Inflation in the Economy of Bangladesh

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Inflation in the Economy of Bangladesh
Economy of Bangladesh

The economy of Bangladesh is a rapidly developing market-based economy. Its per capita income in 2010 was est. US$1,700 (adjusted by purchasing power parity). According to the International Monetary Fund, Bangladesh ranked as the 47th largest economy in the world in 2010 in PPP terms and 57th largest in nominal terms, among the Next Eleven or N-11 of Goldman Sachs and D-8 economies, with a gross domestic product of US$269.3 billion in PPP terms and US$104.9 billion in nominal terms. The economy has grown at the rate of 6-7% p.a. over the past few years. More than half of the GDP belongs to the service sector, a major number of nearly half of Bangladeshis are employed in the agriculture sector, with RMG, textiles, leather, jute, fish, vegetables, leather and leather goods, ceramics, fruits as other important produce.

Remittances from Bangladeshis working overseas, mainly in the Middle East are the major source of foreign exchange earnings; exports of garments and textiles are the other main sources of foreign exchange earning. Ship building and cane cultivation have become a major force of growth. GDP’s rapid growth due to sound financial control and regulations has also contributed to its growth. However, foreign direct investment is yet to rise significantly. Bangladesh has made major strides in its human development index.The land is devoted mainly to rice and jute cultivation as well as fruits and produce, although wheat production has increased in recent years; the country is largely self-sufficient in rice production.Bangladesh’s growth of its agro industries is due to its rich deltaic fertile land that depend on its six seasons and multiple harvests.

Improving at a very fast rate, infrastructure to support transportation, communications, power supply and water distribution are rapidly developing.Bangladesh is limited in its reserves of oil, but recently there was huge development in gas and coal mining. The service sector has expanded rapidly during last two decades, the country’s industrial base remains very positive.The country’s main endowments include its vast human resource base, rich agricultural land, relatively abundant water, and substantial reserves of natural gas, with the blessing of possessing the worlds only natural sea ports in Mongla and Chittagong, in addition to being the only central port linking two large burgeoning economic hub groups SAARCand ASEAN.

Macro-economic trend

This is a chart of trend of gross domestic product of Bangladesh at market prices estimated by the International Monetary Fund with figures in millions of Bangladeshi Taka. However, this reflects only the formal sector of the economy.

Year Gross Domestic Product US Dollar Exchange Inflation Index


Per Capita Income

(as % of USA)

1980 250,300 16.10 Taka 20 1.79
1985 597,318 31.00 Taka 36 1.19
1990 1,054,234 35.79 Taka 58 1.16
1995 1,594,210 40.27 Taka 78 1.12
2000 2,453,160 52.14 Taka 100 0.97
2005 3,913,334 63.92 Taka 126 0.95
2008 5,003,438 68.65 Taka 147

Mean wages were $0.58 per man-hour in 2009

Kawran Bazar, a commercial hub of Bangladesh

Motijheel, a commercial hub of Bangladesh

Economic outlook

Efforts to achieve Bangladesh’s macroeconomic goals have been problematic mostly due to various factors including the country’s large population, corruption within the government, power shortages etc. The privatization of public sector industries has proceeded at a slow pace—due in part to worker unrest in affected industries—although on June 30, 2010, the government took a bold step as it closed down the Adamjee Jute Mill, the country’s largest and most costly state-owned enterprise.The government also has proven unable to resist demands for wage hikes in government-owned industries. Access to capital is impeded. State-owned banks, which control about three-fourths of deposits and loans, carry classified loan burdens of about 50%.

The IMF and World Bank predict GDP growth over the next 5 years will be about 6.5%, well short of the 9-10% needed to lift Bangladesh to Mid Income Nation level, within that time period.The initial impact of the end of quotas under the Multi-Fiber Arrangement has been positive for Bangladesh, with continuing investment in the ready-made garment sector, which has experienced annual export growth in excess of around 20%. Downward price pressure means Bangladesh must continue to cut final delivered costs if it is to remain competitive in the world market. Foreign investors in a broad range of sectors are increasingly frustrated with the politics of confrontation, the level of corruption, the slow pace of reform and privatization and deregulation of the public sector and the lack of basic infrastructure e.g. roads. While investors view favorably recent steps by the interim government to address corruption, governance, and

So far the global financial crisis has not had a major impact on the economy. The World Bank predicted economic growth of 6.5% for current year. Foreign aid has seen a decline of 10% over the last few months but economists see this as a good sign for self-reliance.There has been 18% growth in exports over the last 9 months and remittance inflow has increased at a remarkable 25% rate.

Fiscal Year Total Export Total Import Foreign Remittance Earnings
2007–2008 $14.11b $25.205b $8.9b
2008–2009 $15.56b $22.00b+ $9.68b
2009-2010 $16.7b ~$24b $10.87b
2010-2011 $22.93b $32b $11.65b

Inflation: Definition & Measurements


In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.

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.

Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic.

Today, most mainstream economists favor a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central that control the size of the money supply through the setting of interest, through open market operations, and through the setting of banking reserve requirements.

Inflation Rate Definition

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.


The Consumer Price Index

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 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007. Other widely used price indices for calculating price inflation include the following:

Producer price indices (PPIs)

This measures average changes in prices received by domestic producers for their output. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI. Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be “passed on” to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.

Commodity price indices

Which measure the price of a selection of commodities? In the present commodity price indices are weighted by the relative importance of the components to the “all in” cost of an employee.

Core price indices

Because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of ‘core inflation’, which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Other common measures of inflation are:

GDP deflator is a measure of the price of all the goods and services included in gross domestic product (GDP)

Inflation: Statistical View

Bangladesh Inflation Rate at 10.96 percent

The inflation rate in Bangladesh was last reported at 11 percent in July of 2011. This page includes a chart with historical data for Bangladesh’s Inflation Rate. Inflation rate refers to a general rise in prices measured against a standard level of purchasing power. The most well known measures of Inflation are the CPI which measures consumer prices, and the GDP deflator, which measures inflation in the whole of the domestic economy.

Bangladesh inflation hit 20-year high in September: 11.97%

Bangladesh’s annual inflation rate climbed to 11.97 percent in September, the highest level in 20 years, fuelled by soaring food prices, a government statistics official has said.

Food inflation jumped to 13.75 percent in September from 12.70 percent in August, while non-food inflation edged up to 8.77 percent from 8.76 percent, the official at the Bangladesh Bureau of Statistics said.

Price pressures are major concern for the government as more than a third of the country’s 160 million people live on less than $1.25 a day.

Inflation in urban areas rose even faster than the national average, hitting 12.29 percent in September on a 14.67 percent surge in food prices and 9 percent advance in non-food prices.

Inflation in rural areas hit 11.85 percent, with a 13.35 percent rise in food prices and a 8.69 percent rise in non-food prices.

Food prices have rocketed in recent months — despite plentiful stocks at government inventories and record crops — with analysts blaming inefficient markets and hoarding.

The government raised oil and gas prices in September for the second time since May to help to relieve state firms’ hefty subsidy burden, a move that added more impetus to already high inflation.

The government is under pressure from global lending agencies such as the IMF to raise its heavily subsidized fuel and power prices even more, but more cuts in subsidies would add to public fury over the spiraling cost of living.

The local currency unit, the taka, has continued to fall against the US dollar, further fanning inflation and import costs.

the central bank said in its latest monetary policy statement in July that it aims to cut credit growth to keep inflation within 7.50 percent as targeted for this fiscal year through June 2012. Economic growth is targeted at 7 percent.

Persistent inflation prompted the central bank to raise its key interest rates by half a percentage point in September, its fourth hike since March, following an earlier reserve increase and a 1 percentage point rise in official rates in August 2010.

Like other central banks in the region, Bangladesh Bank is in a tough spot with a buoyant domestic economy and inflation escalating, while global growth prospects are dim.

Current Inflation Rates: 2001-2011

The table of inflation rates displays annual rates from 2001-2011. Rates of inflation are calculated using the Current Consumer Price Index published monthly by the Bureau of Labor Statistics (BLS). For 2011, the most recent monthly data (12-month based) is used in the table.

Table of Inflation Rates by Month and Year (1999-2011)

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Ave
2011 1.6 2.1 2.7 3.2 3.6 3.6 3.6 3.8 3.9
2010 2.6 2.1 2.3 2.2 2.0 1.1 1.2 1.1 1.1 1.2 1.1 1.5 1.6
2009 0 0.2 -0.4 -0.7 -1.3 -1.4 -2.1 -1.5 -1.3 -0.2 1.8 2.7 -0.4
2008 4.3 4 4 3.9 4.2 5.0 5.6 5.4 4.9 3.7 1.1 0.1 3.8
2007 2.1 2.4 2.8 2.6 2.7 2.7 2.4 2 2.8 3.5 4.3 4.1 2.8
2006 4 3.6 3.4 3.5 4.2 4.3 4.1 3.8 2.1 1.3 2 2.5 3.2
2005 3 3 3.1 3.5 2.8 2.5 3.2 3.6 4.7 4.3 3.5 3.4 3.4
2004 1.9 1.7 1.7 2.3 3.1 3.3 3 2.7 2.5 3.2 3.5 3.3 2.7
2003 2.6 3 3 2.2 2.1 2.1 2.1 2.2 2.3 2 1.8 1.9 2.3
2002 1.1 1.1 1.5 1.6 1.2 1.1 1.5 1.8 1.5 2 2.2 2.4 1.6
2001 3.7 3.5 2.9 3.3 3.6 3.2 2.7 2.7 2.6 2.1 1.9 1.6 2.8
2000 2.7 3.2 3.8 3.1 3.2 3.7 3.7 3.4 3.5 3.4 3.4 3.4 3.4
1999 1.7 1.6 1.7 2.3 2.1 2 2.1 2.3 2.6 2.6 2.6 2.7 2.2

Bangladesh Inflation rate (consumer prices)

Definition: This entry furnishes the annual percent change in consumer prices compared with the previous year’s consumer prices.

Source: CIA World Fact book -Unless otherwise noted, information in this page is accurate as of October 14, 2011

Year Inflation, average consumer prices
Units: Percent change
1980 15.385
1981 14.545
1982 12.875
1983 9.531
1984 10.414
1985 10.465
1986 10.175
1987 10.828
1988 9.674
1989 8.734
1990 10.522
1991 8.285
1992 3.624
1993 2.979
1994 6.15
1995 10.117
1996 2.455
1997 4.959
1998 8.648
1999 6.179
2000 2.483
2001 1.908
2002 3.719
2003 5.361
2004 6.103
2005 7.04
2006 6.77
2007 9.109
2008 8.9
2009 5.426
2010 8.126
2011 10.96

Inflation: Causes & Effects

Exploring the causes of inflation in Bangladesh

ECONOMISTS, policy makers and multilateral capital donors have different explanations about the causes of inflation in countries like Bangladesh. A brief look at a few of such explanations merits attention for shaping and re-shaping of appropriate policies to help curb inflation. Here below is a brief critical overview of such explanations.

Food prices in the international market.

One of the causes of inflation, explained as such, 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 shot up phenomenally then.

Excess demand in the Bangladesh economy

Then the link between rising prosperity and inflation is sought to be proved by many. Despite all its problems, Bangladesh has been performing well, in terms of economic growth over the last 10 years. Its gross domestic product (GDP) base is not small, in absolute volume terms. It is the 50th largest economy in a sample of 177 countries. Not many developing countries have grown faster than Bangladesh with bigger GDP volumes since the early 1990s. Those who seek to link inflation and GDP growth performance state that the high growth rate of GDP and the per capita GDP in particular has led to the creation of excess demand in the Bangladesh economy. This has resulted in a demand-pull inflation.

Labor Cost

Wage, the labor cost, is often seen as the key reason behind cost-push inflation. Wage increase without any commensurate increase in productivity kicks off a wage-price spiral, allowing for sustained inflation. Analysis of the movements of nominal wage rate inflation generally gives an idea about the labor cost scenario.

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 food inflation throughout the FY05 was poor harvest of aus, aman and wheat crops. The yearly production of these three crops went down by 18.12, 14.76 and 22.11 percent respectively in FY05 over the FY04.

The growth of money supply

Then there is the growth of money supply that is directly related to the price situation. ‘Inflation is a monetary phenomenon’, so is explained by a good number of economists as well as some of the donor agencies. It is, thus, stated to be caused by the excessive supply of money in the economy. Bangladesh Bank has otherwise been found to be guided by the monetarist approach to inflation — and that is not without some good reason. If has been following a rather “cautious” monetary policy. Many consider it as a pragmatic step.

Relative strength of Bangladesh currency

Then the question of 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 situation here. 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 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, comprising many essential food items.

The import cost for Bangladesh

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. This hypothesis does also provide some reasonably plausible explanation to the movements of prices of essential food items in Bangladesh. However, there are some disagreements among the economists and policymakers with regard to combating this situation. The policy of foreign reserve accumulation by the Bangladesh Bank is considered by some quarters as not being consistent with the exchange rate movements of taka vis-a-vis the Indian rupee in recent years.

Fuel prices

Fuel prices are yet another factor that is cited to have a major impact on the domestic price situation. If the fuel prices go up, that impacts the prices of commodities through two major channels: the high prices of fuels lead to high cost for irrigation, which raises the cost of agricultural production; and, high fuel prices increase the cost of transportation, which also raises the prices of essential items transported from remote villages to urban areas.

“The syndicate” Syndrome

The non-competitive market features — or what are stated to be “the syndicate” syndrome — are otherwise widely considered as being one of the strong factors, igniting price pressures. Here, argument is made about many middle-men, wholesalers and importers acting as syndicates and causing large price hikes, by making cartels and hoarding essential goods like rice, wheat and edible oil. Such cartels do reportedly fix the prices of these goods, dictate supply in the market, and earn excess profits.

However, there is yet no convincing, concrete evidence of ‘syndicates’ being in total control of the markets of essential commodities to take advantage of the weak consumer protection laws. However, some short-term alliances among the suppliers of such goods is not to be rule out to have some influence over supply and prices. This may have some impact on the rising prices of essential items.

The Growth of Remittances

Then the issue of growth of remittances and its links with inflation come. There has been a steady and substantial rise in remittance inflow over the last few years. Such inflow does, no doubt, contribute to demand-pull inflation in Bangladesh. Working as the Rising Prosperity Hypothesis, such demand-pull factors can push up prices. But increased remittance inflow alone is unlikely to be a major cause of inflation. This is so because the rise in demand has been supported by the rise in supply through increased imports.

Black money culture in Bangladesh

Black money holders are controlling the economy of Bangladesh. The most conservative estimate that puts the current total of black money at Tk 50,000 to 60,000 crore or one-fifth of the GDP, which Bangladesh Economic Association figures is no less than Tk 175,000 crore.

Bribery, corruption, smuggling and manipulations in import are generating the black money. The larger chunk of black money is transferred abroad and only a little goes into the fixed deposits, while the black money owners spend the rest on posh living.

Black money makes no positive contribution to the economy. It plays no positive role in employment generation, production or any other sector. On the contrary, it has a severe impact on inflation that affects the poor. The unlimited expenditure of black money owners also leads to higher import and increase in commodity prices.



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 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 payments.

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 you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you 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 Effects

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, 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 fixed exchange rates are imposed, higher inflation in one economy than another will cause the first economy’s exports to become more expensive and affect the balance of trade. There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation

High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices. In the cost-push theory of inflation, rising wages in turn can help fuel inflation. In the case of collective bargaining, wage growth will be set as a function of inflationary expectations, which will be higher when inflation is high. This can cause a wage spiral. In a sense, inflation begets further inflationary expectations, which beget further inflation.


People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.

Social unrest and revolts

Inflation can lead to massive demonstrations and revolutions. For example, inflation and in particular food inflation is considered as one of the main reasons that caused the 2010–2011 Tunisian revolution and the 2011 Egyptian revolution, according to many observators including Robert Zoellick, president of the World Bank. Tunisian president Zine El Abidine Ben Ali was ousted, Egyptian President Hosni Mubarak was also ousted after only 18 days of demonstrations, and protests soon spread in many countries of North Africa and Middle East.


If inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply goods. Hyperinflation can lead to the abandonment of the use of the country’s currency, leading to the inefficiencies of barter.

Allocative efficiency

A change in the supply or demand for a good will normally cause its relative price to change, signaling to buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, price changes due to genuine relative price signals are difficult to distinguish from price changes due to general inflation, so agents are slow to respond to them. The result is a loss of allocative efficiency.

Positive Effects

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, and open 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 a liquidity 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

The Nobel 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.<href=”#cite_note-35″>[36] The lower real rate of interest would induce more borrowing to finance investment. In a similar vein, Nobel laureate James Tobin noted that such inflation would cause businesses to substitute investment in physical 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.)<href=”#cite_note-36″>[37] The two related effects are known as the Mundell-Tobin effect. Unless the economy is already over investing according to models of economic growth theory, that extra investment resulting from the effect would be seen as positive.

Liquidity crisis and inflation in Bangladesh

Liquidity crisis, inflation and currency devaluation are matters of intense concern in the financial and economic circles of Bangladesh since the last few months. For vulnerable and largely unstable small economies like ours, a fairly severe financial shock can have devastating effect on their entire economic, political and social structure. Economic disruptions and dislocations can lead to political and social unrests, even, conflict and chaos.

Such a scenario is one of our most horrible nightmares. All of these may sound pessimistic but we would much rather be conservative and pessimistic than liberal and optimistic where money is concerned. Money is at the root of much good but also much evil. One endeavors to enhance the good and mitigate the evil.

Our present concerns about the state of our “money” have many causes and effects. If one could correctly identify the causes and effects, then one could look for appropriate solutions to the problems. Here looking at the entire complex issue would call for much lengthier deliberations. So, we will here only deal with a few major aspects with a view to facilitating an informed understanding of them


If look at the proposed budget for fiscal 2011-2012, we will see that there is a shortfall of Tk 452 billion between the state’s earnings (Tk. 1.23 trillion) and planned expenditures (1.63 trillion). This is the budget deficit and the government fills it up through borrowings both from home and abroad. In this budget, the Annual Development Programme (ADP) is a massive, Tk. 460 billion, 41% of which will be funded from foreign sources, in all probability through borrowings euphemistically termed “project financing” by the Ministry of Planning.

Some economists contend that government borrowings, if kept well below 5.0% of the GDP, encourage growth and prevent stagnation. If borrowings exceed the 5.0% mark then it either stokes inflation when the government is spending money or recession when the government is not spending money. If the government cannot properly balance between these two contradictory tendencies, the economy faces severe problems and so some economists contend that the best budget is one which balances earnings and expenditures.

Governments borrow for various reasons, in different ways. The recent borrowings of the government are meant to curb inflation, i.e. reduce the amount of money in circulation, resulting a liquidity crisis in private sector banking and financial institutions – that is a shortage of money to lend to businesses and industries.

Without credit to operate businesses, import raw materials and machineries, industries cut down on production and cut costs by lying off workers. Without profits for businesses and industries and without jobs and earnings for individuals, there might be less money to be had; the liquidity crisis is further aggravated. Most importantly, there are less goods and services to be had, which increase the prices of everything; also exports decline reducing the state’s earnings. Thus, lack of liquidity leads to recession, at least temporarily.

Governments also borrow to fund large infrastructure projects and this may stoke inflation, i.e. there is more money in circulation than the demand for it. Consequently, the real value or purchasing power of money declines. Governments also borrow to fund import of foods and fuel when there is a shortage of such items in the country or when price of these suddenly increases in the international markets and exceeds the planned expenditures on these heads.

Governments borrow money either from banks at home and abroad or directly from the citizenry and, in return, they issue bonds, certificates or guarantees which are in effect pieces of paper which purport that the government will return your money after a certain period and will pay you a certain rate of interest for the amount and the period. The state thus incurs a liability which each citizen has to bear, sometime extending over a decade or more.

Government Debts: If we look at the expenditure side of the budget, we will find that the largest head is the interest payment on debts, amounting to 11% of all expenditures or Tk. 180 billion or Taka 1125.00 per head irrespectively, for every man, woman and child of our total population of 160 million. This is besides the repayment of the principal, which in fiscal 2011-2012 will amount to US$ 146.80 per capita. This is obviously a heavy burden to bear. If the government had not borrowed so much, the interests saved could have directly benefited the people or at least the state and the people would not have to bear the burden of “debt servicing”.

If the debts exceed the 5.0% mark, the state is likely to fall into a “debt trap”, i.e. a situation where the payment of one debt leads to incurring of another until the entire system collapses and the state goes bankrupt. This had happened to other countries in the recent past, namely Iceland in 2009 and now Greece is in a similar situation.

Inflation hits rural areas deeper

Soaring food prices have pushed overall inflation on a point-to-point basis by 0.09 percentage point to 7.61 percent in September from a month ago.

Food inflation is higher in rural areas than in urban areas, according to data released by Bangladesh Bureau of Statistics (BBS) yesterday. Food inflation in rural areas reached near 11 percent, which is more difficult for the countryside population to cope with.

In a report, the World Bank (WB) said the rise in the global prices of staples could put further pressure on food prices in Bangladesh in the next few months.

According to BBS data, food inflation continually increased and stood at 9.72 percent in September, which was 9.64 percent in August. However, non-food inflation is declining and stood at 3.69 percent in September, which was 3.76 percent in the previous month.

Rural food inflation increased to 10.51 percent in September, which was 9.95 percent in August, while urban food inflation in September declined to 7.95 percent against 8.95 percent in August.

Zaid Bakht, a research director of Bangladesh Institute of Development Studies, said it is probably because of differences in the consumption basket. Rice is a major part of the food basket for the rural people, which is not the case for urbanites.

A senior official of the Planning Commission said commercial banks disbursed significant amounts of farm loans in rural areas in recent times. There might have an indirect impact of such a move on rural food prices, he said. “The central bank could conduct a study to find the real reasons for soaring food prices in rural areas.”

Recently, a WB report on the Bangladesh economy said prices in Bangladesh are affected by price developments on the international market, especially food prices in India.

India has been experiencing double-digit food inflation since June 2009, and that contributed to food inflation in Bangladesh. On the domestic front, aman production was 4.2 percent lower than targets.

A firm estimate for Boro production is still not available although it might be 2.2 percent lower than last year, according to BBS estimates.

The WB report also said the government’s policy response has so far included participation in food grain markets, expansion of operations of the existing safety net programmes and incentives for increasing rice production.

These measures, together with higher imports to build stocks for the food grain distribution system, could have fiscal implications beyond the amounts provided in the fiscal 2011 budget for public food distribution operations, especially if the situation deteriorates.

Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets

Here is more proof that stock markets around the world have been mainly propped up by inflation (bank credit expansion)

The stock market of Bangladesh (Dhaka Index) posted as the second best performer in the world in 2010 gaining nearly 83%.

In reality fortunes seem to have reversed, as the Dhaka index suffered a record crash. This provoked street riots and prompted for the forced closure of the exchange.

Inflation: Cross Comparison & Resolution Policy

A Cross Comparison of Inflation with India & China

To make a clear understanding of inflation in comparison with India and China we are very grateful to the report published in the Daily Star in April 01,2009 named “ Why Inflation is not Coming Down Faster in Bangladesh?” written by Ahsan H. Mansur and Tamzidul Islam Chowdhury

The background: 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 (Fig: 2), 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 percent 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 percent to 4.39 percent by January 2009 and thereafter further to 2.43 percent by end-February. In China, the inflation rate dropped to the negative territory -1.6 percent 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 percent 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 programs and adoption of fiscal stimulus packages in both countries.

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 highest export dependence has suffered the most. Exports have fallen by more than 25 percent 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 percent in January). In comparison, while exports certainly slowed down in Bangladesh, export receipts still recorded modest growth in dollar terms (11.4 percent) [table: 1].

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 percent over the corresponding month of the previous year. In India, the corresponding decline in January was 18.2 percent, while imports remained steady in Bangladesh in dollar terms (Table: 2). 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 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 percent in 2009 (table: 3).

What is lesson for the policy makers? In the industrial countries bond market yield curves are generally viewed as precursor/predictor of the stages of economic/business cycle. Inflationary development is also a major indicator of the state of economic activity. The higher level of inflation in Bangladesh is essentially a reflection of its relatively robust domestic demand condition. The prevailing high asset prices in Bangladesh (both real estate and stock market), relative to other emerging economies also point to a strong domestic demand condition. In designing policy response to the global meltdown, we have to take this markedly stronger current domestic demand condition into account. While there is merit in supporting selected adversely affected sectors in a targeted and time-bound manner, there is still no case for implementing a general fiscal stimulus package in Bangladesh.

Source: Ahsan H. Mansur and Tamzidul Islam Chowdhury, Policy Research Institute.

Controlling inflation

A variety of policies have been used to control inflation.

Monetary policy

Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level; normally to a target rate around 2% to 3% per annum, and within a targeted low inflation range, somewhere from about 2% to 6% per annum. A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy.

There are a number of methods that have been suggested to control inflation. Central bank can affect inflation to a significant extent through setting interest rates and through other operations. High interest and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.

Monetarists emphasize keeping the growth rate of money steady, and using monetary policy to control inflation (increasing interest rates, slowing the rise in the money supply). Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable. Control of aggregate demand can be achieved using both monetary policy and fiscal policy (increased taxation or reduced government spending to reduce demand).

Fixed exchange rates

Under a fixed exchange rate currency regime, a country’s currency is tied in value to another single currency or to a basket of other currencies (or sometimes to another measure of value, such as gold). A fixed exchange rate is usually used to stabilize the value of a currency, visa-the currency it is pegged to. It can also be used as a means to control inflation. However, as the value of the reference currency rises and falls, so does the currency pegged to it. This essentially means that the inflation rate in the fixed exchange rate country is determined by the inflation rate of the country the currency is pegged to. In addition, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability.

Under the Bretton Woods agreement, most countries around the world had currencies that were fixed to the US dollar. This limited inflation in those countries, but also exposed them to the danger of speculative attacks. After the Bretton Woods agreement broke down in the early 1970s, countries gradually turned to floating exchange rates. However, in the later part of the 20th century, some countries reverted to a fixed exchange rate as part of an attempt to control inflation. This policy of using a fixed exchange rate to control inflation was used in many countries in South America in the later part of the 20th century (e.g. Argentina (1991-2002), Bolivia, Brazil, and Chile).

Gold standard

The gold standard is a monetary system in which a region’s common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself has no innate value, but is accepted by traders because it can be redeemed for the equivalent specie. A U.S. silver certificate, for example, could be redeemed for an actual piece of silver.

The gold standard was partially abandoned via the international adoption of the Bretton Woods System. Under this system all other major currencies were tied at fixed rates to the dollar, which itself was tied to gold at the rate of $35 per ounce. The Bretton Woods system broke down in 1971, causing most countries to switch to fiat money – money backed only by the laws of the country.

Economies based on the gold standard rarely experience inflation above 2 percent annually. Under a gold standard, the long term rate of inflation (or deflation) would be determined by the growth rate of the supply of gold relative to total output.<href=”#cite_note-50″>[51] Critics argue that this will cause arbitrary fluctuations in the inflation rate, and that monetary policy would essentially be determined by gold mining, which some believe contributed to the Great Depression.

Wage and price controls

Another method attempted in the past has been wage and price controls (“incomes policies”). Wage and price controls have been successful in wartime environments in combination with rationing. However, their use in other contexts is far more mixed. Notable failures of their use include the 1972 imposition of wage and price controls by Richard. More successful examples include the Prices and Incomes Accord in Australia and the Wassenaar Agreement in the Netherlands.

In general wage and price controls are regarded as a temporary and exceptional measure, only effective when coupled with policies designed to reduce the underlying causes of inflation during the wage and price control regime, for example, winning the war being fought. They often have perverse effects, due to the distorted signals they send to the market. Artificially low prices often cause rationing and shortages and discourage future investment, resulting in yet further shortages. The usual economic analysis is that any product or service that is under-priced is over consumed. For example, if the official price of bread is too low, there will be too little bread at official prices, and too little investment in bread making by the market to satisfy future needs, thereby exacerbating the problem in the long term.

Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed.

Cost-of-living allowance

The real purchasing-power of fixed payments is eroded by inflation unless they are inflation-adjusted to keep their real values constant. In many countries, employment contracts, pension benefits, and government entitlements are tied to a cost-of-living index, typically to the consumer price index A cost-of-living allowance (COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually in low inflation economies. During hyperinflation they are adjusted more often. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.

Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally determined indexes. Many economists and compensation analysts consider the idea of predetermined future “cost of living increases” to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity and worker bargaining power rather than simply living cos