ECONOMYNEXT – Sri Lanka’s central bank came in for high praise from opposition legislator Kabir Hashim, for the recent deflation it has achieved, after the agency ‘missed’ its inflation target of 5 percent plus or minus 2 percent erring on the side of the poor and stability.
Exceptionally Great
“What the Governor and the team have done in the past two years is exceptionally great,” opposition legislator Kabir Hashim said amid questions from some members of the parliament’s Committee on Public Finances on how quickly inflation will go up to 5 percent.
“We were in a really bad place, we lived through it and saw it.”
“We are not understanding inflation. Inflation is the worst tool that can make people poorer and miserable.
“If you are saying, ‘Why are we not getting to 5 percent?, We are stupid to tell that.”
Sri Lanka’s new government recently appointed a cost of living committee to try to bring down prices and has since imposed price controls on rice, triggering shortages of red rice, while the central bank is supposed to busily print money and depreciate the currency push up inflation to 5 percent under the pact signed with the government under its new monetary law.
In the second and their quarter of 2024 inflation fell below the 2 percent floor, to levels usually achieved in developed nations or the fastest growing East Asian nations with monetary stability, like Singapore, Hong Kong, Thailand, Malaysia, Taiwan or China after 1993.
Reducing cost of living is deflation
A government legislator said it was generally the policy of the government to bring down prices, especially utility prices.
“This year by the third quarter inflation will get back to 5 percent,” Central Bank Governor Nandalal Weerasinghe said.
“Our concern is that it may exceed the target. That is pretty bad. Moving below the target for the time being – if the government objective is to reduce the prices, then deflation is reducing prices.”
However it is inflationist macro-economists themselves, who have spread the narrative making people believe that deflation is bad, creating confusion, critics say.
Before fully fiat money, when a central bank fires a credit bubble through its open market operations, a deflationary collapse (credit contractions) followed which brought prices back to previous levels.
In the collapse that follows rate cuts and inflationary policy, many SMEs and other investments including real estate projects collapse.
Sri Lanka’s credit has already started expanding as falling prices drive retail demand.
Retailers have also to expand even though basket sizes have not yet exceeded pre-crisis levels. Building material prices have also eased, helping investment projects.
In 1980, Singapore’s then Finance Minister told Sri Lanka President J R Jayewardene to watch the central bank’s treasury bill stock and building material prices. Singapore does not have centrally planned policy rates like Sri Lanka.
After 1971 in particular, collapses coming after rate cuts were inflationary, leading to permanent inflation.
And after 1978, people in developing countries without a credible anchor, literally starved (skipped meals) as inflation exploded amid depreciating fiat money.
Full Employment Inflationism
Until the early 1960s, inflation in the world whether advanced economies or developing countries was the same and close to zero.
In the 1960s, inflationist US and UK academics claimed that there was a trade-off between growth (or employment) and inflation.
Post World War II German and Austrian economists rejected the idea and grew strongly while English speaking countries suffered.
The doctrine hit Sri Lanka as potential output after the end of a civil war with IMF technical assistance.
It has also crept into the new monetary law where a massive 5 percent inflation target has now been set.
As inflation rose in the 1960s Anglophone statistical inflationists then started a narrative about ‘real’ interest rates.
The US then started to fire longer credit cycles with centrally planned rate cuts and to boost employment and rate hikes when inflation went up (lean against the wind) without regard to gold losses and build ups of its notes at other central banks.
Inflation (and gold prices) went up around the world as so-called ‘full employment policies’ with inflationary open market operations conflicted with gold as the final backstop under the Bretton Woods. The US avoided redeeming its notes against gold through various uses, including swaps.
However, since developing countries were fairly strongly pegged (anchor) to the US, inflation rose in tandem but there was no divergence.
Sri Lanka started to go to the IMF at that time, with central bank re-finance of private credit worsening external crises and making budgets unmanageable.
In 1971, after the Bretton Woods collapsed, leaving advanced nations without an anchor, inflation rocketed in the so-called Great Inflation.
However, there was also no divergence with developing countries in the 1970s as the US dollar was mostsly their anchor for money.
Sri Lanka also had broadly the same inflation as the US up to 1978.
Inflation Apartheid
Amid floating exchange rates, commodity prices went through large fluctuations unlike when the gold standard was kept more strictly.
Econometricians including Robert Gordon, then came up with the concept of ‘core inflation,’ cherry picking (non-traded) items that took more time to respond to money printing.
In 1978, the International Monetary Fund which was originally set up to maintain exchange rate parity amended its Articles and there was no longer a requirement to anchor money either to the US dollar or to gold. Developing countries were cut off without a credible anchor for money.
Currencies collapsed as they tried to run independent monetary policy by printing money, running credit cycles even longer than the US, or tried money supply targeting without a clean float.
Latin American nations which did not have exchange controls and more developed open market operations, suffered the worst. External defaults followed in quick succession.
The most successful East Asian nations ignored the Second Amendment and kept their pegs as required under their respective monetary laws, running neutral or deflationary policy and maintained social and political stability.
As advanced floating rate central banks initially targeted money supply from 1979 as an anchor and got inflation down, the tightly (more or less) pegged East Asian nations benefited and became industrial powerhouses.
Japan and Singapore as well as Germany and Switzerland ran deflationary policies, rejected full employment policies and appreciated against the US dollar after 1971.
Five percent target is too high
The US Fed abandoned full employment policies under Paul Volcker bringing in the so-called Great Moderation which ended in 2000 with reflation policies.
In 1994, New Zealand was credited with inventing low inflation targeting, also abandoning full employment policies to provide a rule or anchor for clean floating fiat money.
Sri Lanka’s inflation this year is actually better than advanced nations which are struggling with so-called ‘ample reserve frameworks’, quantity easing seeing inflation levels close to Great Inflation after quantity easing and a revival of full employment policies.
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Hashim said Sri Lanka’s cost of living target of 5 percent was set during the government of ex-President Ranil Wickremesinghe.
“Five percent was too high in my opinion. I said at the time, we should set it at 4 percent or 3 percent. New Zealand has 3 percent as its inflation target,” Hashim said.
“Because with 5 percent plus or minus 2 percent he can to up to 7 percent. And when you go to 7 percent you can have runaway inflation.
“As he said, six months later bringing it down would be a nightmare. Our exchange rate will go through the roof, we will have huge problems.”
In batting for a lower inflation target, Hashim was echoing the words of a former Bundesbank chief Karl Blessing, who provided the backdrop for its post World War II German economic miracle and Social Market Economy.
“The Anglo-Saxon slogan ‘living with inflation’ is not valid for us,” Blessing said as the UK in particular struggled after World War II and Germany took off.
“Inflation, as a wise man once said, is a nymph who is never satisfied with a simple flirt.”
Hashim said the Yahapalana administration suffered from monetary instability as “we played around with interest rates” the currency collapsed from “152 to 180-odd within a month or so” during their rule by trying to push growth.
“So we can make mistakes like that.”
In 2018 the currency collapsed despite budget deficits being brought down, reducing government credit demand and fuel was market priced, making the CPC deposit cash in state banks, rather than borrowing.
However, the currency collapsed as money was printed to cut rates and later to sterilize inflation leading to its economic policy being discredited and the government losing elections.
“I think the inflation targeting they are doing is correct,” Hashim said. “What they are doing now is not to get it over (the target).
“It will be worse for the government if inflation gets out of control.” (Colombo/Jan28/2025)
