Bangladesh inflation. Monetary and credit expansions in
India [and China] were quite similar to the rate of expansion in Bangladesh. Fiscal
policy in these economies was also no less expansionary than Bangladesh. In
particular, in the aftermath of the ongoing global recession both India and China
rapidly moved to an easy money policy. Fiscal policy also became much more
expansionary with the acceleration of investment programmes and adoption of fiscal
stimulus packages in both countries.
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What could then explain this higher inflation in Bangladesh? Since inflation in many
instances is a barometer for domestic demand pressures, one plausible reason for
Bangladesh's differential inflation performance could be that its economy has so far
been impacted marginally by the global meltdown, in comparison to China and India.
Economic recessions or depressions are usually accompanied by softening of
inflation or price deflation (negative inflation), and a strong economic environment
generally puts upward pressures on the price level. Thus, a significant weakening of
domestic demand or foreign demand for domestic products, reflected through exports
and imports data, would be good indicators for a weakening of domestic economic
activity leading to lower inflation and in some cases even a decline in the price level,
as happened in China.
China with its highest export dependence has suffered the most. Exports have fallen
by more than 25 per cent in January and February 2009. India with similar exposure
to the export market as Bangladesh also recorded a significant fall in export receipts
(15.9 per cent in January). In comparison, while exports certainly slowed down in
Bangladesh, export receipts still recorded modest growth in dollar terms (11.4 per
cent).
Bangladesh's import demand has been much more robust than in India and China. As
the fastest growing economy in the world, China traditionally recorded the highest
rate of import growth and 2008 was no exception until the beginning of the global
meltdown. Since [December] 2008, China's imports in dollar terms nosedived to the
extent that in January 2009 import payments declined by more than 43 per cent over
the corresponding month of the previous year. In India, the corresponding decline in
January was 18.2 per cent, while imports remained steady in Bangladesh in dollar
terms. After adjusting for the drop in commodity prices, imports in volume terms
should have increased at a double-digit rate.
The combined effect of all these various economic indicators have been reflected in
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the markedly slower overall growth performance of India and China. Real GDP
growth rates of China and India in 2009 are projected by the IMF to be almost half of
what both of these economies recorded in 2007. In contrast, Bangladesh's growth
outlook remains fairly robust, down by only half a percentage point to 5.6 per cent in
2009.
Faces of Inflations/ Types of Inflations:
The most burning issue, at this time, in Bangladesh is the price inflation, it is too tough
and really hard to find any sector that is free from the impact of the inflation or find any
one who does not face the faces of inflation.
In the very recent, the prices of most things Bangladeshis buy more than doubled. Such a
general increase in prices is called inflation. Prices of selected goods may increase for
reasons unrelated to inflation: the price of rice may rise because unseasonably heavy
rainfall in the country that ruined the rice or the price of gasoline may rise if the oil-
producing countries set a higher price for oil. During inflation, however, all prices tend to
rise. Over the last 400 years there have been many periods of inflation. . Inflation hasbeen defined as "too much money chasing too few goods." As prices rise, wages and
salaries also have a tendency to rise. More money in people's pockets causes prices to rise
still higher so that consumers never quite catch up. Inflation can go on continuously year
after year so long as the money supply continues to increase. Continued inflation affects
people in diverse ways. Those who live on fixed incomes, or those whose incomes
increase very slowly, suffer most from inflation because they are able to buy less and
less. Those who lend money when prices are lower may be paid back in taka of reduced
purchasing power. Banks and savings and loan associations generally lose from inflation.
People who borrow money, however, may profit by paying their debts in taka that have
shrunk in purchasing power. Inflation thus encourages borrowing and discourages saving.
It also leads people to buy real estate and durable goods that will keep their value over
time. In Bangladesh this tendency is reinforced by the tax system, which allows taxpayers
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to deduct property taxes and interest payments from their taxable incomes. If inflation
continues for a long time, the country as a whole may begin to consume more and invest
less as people find it more profitable to borrow than to save. In other words inflation
causes society to use more of its resources for today's purposes and to set aside less for
tomorrow's needs
Rising rate of inflation has become a serious concern in Bangladesh in recent years. The
impact of rising inflation rate is being felt almost everywhere. The prices of essential
commodities have gone up, and so is the cost of living. Countrys vast multitude of poor
and unemployed people is having a difficult time to survive.
To talk about inflation and its effects on our every day life in Bangladeshis and to combat
it or cope with the present situation, we first in a very need of look at the faces of
inflation; Let us define what inflations are and what their faces are?
This Inflation is divided into two types-:
Price Inflation
Monetary Inflation
The first type (about prices) is when there is a rise in the general level of prices of goods
and services over a period of time, and
The second type (monetary) is when there is a rise in the quantity of money in an
economy.
Both types are in many times interrelated, and both have negative effects on the economy
and individuals. We will focus mainly on the price inflation.
Price Inflation The term inflation generally refers to a rise in the general level of prices
of goods and services in an economy over a period of time. If the price level increases,
one unit of currency can purchase fewer amount of goods and services. In order words, it
reduces purchasing power of money, the unit of
account of an economy
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Price inflation can also be seen in a slightly different form, where the price of a good is
the same year over year, but the amount of the good received gradually decreases. For
example, you may notice this in low-cost snack foods such as potato chips and chocolate
bars, where the weight of the product gradually decreases while the price remains the
same
There are four main types of inflation. The various types of inflation are briefed below-
1. Demand pull Inflation
2. Cost-push Inflation
3. Pricing Power Inflation
4. Sectoral Inflation
5. Fiscal Inflation
6. Hyperinflation
Demand-pull Inflation: Demand-pull or excess demand inflation is also called as
Wage inflation. This type of inflation occurs when total demand for goods and services in
an economy exceeds the supply of the same. When the supply is less, the prices of these
goods and services would rise, leading to a situation called as demand-pull inflation.
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The demand-pull inflation stems from a situation when aggregate demand surpasses
aggregate supply of the economy. When the income of the consumers increases due to
increased investment, government expenditure and exports, it leads to rightward shift of
the aggregate demand curve from D0 to D1. In response, aggregate supply (S) cannot
expand immediately. In the initial price level, it creases an excess demand pressure (y1
y0) at initial price levelP0, and prices begin to go up. This causes real income, investment
and real net exports to decrease, which ultimately lead to reduce in output to y1 with a
new price level P1 (Figure 3.1). The price increase generated by an upward shift in the
economys aggregate demand is referred to be demand-pull inflation.
This type of inflation affects the market economy adversely during the wartime.
Cost-push Inflation: As the name suggests, if there is increase in the cost ofproduction of goods and services, there is likely to be a forceful increase in the prices of
finished goods and services. For instance, a rise in the wages of laborers would raise the
unit costs of production and this would lead to rise in prices for the related end product.
This type of inflation may or may not occur in conjunction with demand-pull inflation.
cost-push inflation, which has its impetus on the supply side of the economy, results from
an upward or inward shift of the aggregate supply. The exogenous upward shift of the
aggregate supply curve from S0 to S1 due to demand for higher wage, higher price of raw
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material and fuel, etc. creates excess demand pressure (y1y0) at initial price P0, thereby
increasing price level but reducing equilibrium output level along the aggregate demand
curve.
Two measures are mainly used to indicate the changes in price level or inflation:
consumer price index (CPI) and GDP deflator.6 However, the former is the most widely
used method of estimating inflationary pressure where general, food and non-food
Pricing Power Inflation: Pricing power inflation is more often called as administered
price inflation. This type of inflation occurs when the business houses and industries
decide to increase the price of their respective goods and services to increase their profit
margins. A point noteworthy is pricing power inflation does not occur at the time of
financial crises and economic depression, or when there is a downturn in the economy.
This type of inflation is also called as oligopolistic inflation because oligopolies have the
power of pricing their goods and services.
Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes
place when there is an increase in the price of the goods and services produced by a
certain sector of industries. For instance, an increase in the cost of crude oil would
directly affect all the other sectors, which are directly related to the oil industry. Thus, the
ever-increasing price of fuel has become an important issue related to the economy all
over the world. Take the example of aviation industry. When the price of oil increases,
the ticket fares would also go up.
Some other type of Inflation is explained below:
Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This
occurs when there is a deficit budget.
Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation.
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This type of inflation occurs during or soon after a war.
Causes of Inflation:
Bangladesh has no specific reason of inflation at present. Inflation is increasing more and
more for several reasons. But all reasons are not equally important. Some reasons
influence more and some reasons influence less. It is obvious that inflation rate in the
recent period increased due to price hike of food items in both domestic and international
markets. Inflation in Bangladesh also surged due to increase in the prices of petroleum
products and natural gas by the government.
The reasons of inflation are:
1) Decreasing the price of money
2) Raising price in world market
3) Raising price of fuel
4) Lower growth in agricultural sector
5) Import cost
6) Supply Shortage
7) Market Syndication
8) Increase in wage rate
9) Exchange rate
10) Taking initiative against corruption
1) Decreasing the price of money:
The relative strength of Bangladesh currency in relation to those of other countries,
particularly which of neighboring India, is considered an issue of consequence for
analyzing the price inflation situation. The Bangladeshi taka has depreciated to some
extent against its intervention currency, US dollar over the past several years. But the
Indian rupee has depreciated higher than that. As a result, the relative position of the
Bangladesh currency has suffered, having its impact on the economy because India is
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Bangladesh's major source of import, through both formal and informal channels. Imports
from India in recent years constitute more than 20 per cent of Bangladesh's total imports.
If the import cost for Bangladesh is affected by the cross-currency exchange rates, this
affects the prices. Any movement of prices in the upward direction indicates depreciation
of taka relative to the currency in question after adjusting for inflation.
2) Raising price in world market:
One of the causes of inflation relates to food prices in the international market.
Bangladesh being a food importing country, any rise in food prices in the world market
can push up the domestic prices of those commodities. In the not too distant past the
prices of essential commodities like rice, wheat and edible oil increased significantly in
the international markets. So, domestic prices of those items also went up.
3) Raising price of fuel:
The net impact of recent fuel price is unlikely to be significant but it would have effect
on poor people, whose livelihood depends on the use of kerosene and diesel. In order to
catch up with the cost of imported oil, domestic prices have gone up immediately. Higher
price, to some extent, is not domestically induced. Rather it is attributed to an increase in
international prices, particularly of several food items as well as items steel and oil. If we
look at the international price of the oil then we see that oil price has risen significantly,
which affects almost every sector such as industry, agriculture, transportation and is
increasing the cost of production.
4) Lower growth in agricultural sector:
Bangladesh is regularly hit by natural calamities like flood and cyclone, and these
hamper the agricultural production very much. And also mismanagement in fertilizerdistribution, insufficient electricity supply hampers production. Also lack of knowledge
in using and adapting to modern technologies and ideas in the agricultural sector limit
the chance of rapid improvement.
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5) Import cost:
Typically import occupies a significant place in the Bangladesh economy, most of the
essential food items (for example, sugar, rice, wheat, onion etc) and, more generally,
machineries, intermediate goods and raw materials used in production are imported. Cost
of imports can, therefore, be expected to have a substantial influence on domestic
inflation directly (through final goods) or indirectly (through intermediate goods).
According to available statistics, import price index (MPI) of Bangladesh has
continuously soared over time. Import is increasing gradually day-by-day and sudden
hike international price or decrease in real interest raise the price of the goods.
Bangladesh Bank (BB) has projected continuous inflation in the domestic economy due
to constant external pressure on prices and demand side.
6) Supply Shortage:
Production in agriculture and fisheries sectors in Bangladesh is still subject to the
whims of nature to a notable extent. It has been claimed that one of the main causes of
the high inflation rate is the supply shortage of the agricultural and industrial goods.
7) Market Syndication:
Unfair cartel among the suppliers might seriously hamper the course of the economy by
engendering inflation via the creation of a false supply shortage even during a period of
robust growth in production. Such undesirable events have taken place in recent years as
food inflation remained high in the same time period despite the notable growth in food
production. Monopolistic control of several food items such as sugar, onion, pulses and
edible oil by market syndication seems to have led to this situation. Obviously such
manipulation is a type of supply side disturbance.
8) Increase in wage rate:
The role of inflationary expectations is also important in explaining inflationary process
in a given period. If workers expect a rise in the inflation rate, they will demand higher
nominal wage to keep their real wage stable. Once people come to expect high rates of
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inflation, the expectation alone will generate further inflation without any change in the
existing labor market conditions. In general, if there is a lack of confidence in monetary
policy, inflationary expectations are likely to be self-fulfilling.
9) Exchange Rate:
Exchange rate exerts inflationary pressure mainly via import prices. Historically,
exchange rate in Bangladesh exhibited steady increase over time. Exchange rate generally
increases the import cost and that cause inflation.
10) Taking initiative against corruption:
Taking initiative action against corruption and corrupted businessmen by the government
put fear among the businessmen. So most of themselves take away themselves from
normal business flow or import and this occur shortage in goods and create inflation.
Impact of price inflation in Bangladesh:
The effects of monetary inflation are three-fold;
First, it brings about an unwarranted transfer of purchasing power (resources) to the
creator of the new money and/or the first user of the new money. Another name for this
unwarranted transfer is theft.
Second, it has a NON-UNIFORM effect on prices, leading to mal-investment and the
wastage of resources. The huge amount of savings and resources squandered in real-
estate investments over the past several years exemplifies the havoc that can result from
monetary inflation and why its effects cannot simply be counteracted at some later time
by "withdrawing liquidity".
Third, it EVENTUALLY results in a broad-based increase in the prices of everyday
goods and services.
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Almost everyone focuses on the third of these effects, but the greatest injustices and
economic problems result from the first two. The "Keynesians" and the "Monetarists", for
instance, are generally unaware of the first two effects. In their fatally flawed views of
the economic world, monetary inflation either doesn't matter at all or doesn't matter
unless/until it causes the CPI to rise.
Inflation always hurts our standard of living. Rising prices means we have to pay more
for the same goods and services. If our income increases at a slower rate as inflation, our
standard of living declines even if we are making more. Inflation's main consequence is a
subtle reduction in our standard of living.Inflation doesn't affect everything equally.Gas pricescan double while our home loses
value. This makes financial planning more difficult.
Inflation is really bad for ourretirement planning because our target has to keep getting
higher and higher to pay for the same quality of life. In other words, our savings will buy
less. As a result, we will need to save more today to pay for higher priced goods and
services in the future. Since everything we buy today costs more, so we have less left-
over income available to save.
Inflation has another bad side-effect...once people start to expect inflation, they will
spend now rather than later. That's because they know things will only cost more lately.
This consumer spending heats up the economy even more, leading to further inflation.
This situation is known as spiraling inflation because it spirals out of control.
General effect:
An increase in the general level of prices implies a decrease in the purchasing power of
the currency. That is, when the general level of prices rises, each monetary unit buys
fewer goods and services. The effect of inflation is not distributed evenly in the economy,
and as a consequence there are hidden costs to some and benefits to others from this
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decrease in the purchasing power of money. For example, with inflation, lenders or
depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing
power from their interest earnings, while their borrowers benefit. Individuals or
institutions with cash assets will experience a decline in the purchasing power of their
holdings. Increases in payments to workers and pensioners often lag behind inflation,
especially for those with fixed payment.
Increases in the price level (inflation) erode the real value of money (the functional
currency) and other items with an underlying monetary nature (e.g. loans and bonds).
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the
"real" interest rate as the inflation rate rises. The real interest on a loan is the nominal rate
minus the inflation rate (approximately ). For example if we take a loan where the stated
interest rate is 6% and the inflation rate is at 3%, the real interest rate that we are paying
for the loan is 3%. It would also hold true that if we had a loan at a fixed interest rate of
6% and the inflation rate jumped to 20% we would have a real interest rate of -14%.
Banks and other lenders adjust for this inflation risk either by including an inflation
premium in the costs of lending the money by creating a higher initial stated interest rate
or by setting the interest at a variable rate. As the rate of inflation decreases, this has the
opposite (negative) effect on borrowers.
Negative:
High or unpredictable inflation rates are regarded as harmful to an overall economy. They
add inefficiencies in the market, and make it difficult for companies to budget or plan
long-term. Inflation can act as a drag on productivity as companies are forced to shift
resources away from products and services in order to focus on profit and losses from
currency inflation. Uncertainty about the future purchasing power of money discourages
investment and saving. And inflation can impose hidden tax increases, as inflated
earnings push taxpayers into higher income tax rates unless the tax brackets are indexed
to inflation.
With high inflation, purchasing power is redistributed from those on fixed nominal
incomes, such as some pensioners whose pensions are not indexed to the price level,
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towards those with variable incomes whose earnings may better keep pace with the
inflation. This redistribution of purchasing power will also occur between international
trading partners. Where fixedexchange rates are imposed, higher inflation in one
economy than another will cause the first economy's exports to become more expensive
and affect thebalance of trade. There can also be negative impacts to trade from an
increased instability in currency exchange prices caused by unpredictable inflation.
Positive:
Labor-market adjustments
Keynesians believe that nominal wages are slow to adjust downwards. This can
lead to prolonged disequilibrium and high unemployment in the labor market.Since inflation would lower the real wage if nominal wages are kept constant,
Keynesians argue that some inflation is good for the economy, as it would allow
labor markets to reach equilibrium faster.
Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate,
the rate at which banks can borrow from the central bank, andopen market
operations which are the central bank's interventions into the bonds market with the aim
of affecting the nominal interest rate. If an economy finds itself in a recession with
already low, or even zero, nominal interest rates, then the bank cannot cut these rates
further (since negative nominal interest rates are impossible) in order to stimulate the
economy - this situation is known as aliquidity trap. A moderate level of inflation tends
to ensure that nominal interest rates stay sufficiently above zero so that if the need arises
the bank can cut the nominal interest rate.
Mundell-Tobin effect
TheNobel laureate Robert Mundell noted that moderate inflation would induce savers to
substitute lending for some money holding as a means to finance future spending. That
substitution would cause market clearing real interest rates to fall. The lower real rate of
interest would induce more borrowing to finance investment. In a similar vein, Nobel
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laureate James Tobin noted that such inflation would cause businesses to substitute
investment inphysical capital (plant, equipment, and inventories) for money balances in
their asset portfolios. That substitution would mean choosing the making of investments
with lower rates of real return. (The rates of return are lower because the investments
with higher rates of return were already being made before.). The two related effects are
known as the Mundell-Tobin effect. Unless the economy is already over investing
according to models ofeconomic growth theory, that extra investment resulting from the
effect would be seen as positive.
Instability with Deflation
Economist S.C. Tsaing noted that once substantial deflation is expected, two important
effects will appear; both a result of money holding substituting for lending as a vehicle
for saving. The first was that continually falling prices and the resulting incentive tohoard money will cause instability resulting from the likely increasing fear, while money
hoards grow in value, that the value of those hoards are at risk, as people realize that a
movement to trade those money hoards for real goods and assets will quickly drive those
prices up. Any movement to spend those hoards "once started would become a
tremendous avalanche, which could rampage for a long time before it would spend
itself." Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes
of rapid inflation and consequent real economic disruptions. Moderate and stable
inflation would avoid such a seesawing of price movements.
Financial Market Inefficiency with Deflation
The second effect noted by Tsaing is that when savers have substituted money holding
for lending on financial markets, the role of those markets in channeling savings into
investment is undermined. With nominal interest rates driven to zero, or near zero, from
the competition with a high return money asset, there would be no price mechanism in
whatever is left of those markets. With financial markets effectively euthanized, the
remaining goods and physical asset prices would move in perverse directions. For
example, an increased desire to save could not push interest rates further down (and
thereby stimulate investment) but would instead cause additional money hoarding,
driving consumer prices further down and making investment in consumer goods
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production thereby less attractive. Moderate inflation, once its expectation is incorporated
into nominal interest rates, would give those interest rates room to go both up and down
in response to shifting investment opportunities, or savers' preferences, and thus allow
financial markets to function in a more normal fashion.
How to combat inflation:The three tools that the government used to combat inflation are:
1. Fiscal policy of the government
2. Monetary policy of the government
3. Direct action policy of the government
The tools are explained briefly below:
1. Fiscal policy of the government:
a. Increasing the rate of direct tax
When government increases the tax, available money in the hands of the
people decreases and thus buying power decreases for which demand
decrease.
b. Lowering the rate of indirect tax
When government lowers the indirect tax such as taxes on imported goods,
the price of those goods doesnt inflate.
c. Offering subsidy in production/import
Subsidy in the goods and services produced and also on the imported goods,
keep the price of those things in normal range
d. Contracting government development expenditure
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In economics, fiscal policy is the use of government expenditure and revenue collection
(taxation) to influence the economy.
Fiscal policy can be contrasted with the other main type of macroeconomic policy,
monetary policy, which attempts to stabilize the economy by controlling interest rates
and the money supply. The two main instruments of fiscal policy are government
expenditure and taxation. Changes in the level and composition of taxation and
government spending can impact on the following variables in the economy:
Aggregate demand and the level of economic activity;
The pattern of resource allocation;
The distribution of income.
Fiscal policy refers to the use of the government budget to influence the first of these:
economic activity.
Stances of fiscal policy
The three possible stances of fiscal policy are neutral, expansionary and contractionary.
The simplest definitions of these stances are as follows:
A neutral stance of fiscal policy implies a balanced economy. This results in a large tax
revenue. Government spending is fully funded by tax revenue and overall the budget
outcome has a neutral effect on the level of economic activity.
An expansionary stance of fiscal policy involves government spending exceeding
tax revenue.
A contractionary fiscal policy occurs when government spending is lower than tax
revenue.
However, these definitions can be misleading because, even with no changes in spending
or tax laws at all, cyclical fluctuations of the economy cause cyclical fluctuations of tax
revenues and of some types of government spending, altering the deficit situation; these
are not considered to be policy changes. Therefore, for purposes of the above definitions,
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"government spending" and "tax revenue" are normally replaced by "cyclically adjusted
government spending" and "cyclically adjusted tax revenue". Thus, for example, a
government budget that is balanced over the course of the business cycle is considered to
represent a neutral fiscal policy stance.
Methods of funding
Governments spend money on a wide variety of things, from the military and police to
services like education and healthcare, as well as transfer payments such as welfare
benefits. This expenditure can be fundedin a number of different ways:
Taxation
Seigniorage, the benefit from printingmoney Borrowing money from the population or from abroad
Consumption of fiscal reserves.
Sale of fixed assets (e.g., land).
All of these except taxation are forms of deficit financing
Borrowing
A fiscal deficit is often funded by issuing bonds, liketreasury bills orconsolsand gilt-
edged securities. These pay interest, either for a fixed period or indefinitely. If the interest
and capital repayments are too large, a nation may default on its debts, usually to foreign
creditors.
Consuming prior surpluses
A fiscal surplus is often saved for future use, and may be invested in local (same
currency) financial instruments, until needed. When income from taxation or othersources falls, as during an economic slump, reserves allow spending to continue at the
same rate, without incurring additional debt.
Economic effects of fiscal policy
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Governments use fiscal policy to influence the level of aggregate demand in the
economy, in an effort to achieve economic objectives of price stability, full employment,
and economic growth. Keynesian economics suggests that increasing government
spending and decreasing tax rates are the best ways to stimulate aggregate demand. This
can be used in times of recession or low economic activity as an essential tool for
building the framework for strong economic growth and working towards full
employment. In theory, the resulting deficits would be paid for by an expanded economy
during the boom that would follow; this was the reasoning behind theNew Deal.
Governments can use a budget surplus to do two things: to slow the pace of strong
economic growth and to stabilize prices when inflation is too high. Keynesian theory
posits that removing spending from the economy will reduce levels of aggregate demandand contract the economy, thus stabilizing prices.
Economists debate the effectiveness of fiscal stimulus. The argument mostly centers on
crowding out, a phenomenon where government borrowing leads to higher interest rates
that offset the simulative impact of spending. When the government runs a budget deficit,
funds will need to come from public borrowing (the issue of government bonds),
overseas borrowing, ormonetizing the debt. When governments fund a deficit with the
issuing of government bonds, interest rates can increase across the market, because
government borrowing creates higher demand for credit in the financial markets. This
causes a lower aggregate demand for goods and services, contrary to the objective of a
fiscal stimulus. Neoclassical economists generally emphasize crowding out while
Keynesians argue that fiscal policy can still be effective especially in a liquidity trap
where, they argue, crowding out is minimal.
Some classical and neoclassical economistsargue that crowding out completely negates
any fiscal stimulus; this is known as the Treasury View which Keynesian economics
rejects. The Treasury View refers to the theoretical positions of classical economists in
the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same
general argument has been repeated by some neoclassical economists up to the present.
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In the classical view, the expansionary fiscal policy also decreases net exports, which has
a mitigating effect on national output and income. When government borrowing increases
interest rates it attracts foreign capital from foreign investors. This is because, all other
things being equal, the bonds issued from a country executing expansionary fiscal policy
now offer a higher rate of return. In other words, companies wanting to finance projects
must compete with their government for capital so they offer higher rates of return. To
purchase bonds originating from a certain country, foreign investors must obtain that
country's currency. Therefore, when foreign capital flows into the country undergoing
fiscal expansion, demand for that country's currency increases. The increased demand
causes that country's currency to appreciate. Once the currency appreciates, goods
originating from that country now cost more to foreigners than they did before and
foreign goods now cost less than they did before. Consequently, exports decrease and
imports increase.[2]
Other possible problems with fiscal stimulus include the time lag between the
implementation of the policy and detectable effects in the economy, and inflationary
effects driven by increased demand. In theory, fiscal stimulus does not cause inflation
when it uses resources that would have otherwise been idle. For instance, if a fiscal
stimulus employs a worker who otherwise would have been unemployed, there is no
inflationary effect; however, if the stimulus employs a worker who otherwise would have
had a job, the stimulus is increasing labor demand while labor supply remains fixed,
leading to wage inflation and therefore price inflation.
2. Monetary policy of the government:
a. Increasing the bank rate of interest
When the rate of interest is low, people tend to withdraw the money from the
bank and spend in different ways which cause inflation. Government by
increasing the rate manages that.
b. Increasing the statutory reserve ratio
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Same goes for the RSS where the increase in the ration keeps the inflation
down.
Monetary policy rests on the relationship between the rates of interest in an economy,
that is, the price at which money can be borrowed, and the total supply of money.
Monetary policy uses a variety of tools to control one or both of these, to influence
outcomes like economic growth, inflation, exchange rates with other currencies and
unemployment. Where currency is under a monopoly of issuance, or where there is a
regulated system of issuing currency through banks which are tied to a central bank, the
monetary authority has the ability to alter the money supply and thus influence the
interest rate (to achieve policy goals). The beginning of monetary policy as such comes
from the late 19th century, where it was used to maintain the gold standard.
A policy is referred to as contractionary if it reduces the size of the money supply or
increases it only slowly, or if it raises the interest rate. An expansionary policy increases
the size of the money supply more rapidly, or decreases the interest rate. Furthermore,
monetary policies are described as follows: accommodative, if the interest rate set by the
central monetary authority is intended to create economic growth; neutral, if it is intended
neither to create growth nor combat inflation; or tight if intended to reduce inflation.
There are several monetary policy tools available to achieve these ends: increasing
interest rates by fiat; reducing the monetary base; and increasing reserve requirements.
All have the effect of contracting the money supply; and, if reversed, expand the money
supply. Since the 1970s, monetary policy has generally been formed separately from
fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most
nations would form the two policies separately.
Within almost all modern nations, special institutions (such as the Federal Reserve
System in the United States, the Bank of England, the European Central Bank, the
People's Bank of China, and the Bank of Japan) exist which have the task of executing
the monetary policy and often independently of the executive. In general, these
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institutions are called central banks and often have other responsibilities such as
supervising the smooth operation of the financial system.
The primary tool of monetary policy is open market operations. This entails managing the
quantity of money in circulation through the buying and selling of various financial
instruments, such as treasury bills, company bonds, or foreign currencies. All of these
purchases or sales result in more or less base currency entering or leaving market
circulation.
Usually, the short term goal of open market operations is to achieve a specific short term
interest rate target. In other instances, monetary policy might instead entail the targeting
of a specific exchange rate relative to some foreign currency or else relative to gold. For
example, in the case of the USA the Federal Reserve targets the federal funds rate, the
rate at which member banks lend to one another overnight; however, the monetary policy
of China is to target the exchange ratebetween the Chinese renminbi and a basket of
foreign currencies.
The other primary means of conducting monetary policy include: (i) Discount window
lending (lender of last resort); (ii) Fractional deposit lending (changes in the reserve
requirement); (iii) Moral suasion (cajoling certain market players to achieve specifiedoutcomes); (iv) "Open mouth operations" (talking monetary policy with the market).
Theory
Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls (i) the supply of money, (ii) availability of money, and
(iii) cost of money or rate of interest to attain a set of objectives oriented towards the
growth and stability of the economy.[1] Monetary theory provides insight into how to
craft optimal monetary policy.
Monetary policy rests on the relationship between the rates of interest in an economy,
that is the price at which money can be borrowed, and the total supply of money.
Monetary policy uses a variety of tools to control one or both of these, to influence
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outcomes like economic growth, inflation, exchange rates with other currencies and
unemployment. Where currency is under a monopoly of issuance, or where there is a
regulated system of issuing currency through banks which are tied to a central bank, the
monetary authority has the ability to alter the money supply and thus influence the
interest rate (to achieve policy goals).
It is important for policymakers to make credible announcements. If private agents
(consumers and firms) believe that policymakers are committed to lowering inflation,
they will anticipate future prices to be lower than otherwise (how those expectations are
formed is an entirely different matter; compare for instance rational expectations with
adaptive expectations). If an employee expects prices to be high in the future, he or she
will draw up a wage contract with a high wage to match these prices. Hence, theexpectation of lower wages is reflected in wage-setting behavior between employees and
employers (lower wages since prices are expected to be lower) and since wages are in
fact lower there is no demand pull inflation because employees are receiving a smaller
wage and there is no cost push inflationbecause employers are paying out less in wages.
To achieve this low level of inflation, policymakers must have credible announcements;
that is, private agents must believe that these announcements will reflect actual future
policy. If an announcement about low-level inflation targets is made but not believed by
private agents, wage-setting will anticipate high-level inflation and so wages will be
higher and inflation will rise. A high wage will increase a consumer's demand (demand
pull inflation) and a firm's costs (cost push inflation), so inflation rises. Hence, if a
policymaker's announcements regarding monetary policy are not credible, policy will not
have the desired effect.
If policymakers believe that private agents anticipate low inflation, they have an
incentive to adopt an expansionist monetary policy (where the marginal benefit of
increasing economic output outweighs the marginal cost of inflation); however, assuming
private agents have rational expectations, they know that policymakers have this
incentive. Hence, private agents know that if they anticipate low inflation, an
expansionist policy will be adopted that causes a rise in inflation. Consequently, (unless
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policymakers can make their announcement of low inflation credible), private agents
expect high inflation. This anticipation is fulfilled through adaptive expectation (wage-
setting behavior);so, there is higher inflation (without the benefit of increased output).
Hence, unless credible announcements can be made, expansionary monetary policy will
fail.
Announcements can be made credible in various ways. One is to establish an independent
central bank with low inflation targets (but no output targets). Hence, private agents
know that inflation will be low because it is set by an independent body. Central banks
can be given incentives to meet targets (for example, larger budgets, a wage bonus for the
head of the bank) to increase their reputation and signal a strong commitment to a policy
goal. Reputation is an important element in monetary policy implementation. But the ideaof reputation should not be confused with commitment.
While a central bank might have a favorable reputation due to good performance in
conducting monetary policy, the same central bank might not have chosen any particular
form of commitment (such as targeting a certain range for inflation). Reputation plays a
crucial role in determining how much markets would believe the announcement of a
particular commitment to a policy goal but both concepts should not be assimilated. Also,
note that under rational expectations, it is not necessary for the policymaker to have
established its reputation through past policy actions; as an example, the reputation of the
head of the central bank might be derived entirely from his or her ideology, professional
background, public statements, etc.
In fact it has been argued[3] that to prevent some pathologies related to the time
inconsistencyof monetary policy implementation (in particular excessive inflation), the
head of a central bank should have a larger distaste for inflation than the rest of the
economy on average. Hence the reputation of a particular central bank is not necessary
tied to past performance, but rather to particular institutional arrangements that the
markets can use to form inflation expectations.
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Despite the frequent discussion of credibility as it relates to monetary policy, the exact
meaning of credibility is rarely defined. Such lack of clarity can serve to lead policy away
from what is believed to be the most beneficial. For example, capability to serve the
public interest is one definition of credibility often associated with central banks. The
reliability with which a central bank keeps its promises is also a common definition.
While everyone most likely agrees a central bank should not lie to the public, wide
disagreement exists on how a central bank can best serve the public interest. Therefore,
lack of definition can lead people to believe they are supporting one particular policy of
credibility when they are really supporting another.
Monetary decisions today take into account a wider range of factors, such as:
short term interest rates; long term interest rates;
velocity of money through the economy;
exchange rates;
credit quality;
bonds and equities(corporate ownership and debt);
government versus private sector spending/savings;
international capital flowsof money on large scales;
Financial derivativessuch as options, swaps, futures contracts, etc.
3. Direct action policy of the government:
a. Setting price ceiling
When the price of certain goods have gone up to an alarming high state,
government pts a ceiling in that products price above which the business arenot allowed to sell. For example in the recent days we have seen that
government has set sugar price and edible oil fixed to tk 65 and tk 109
respectively.
b. Confiscating legal tender
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c. Persuasive Policy.
Setting price ceiling:
When the price of anything goes very high, government sets price ceiling above which
businessmen are not allowed to sell that goods.
Setting the ceiling reduces the products price from the current market price for which
demand goes up. But due to the possibility of incurring loss, many of the businessmen
keep away from selling the product. So supply decreases. This excess demand and
decreased supply creates a shortage in the market.
In order to manage this situation, government takes up the following five measures:
1. Government becomes ready to supply the required quantity of products from its own
production.
2. Government supplies the required goods and by importing that from foreign countries
under its one command and thus manages the situation.
3. Government helps the indigenous producers to produce. It helps in setting up plants with
equipment and machinery so that they can produce it and supply.
4. Government also helps the private importers to import the necessary ready products or
raw materials to produce the product and sell through their own distribution channel.
5. Government also supplies from its own buffer stock created earlier Setting price floor:
When the price of something goes below its normal range, government sets up price floor
below which, businessmen are not allowed to sell it. We have seen in man occasions
where the farmers of Bangladesh are struggling to get at least the production expense in
order to avoid direct loss. It happens because of the syndication of middle men who buy
the products from the farmers and sell it to the retailers. Here government has a big role
to play to set the floor and monitor closely so that the poor farmers dont incur loss.
When the price floor is set, the price of the product goes up from the current price of it in
the market, so demand goes down again the business become interested to sell it since the
price is up and thus the supply overflows. These two incidents create a surplus.
In order to manage the situation, government does the following things:
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1. Government buys the stock and keeps it in stores.
2. Government buys the stock on the previous price and sells it to another country.
3. Government acquires the stock and destroys it.
A buffer stock makes use of the price floor and price ceiling below and above which,
product cannot be sold. These two boundaries upper and lower doesnt allow the price
to go above or below it. It protects the interest of the producers and the customers as well.
Remedy of Inflation:
Unfortunately, there is hardly any market oriented policy move on the part of fiscal or
monetary authorities that can be taken for checking the cost induced inflation. On the
fiscal side, although cutting down of the indirect tax on commodities is often proposed as
a remedial measure, it only makes a temporary contribution to reducing inflation. Long-
term continuation of such policy may cause continuous erosion of the government
exchequer. Some also argue in favor of government control on wage increases that are
not supported by the corresponding increase in productivity to resist wage-price spiral. In
Bangladesh, however, the presence of powerful trade unions tends to render the
implementation of such control almost impossible. On a positive note, however, our
analysis did not find any noteworthy impact of wage growth on inflation. It is widely
recognized, however, that government can effectively use its legal powers to break up the
market syndication and thus improve competitiveness of the distribution network.
On the monetary side, in the absence of any direct controlling instrument, Bangladesh
Bank can initiate some case specific counter-action. Bangladesh Bank can take over some
responsibilities such as monitoring modalities of Letter of Credit (L/C) operation so that
market forces determines the exchange rate in a process that remains free from much
speculative transactions.
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Renowned economist Prof Rahman Siobhan at a recent seminar organized by the Center
for Policy Dialogue (CPD) said inflation hurts ordinary people of the country. So,
monetary policy of the central bank should ensure their welfare. Appreciating
government measures after the devastating floods in 1998, he said the central bank should
take proper steps in line with those post-flood programmers.
Following the government move, Tk 2412 crore is going to be allocated in the
revenue budget for increasing agriculture production and to supply agricultural inputs at
low costs. Of this amount, Tk 350 core will be allocated for agriculture research, Tk 750
core for diesel supply and Tk 1312 core for supplying fertilizer and electricity at
subsidized rates.
The government has already taken some initiatives to check inflation. The chief adviser
in his address to the nation on Sunday mentioned some government programmers like
Open Market Sale (OMS). Price of rice under OMS has been fixed at Tk 19 a kg against
the import cost of Tk 25 per kg. Import of 900,000 tones of food grains under
government initiative during the current fiscal year is now being finalized.
The central bank can use two instruments interest rate hike and lower money supply
to curb inflation. Central bank can issue government bond and securities in the market to
reduce the money supply.
The import rate of Bangladesh is highest among other south Asian country [almost
35%], so the price of goods and services fluctuate based on the rise and fall in world
price. To stabilize rice price in domestic market, the government should import coarse
rice from Myanmar or Indonesia or any other country where rice is cheaper.
Stock market can play an important role in controlling inflation by easing the
investment policy and implying effective monetary control on the profit distribution of
companies to the investors.
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Government can imply the flexible terrify and quota system to control the import price
and make it stable in the domestic market.
Government should find the alternative country or place for importing goods rather than
depending only on India.
Unethical storing or warehousing should be controlled with developing new laws and
efficient apply of consumer law.
Government can establish new agencies like TCB or make sure their continuous
efficient operation.
And at last try to ensure the domestic production is increasing and take active and
elaborate plans for that and ensure the swift and smooth agricultural production.
Conclusion:
At the import of our report we can say that the main reason of inflation is our internal
capabilities of production. Thats why we have to import from abroad. And the main
reason of inflation is the huge amount of import. Other all causes like interest rate,
supply, exchange rate, and syndication are relative effect of the import. So our suggestion
to government will be that government should take the proper steps or plan that increase
the total internal production and that can be ensured by concentrate on both local industry
and agriculture so that capital per person or employment opportunity and Per capitaincome rise.