Inflation in Bangladesh and Its Reason and Solution

There are number of factors behind the rising trend of inflation in Bangladesh. The factors contributed the most in the rise hike of essential items, particularly food, are slow growth in agriculture, rise in the world prices of food items, sharp depreciation of taka against US dollar and especially against the Indian rupee, and rise in the prices of diesel and kerosene. These causes affect our general people directly. As per capita GDP is not responding with inflation, purchasing power of people has shrunk drastically. Food inflation is causing more problems for rural people than urban people. And loss of Taka’s value is making people go down class hierarchy. We recommend that Bangladesh Bank should take necessary steps to reduce inflation rate. We have to be concerned about devaluation of our currency. Inflation is a complex, dynamic process which cannot be comprehended simply through occasional debates or newspaper articles. Rigorous research is needed to understand inflation dynamics and its implications for monetary policy. Much of the responsibilities lay within the purview of local universities, policy institutes, and in particular the Bangladesh Bank.

Table of Contents

Introduction
Inflation is an increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand. This definition includes some of the basic economics of inflation and would seem to indicate that inflation is not defined as the increase in prices but as the increase in the supply of money that causes the increase in prices i.e. inflation is a cause rather than an effect. Inflation’s effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects. Today, most mainstream economists favor a low, steady rate of inflation. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

Components of inflation:
Inflation=Expected inflation-β(U-U*) +V
Here,
β = Sensitivity
U*= Natural rate of unemployment
U= Unemployment
V= Supply shocks
Policy maker do not have any influence over Supply shock & expected rate of inflation. So, they try to manage inflation by controlling unemployment rate. Measure of Inflation:
Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer Price Index. The Consumer Price Index measures prices of a selection of goods and services purchased by a “typical consumer”. The inflation rate is the percentage rate of change of a price index over time. For instance, in January 2010, the Bangladesh Consumer Price Index was 324.21, and in January 2011 it was 350.54. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2010 is: (350.54-324.21)/324.21=0.103 or 10.3%

The resulting inflation rate for the CPI in this one year period is 10.3%, meaning the general level of prices for typical Bangladeshi consumers rose by 10.3% in 2010.

Types of Inflation
There are two major types of inflation:
1. Cost-push inflation
This is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil can create cost-pull inflation. It is also called “Supply shock inflation”. Because it is caused by adverse supply shock. Example: if Production Costs increases, a company may need to increases wages if laborers demand higher salaries (due to increasing prices and thus cost of living) or if labor becomes more specialized. If the cost of labor, a factor of production, increases, the company has to allocate more resources to pay for the creation of its goods or services. To continue to maintain (or increase) profit margins, the company passes the increased costs of production on to the consumer, making retail prices higher. Along with increasing sales, increasing prices is a way for companies to constantly increase their bottom lines and essentially grow. Another factor that can cause increases in production costs is a rise in the price of raw materials. It happened because of scarcity of raw materials.

Fig: Cost-Push Inflation
To visualize how cost-push inflation works, we can use a simple price-quantity graph showing what happens to shifts in aggregate supply. The graph above shows the level of output that can be achieved at each price level. As production costs increase, aggregate supply decreases from AS1 to AS2 (given production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is that, for companies to maintain (or increase) profit margins, they will need to raise the retail price paid by consumers, thereby causing inflation. Cost-push inflation cause inflationary recession. 2. Demand-Pull Inflation

The rate of inflation accelerates whenever aggregate demand is increased beyond the ability of the economy to produce (its potential output). Hence, any factor that increases aggregate demand can cause inflation. Example: an increase in government purchases can increase aggregate demand, thus pulling up prices. Another factor can be the depreciation of local exchange rates, which raises the price of imports and, for foreigners, reduces the price of exports. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases, thereby raising the overall level of aggregate demand (we are assuming aggregate supply cannot keep up with aggregate demand as a result of full employment in the economy). Rapid overseas growth can also ignite an increase in demand as more exports are consumed by foreigners.

Fig: Demand-Pull Inflation
Demand-pull inflation is a product of an increase in aggregate demand that is faster than the corresponding increase in aggregate supply. When aggregate demand increases without a change in aggregate supply, the ‘quantity supplied’ will increase (given production is not at full capacity). Looking again at the price-quantity graph, we can see the relationship between aggregate supply and demand. If aggregate demand increases from AD1 to AD2, in the short run, this will not change (shift) aggregate supply, but cause a change in the quantity supplied as represented by a movement along the AS curve. The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply. As companies increase production due to increased demand, the cost to produce each additional output increases, as represented by the change from P1 to P2. The rationale behind this change is that companies would need to pay workers more money (e.g. overtime) and/or invest in additional equipment to keep up with demand, thereby increasing the cost of production.

Causes of inflation:
The major causes of inflation are shortly described below:
1. Excess money supply:
Money supply plays a large role in inflation. According to the famous monetarist economist Milton Friedman, “Inflation is always and everywhere a monetary phenomenon.” If the Central Bank does not control the money supply adequately, it may actually grow at a rate faster than that of the potential output in the economy, or real GDP. The belief is that this will drive up prices and hence, inflation. Low interest rates correspond with a high level of money supply and allow for more investment in big business and new ideas which eventually leads to unsustainable levels of inflation as cheap money is available. The credit crisis of 2007 is a very good example of this at work. The study of monetary history shows that inflation has always been a monetary phenomenon. The quantity theory of money, simply stated, says that any change the amount of money in a system will change the price level. This theory begins with the equation of exchange: MV = PQ

Where
M = the nominal quantity of money.
V = the velocity of money in final expenditures;
P = the general price level;
Q = an index of the real value of final expenditures;
It is assumed that the velocity of money is unaffected by monetary policy (at least in the long run), and the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money. With exogenous velocity (that is, velocity being determined externally and not being influenced by monetary policy), the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not exogenous in the short run, and so the formula does not necessarily imply a stable short-run relationship between the money supply and nominal output. However, in the long run, changes in velocity are assumed to be determined by the evolution of the payments mechanism. If velocity is relatively unaffected by monetary policy, the long-run rate of increase in prices (the inflation rate) is equal to the long run growth rate of the money supply plus the exogenous long-run rate of velocity growth minus the long run growth rate of real output.

2. Unemployment:
A connection between inflation and unemployment has been drawn since the emergence of large scale unemployment in the 19th century, and connections continue to be drawn today. There is an inverse relation between rate of inflation and the rate of unemployment in an economy. The more the entrepreneur extends the employment opportunity the more he has to pay to that particular factor of production and the more payment to factor of production the increase in the cost of producing a unit will be observed and in order to maintain the profitability of the product the entrepreneur will inflate the price of that product. A similar process will be observed throughout the economy when the government intends to create job. The price of products or services, where the workforce is installed, will increase hence an increase in the rate of inflation will be visible throughout the economy. Famous economist A.W Philips discovered a graphical way to show this relation which is known as Philips curve. Phillips curve showed that unemployment and inflation shared an inverse relationship: inflation rose as unemployment fell, and inflation fell as unemployment rose. Since two major goals for economic policy makers are to keep both inflation and unemployment low, Phillip’s discovery was an important conceptual breakthrough.

Fig: Phillips Curve
The inflation rate is represented on the vertical axis in units of percent per year. The unemployment rate is represented on the horizontal axis in units of percent. The curve shows the levels of inflation and unemployment that tend to match together approximately, based on historical data. 3 International lending & national debt

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

Present State of Inflation and comparison (country wise Scenario) with some developing countries: According to the Bangladesh Bureau of Statistics (BBS), the national inflation in Bangladesh is 8.56% on point-to-point basis in June 2012; whereas the food-inflation hit 7.08% and the non-food inflation hit 11.72% in the same period. The rural inflation is 7.88% on point-to-point basis in June 2012; whereas rural food and non-food inflation knockout to 6.02% and 11.88% consecutively in the same period. The urban inflation is 10.29% on point-to-point basis in June 2012 as well as successive food and non-food inflation for the same period knockout to 9.57%
and 11.28%. By observing above data it can say that national inflation is highly influenced by urban inflation and non-food inflation. Table 1: Inflation Rate (Point-to-Point) FY2011-12

(1995-96=100)
| | Jul, 11| Aug, 11| Sep, 11| Oct, 11| Nov, 11| Dec, 11| Jan, 12| Feb, 12| Mar, 12| Apr, 12| May, 12| Jun, 12| National| General| 10.96| 11.29| 11.97| 11.42| 11.58| 10.63| 11.59| 10.43| 10.1| 9.93| 9.15| 8.56| | Food| 13.4| 12.7| 13.75| 12.82| 12.47| 10.4| 10.9| 8.92| 8.28| 8.12| 7.46| 7.08| | Non-food| 6.46| 8.76| 8.77| 9.05| 10.19| 11.38| 13.16| 13.57| 13.96| 13.77| 12.72| 11.72| Rural| General| 11.09| 11.34| 11.85| 11.01| 11.37| 10.25| 11.15| 9.79| 9.4| 9.21| 8.38| 7.88| | Food| 13.53| 12.59| 13.35| 11.94| 11.8| 9.8| 10.18| 8.05| 7.21| 7.01| 6.3| 6.02| | Non-food| 6.14| 8.74| 8.69| 9.01| 10.46| 11.62| 13.23| 13.57| 14.17| 13.97| 12.82| 11.88| Urban| General| 10.65| 11.2| 12.29| 12.47| 12.11| 11.62| 12.73| 12.06| 11.89| 11.77| 11.12| 10.29| | Food| 13.12| 12.94| 14.67| 14.87| 14.04| 12.28| 12.56| 10.96| 10.8| 10.72| 10.17| 9.57| | Non-food| 7.32| 8.8| 9| 9.17| 9.47| 10.74| 12.97| 13.59| 13.42| 13.25| 12.44| 11.28| Source: Bangladesh Bureau of Statistics

Figure 1: The point-to-point inflation scenarios in Bangladesh H1 FY12 (July-December 2011)

In first half of the fiscal year (FY) 2012 national point-to-point food inflation was high due to the patent rise in global food. In first half of FY 2012 highest national point-to-point food inflation was 13.75% in September, 2011 and over all national point-to-point food inflation was 11.97% in September, 2011. On the other hand, in first half of FY 2012 national point-to-point non-food inflation gradually increasing due to global commodity price increase, a tough increase in domestic credit and depreciation of the taka. In first half of FY 2012 highest domestic credit was 463,473.70 crore in December, 2011and lowest domestic credit was 419,829.60 crore in July, 2011. In first half of FY 2012 highest national point-to-point non-food inflation was 11.83% in December, 2011 and at the same time over all national point-to-point non-food inflation was 10.63%.

Figure 2: The point-to-point inflation scenarios in Bangladesh H2 FY12 (January-June 2012)

In the second half of FY 2012 food inflation was gradually decreasing because of global food price declining. Highest point-to-point food inflation was 10.9% in January, 2012 and lowest point-to-point food inflation was 7.08% in June, 2012. This declining food inflation also reflected in Overall inflation and at June, 2012 overall point-to-point inflation was 8.56%

On the other hand, in the second half of 2012 national non-food increasing in third quarter due to express increase in domestic borrowing, high import demand and decreasing in fourth quarter due to strong price pressures came from upward adjustments in fuel and electricity prices. Highest point-to-pint non-food inflation was 13.96% in March, 2012 at the same time domestic credit hit to 581,495 crore. Finally, in June, 2012 overall inflation and non-food inflation was consecutively 8.56% and 11.72%. Inflation in South Asian Countries

Countries/Years| 2007| 2008| 2009| 2010| 2011| 2012Projected| 2013Projected| Afghanistan| 13.0| 26.8| 10.0| 7.7| 8.0| 4.6| 5.0|
Bangladesh| 7.2| 9.9| 6.7| 8.7| 10.2| 11.0| 8.5|
Bhutan| 5.2| 6.4| 7.1| 7.0| 8.6| 7.3| 6.5|
India| 4.8| 8.3| 3.6| 9.4| 9.5| 7.0| 6.5|
Maldives| 7.4| 12.3| 4.0| 4.7| 3.5| 4.5| 7.5|
Nepal| 6.4| 7.7| 13.2| 9.6| 8.5| 8.0| 7.0|
Pakistan| 7.8| 12.0| 20.8| 15.5| 9.7| 12.0| 10.0|
Sri Lanka| 15.8| 22.6| 3.5| 6.9| 6.7| 8.0| 7.0|
South Asia| 5.9| 9.3| 5.6| 6.0| 6.0| 6.5| 6.5|
Source: Asian Development Outlook, 2012

Country-wise Scenario
Afghanistan: Afghanistan has been experiencing in the management of inflation and growth. The inflation rate was 26.8 in 2008 compared to 13% in 2007. This was due to mainly poor harvest, high food and fuel prices, existing law and order situation hampering free movement of goods within the country. Consumer prices are highly volatile because of heavy import dependence, including food and fuel. Overall (year-on-year) inflation, which peaked at 18.2% in January 2011, receded to 9.2% in February 2012, mainly due to a fall in food inflation, which dropped from 21.0% to 7.1% mainly because of declining global food prices. Nonfood inflation was fairly stable in this period—varying around 14%—kept high by price adjustments for electricity and fuel, construction materials, transport, and housing rents. Average inflation in FY2012 is estimated at 4.6%.

Bangladesh: Average annual inflation rose to 8.3% from 7.3% in FY2010 owing to the marked rise in global food and commodity prices, a strong expansion in domestic credit, and depreciation of the taka in the latter half of the fiscal year. Price pressures have intensified in FY2012 and year-on-year inflation climbed slightly from 10.2% in June 2011 to 10.4% in February 2012; nonfood inflation more than doubled to 13.6% but food inflation edged down to 8.9%. In addition to the rapid expansion in credit, stronger price pressures came from upward adjustments in domestic administered fuel and electricity prices, and from sharper taka depreciation because of continued high import demand, especially fuel imports. The food inflation rate was 9.15% in May 2012.

Bhutan: Local price movements of Bhutan continued to follow India’s because Bhutan’s currency is pegged to India’s and because the country keeps strong trading ties with its giant neighbor (taking about 90% of exports and providing 75% of imports). Bhutan’s average inflation, therefore, rose to 8.6% in FY2011. Food prices rose by 9.3% and nonfood prices by 8.0%.

India: It is seen that the recent developments are challenging India’s strong growth performance of recent years. Emerging capacity constraints, continued rapid expansion in credit, and partial pass-through of global commodity price increases have triggered steep domestic inflation and consequent monetary tightening. The inflation recorded in 2008 was 8.3% which was dropped to 3.6% in 2009. Services continued to grow rapidly, at 9.4%, accounting for nearly 80% of overall GDP growth and reflecting continued strong performance in trade, hotels, transport, communications, and financial services. With good monsoons, rice and wheat production is estimated to have hit records. Agriculture’s 2.5% expansion was low compared with the previous year’s weather-related 7.0% recovery, but still came in close to trend (3%).

Inflation persisted at 9.5–10% through most of FY2011 despite earlier rounds of monetary tightening, eased to 7.0% by February 2012. This moderation largely reflected a drop in food prices. A proxy for the core rate, nonfood manufactured goods inflation remained at around 8% then fell to 5.5% in February 2012. Since monetary tightening aimed to stabilize this measure, the central bank has seen progress in bringing it down to its historical average of 4%, consistent with maintaining stable inflationary expectations.

Pakistan: Severe floods at the start of FY2011 (ended 30 June 2011) disrupted economic activity in most sectors in the first half of the year. A slight recovery during the second half, supported by higher prices for key exports and expanded services activity in part related to flood relief—kept growth positive at 2.4% for the year (Figure 3.20.1). Solid growth in livestock, minor crops, and wheat and sugarcane outweighed a marked fall in cotton and rice harvests to allow a 1.2% expansion in agriculture. Industry, however, stagnated under the weight of energy shortages and low investment. Thus for the fourth year the economy was characterized by low growth (a period average of 3%), well below the estimated 7% needed to provide a firm basis to provide jobs to new labor-force entrants, increase per capita income, and reduce poverty.

Inflation, already under pressure from increasing global commodity prices, remained high, reflecting flood-related shortages, especially for food, and higher costs due to damaged transport networks. Peaking at more than 15% in December 2010, inflation eased modestly in the second half, and declined to 13.3% for the year to June 2011.

Sri Lanka: Overall inflation remained in single digits in 2011, averaging 6.7% and little changed from a year earlier (Figure 3.21.2). Food inflation, though, was volatile, reflecting flood damage, crop failures, and price pressure early in the year and, later, declining prices as production recovered. Nonfood inflation trended upward, due to strong demand and price increases for diesel, petrol, kerosene, liquefied petroleum gas, and bus fares late in 2011 and in February 2012, when it reached 9.2%. Fuel prices were suppressed during 2011 as international oil prices shot up by 41%.

Problems faced by Entrepreneurs and Consumers

Two notable problems are associated with inflation–uncertainty and haphazard redistribution. Inflation, especially inflation that varies from month to month and year to year, makes long-term planning quite difficult. Prices, wages, taxes, interest rates, and other nominal values that enter into consumer, business, and government planning decisions can be significantly affected by inflation. Moreover, inflation tends to redistribute income and wealth in a haphazard manner–some people win and some people lose. This redistribution might not be that desired by society, failing to promote any of the basic economic goals of efficiency, equity, stability, growth, or full-employment.

Policies to tackle inflation
Terming the taming of the inflation rate to 7.5 per cent this fiscal a big challenge for the government, general inflation, on a point-to-point basis, dropped marginally to 10.10 per cent in March, 2012 from 10.43 per cent in the previous month, due mainly to a slow rise in food prices. In September 2011, the country’s consumer price index (CPI) was at a record two-decade high of 11.97 per cent. The national food inflation came down to 8.28 per cent in March, 2012 from 8.92 per cent in the previous month, but non-food inflation jumped to 13.96 per cent from 13.57 per cent mainly due to the recent increase in power tariff, fuel prices and household items. Government has reduced its borrowing from the banking system over the last couple of days to tackle the growing rate of inflation. Government’s borrowing from the banking system amounted to 161.75 billion BDT from January 3 to January 12 this year while the amount was 173 billion BDT during the same period from December 25 last year to January 3 this year, Bangladesh Bank data shows. Borrowing from the banking sector has been reduced to ensure availability of private sector funds in banking system.

The government scaled down its bank borrowing as hefty borrowing from the state-owned banks may lead the entrepreneurs and industrialists to be deprived of credit facility in their needs. Earlier, the government has set a target to borrow 189.57 billion from the banking sector this fiscal. Sources said 12 commercial banks had been facing tough time after providing loans to the government. Meanwhile, the government has increased the rate of government securities (Bond) as the interest on deposit had been increased recently. The 12 primary dealer banks will have to incur a total loss of 18.55 billion BDT due to the hike in securities’ rates. Experts opined that the reducing tendency in bank borrowing is a good sign for the country’s country.

If the government borrows directly from Bangladesh Bank, it should try to return the money as early as possible as the central bank has no back up for funds. On the other hand, hefty borrowing from central bank pushes up inflation rate which ultimately cast the major impact on general people. BB has been taking tight monetary policy regarding import and internal credit distribution. The central bank has been discouraging the banks not to open Letter of Credits (LCs) for importing luxurious commodities or distributing loan in unproductive sectors. Keeping essentials’ price stable is a vital factor to contain high inflation which can be ensured through reducing government’s borrowing. Effective monetary and fiscal policy and bringing discipline in exchange rate mechanism and management will help to reduce inflation. IMF, World Bank and other donor agencies are also putting pressure on government to reduce bank borrowing.

Some Specific Programs
* The central Bank increased its key interest rates by 50th basis point. This is the fifth time rates were raised since March as the central bank is struggling to control high rate of inflation. The central bank also announced that it was raising the repo rate to 7.75%, it will inject money to the banking system. BB also increases the reverse repo rate to 5.75%. Through the reverse repo rate, it will absorb money from the banking system. However, it may show an upward trend as the government decided to raise oil price and power tariffs to cut the subsidy. This hike in oil price is responsible for non food inflation acceleration Since May. This stubborn inflation has forced the central bank to raise the key interest rate by 50 basis points last September, fourth time in the last year. * Programs such as feeding the school children, food for work program, open market sales etc are taken by the government.

Conclusion

References

Bibliographical References:
* Macroeconomics by
N. Gregory Mankiw
* Macro Economics by
Rudiger Dornbusch, Stanley Fischer & Richard Startz

Journals:
* Bangladesh Economic Review (2009-10)
* Major Economic Indicators, Bangladesh Bank, April ‘11 * Bangladesh Economic Update, Vol. 2, no. 1, Jan-Feb ‘11
Websites:
* www.banladesh-bank.org
* www.adb.org
* www.imf.org
* www.bbs.gov.bd