ECONOMYNEXT – Sri Lanka’s cost of living will rise to the 5 to 7 percent target, in the second half of 2025, the central bank has said, ending falling price it has achieved under broadly deflationary monetary policy since the second half of 2022.
Amid deflationary policy the central bank allowed the exchange rate to appreciate, bringing down prices absolutely, which is not usual under International Monetary Fund programs.
In the ‘age of inflation’ involving the invention of indiscriminate open market operations and currency debasement, deflation is rarely seen, but Sri Lanka’s central bank allowed the exchange rate to appreciate in the current program amid deflationary policy.
The central bank however claimed that the deflation was due to ‘supply side’ factors.
“The deflationary environment resulting from the one-off effects of supply-side price adjustments will continue in early 2025 as per the current projections of the Central Bank,” said in a policy action report in January.
“However, inflation is projected to converge to the target during the latter half of the year with the dissipation of the effects of such supply-side factors and accommodative conditions created by relaxed monetary policy.”
“Until then, the Central Bank will continue to submit comprehensive reports to the Parliament as required under the Central Bank of Sri Lanka Act (CBA), providing reasoning for missing the inflation target, despite it being on the downside, with the aim of ensuring transparency and accountability of the actions of the Central Bank.”
The first such report has already been submitted.
Central bank’s deflationary policy, which restored external stability, and currency appreciation which helped bring down the price of traded goods and energy, was probably its greatest short term achievement a 75 year history, where it has done the opposite, according to some analysts.
The US Fed started to reverse money printing from 2022 March, helping bring down commodity prices.
The belief in non-monetary inflation is found in high inflation countries with bad money central banks, and was championed in the US and UK until Paul Volker became the Chairman of the Federal Reserve.
IMF programs in the 1970s – including the largest at the time for the UK – had provisions limiting wages in the belief of ‘wage spiral inflation’, rather than the lack of a credible anchor to control central bankers under completely fiat money.
Classical economists have attributed to the belief in supply driven inflation or cost push (so-called monetary policy neglect) as the key reason for the Great Inflation of the 1970s.
READ MORE: Great Inflation of the 1970s: What Really Happened? – US Fed
The 9 percent inflation generated by the Fed recently was also due its belief that inflation was caused by supply chain bottlenecks, which was ‘transitory’ rather than its open market operations and ‘ample reserves regime’.
Only a few legislators challenged the doctrine, which Fed Chief Jerome Powell, finally admitted was a mistake.
“Following the high inflation episode from late 2021 to early 2023, it is believed that this temporary period of deflation would provide some respite to the general public by dampening the cost of living to some extent,” the central bank report said.
Sri Lanka’s central bank has an inflation or cost of living increase target of 5 percent which can go up to 7 percent, which 200 to 350 percent of the levels imposed on central banks in countries with monetary stability.
The central bank triggered currency crises in 2012, 2015, 2018 and 2020 in printing money to generate 5 percent inflation.
Successive governments have appointed cabinet sub committees to reduce the cost of living instead of giving a tighter inflation target to control the monetary authority’s ability to push prices.
Unlike classical economists, modern inflationists in the age-of-inflation of permanently rising prices, believe that positive inflation or ‘price pressure’ is needed for ‘growth’. (Colombo/Jan19/2025)
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