ECONOMYNEXT – Sri Lanka’s central bank has limited back-door money printing, opposition legislator Rohini Kaviratne said, thanking the agency for limiting its liquidity injections through open market operations in display of increasing parliamentary scrutiny of its inflationary operations.
“I have to thank the central bank because subsequent to my revelation in parliament in October about the 100 billion rupees printed through the backdoor, they have changed their operations,” Kaviratne told parliament.
“Now the practice of pumping money through the backdoor into the interbank market for 7-days and 14-days at low rates has been limited.”
Kaviratne sparked a public debate on open market operations by her revelations that 100 billion rupees had been printed by the central bank in October.
Kaviratne is the latest of several legislators to question the inflationary operations of the central bank and as well as its inflation goals.
In 2025 the central bank has terminated the printed money from domestic operations amid liquidity from unsterilized dollar purchases.
Excess liquidity in money markets have risen in the first quarter of 2025 from dollar purchases after private credit declined in January 2025, allowing macro-economists to withdraw the printed money. It may not have been done due to public outrage, analysts say.
Excess liquidity from unsterilized dollar purchases, which leads to fall in short term interbank markets, could also lead to depreciation if there is no exchange rate target, analysts have pointed out.
Analysts have pointed out that claims floated that the central bank has been prevented by its new monetary law from printing money is a silly idea.
No central bank with a policy rate is prevented from printing money and de-stabilizing a country unless its flexibility or discretion is tightly controlled by law.
In Sri Lanka government legislators generally do not criticize the central bank for printing money, partly out of a reluctance to undermine its ‘independence’, but also because money printing initially reduces interest rates.
However they pay the price later, food and energy prices go up, and the inevitable stabilization crisis bites after forex shortages trigger a currency crisis if the low rates are maintained long enough.
Inflation for Growth?
Opposition legislator Kabir Hashim earlier this year while praising the central bank for its deflationary policy questioned its high 5 percent inflation target which had led to peacetime currency crises after the end of a civil war.
“We are not understanding inflation,” Hashim said during a hearing on the central bank at the parliament’s Committee on Public Finance.
“Inflation is the worst tool which can make people poorer and miserable. If you are thinking why are you not getting to five percent, we are stupid to try and tell that. Five percent is too high in my opinion.”
Under the current framework where inflation can deviate 2 percent from the target or go up to 7 percent.
Ravi Karunanayake another opposition legislator questioned what was the inflation target in India.
“Was it 2 percent”, he questioned. “Re-alinging that may be looked at,” he commented upon being told that it was 4 percent.
After the shift to a broader consumer price index from its earlier whole sale price index, the India rupee which was around 40 rupees to the US dollar for 20 years had fallen to 87 to the dollar in 14 years.
After gaining independence from Britain the nationalized Reserve Bank of India followed increasingly bad policy, forcing countries like Qatar and Dubai, Oman and the other Trucial States, which used Indian rupees to dump it and go for currency board like regimes.
The Chairman of the Parliament’s Committee on Public Finance, Harsha de Silva who called for a rate hike in public as money was printed in 2018 for mid corridor targeting (single policy rate) in the up to the currency crisis in that year has also warned about pushing growth through rate cuts.
After repeated stabilization crises from targeting 5 percent inflation and the ‘output gap’, Sri Lanka’s ‘potential output’ is now believed to be far below its actual 5 percent growth.
The IMF gave technical advice to calculate potential output, just like it is now giving technical advice to do a single policy rate and liquidity forecasts.
Sri Lanka’s excessive inflation also seems to be coming from a belief among macro-economists that inflation, not stability, is required for growth.
Abundant Reserves
Warnings have also been given about Sri Lanka’s shift to a single policy rate following IMF technical advice which implies an excess reserve framework.
A single policy rate with excess liquidity – unlike a corridor system where money is given through a liquidity adjustment facility for clearing purposes only – with government liquidity forecasts absolving banks from managing their own assets and liabilities – is a deadly regime, critics have pointed out.
The current troubles in the US have come from an abundant reserve system, coupled with what is called Flexible Average Inflation Targeting (FAIT), which allows the Fed to suppress rates for a longer period, giving various excuses.
In the latter part of 2024, Sri Lanka’s central bank swaps have also increased.
Through swaps, a central bank can pump liquidity into money markets to artificially push down rates, unrelated to current credit market or development in the balance of payments development, in a similar way to printing money through domestic operations.
About 40 billion rupees of excess liquidity since October 2024 have come from inflows into Treasuries markets due to confidence in exchange rate management up to now.
Foreign capital inflows that come from confidence in the exchange rate are a legitimate source of additional capital that reduces the interest rate structure of a country that does not have exchange controls.
However, in a country with a flawed monetary regime with anchor conflicts (a flexible exchange rate) which has resulted in exchange controls, such flows can lead to worsening external instability when rates are mis-targeted, as happened from 2015 to 2019 in Sri Lanka, critics have pointed out.
The Age of Inflation and OMO
Central bankers ushered in what is called the ‘age of inflation’ after the 1920s where currency crises and economic bubbles are fired in peacetime without a war, through indiscriminate liquidity injections to defend a pattern of interest rates (transmission mechanism).
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When Scottish Mercantilist John Law originally proposed rate cuts, through indiscriminate domestic operations, classical economists in Britain opposed him. Law then persuaded the Duke of Orleans, who was regent to Phillip XV of France to do it.
The central bank he built, called Bank Generale (later Bank Royale), then fired what came to be called the Mississippi Bubble, bringing down France like Sri Lanka and also endangering neighboring countries.
READ MORE: John Law and the Mississippi Bubble
Classical economists in Britain and legislators like Kaviratne, have long opposed indiscriminate credit operations in Britain, bringing a number of laws against the Bank of England to stop its excesses through a series of debates in and out of parliament.
Fed’s New York Bubbles
Modern open market operations were suddenly devised in April 1923 by the Federal Reserve, without any debate in the Congress about its merits.
The Fed then fired a veritable Mississippi Bubble in the New York Stock Exchange, while the government was running budget surpluses to reduce World War I debt.
In earlier ages, including during World War I, money was printed as a desperate last resort, with full knowledge of its consequences.
The collapse of the Fed’s Mississippi-like bubble (also known as the roaring 20s bubble) led to the Great Depression.
There have been claims that stock market investors jumped from high rises in New York as the OMO fired stock market bubble collapsed in 2029. READ MORE (THE JUMPERS OF ’29)
The Great Depression legitimized ‘macroeconomic policy’ with Keynes writing his General Theory leading stimulus and the de-stabilization of state finances as a deliberate policy advocated by state interventionists which was strengthened by statistics or econometrics.
As policy rates infected other countries, currencies collapsed in the 1930s as other economies recovered from the depression, and import duties and protectionism came to the fore.
It was primarily through open market operations and rate cuts to the floor, that the Federal Reserve also fired the Mississippi-like Housing Bubble, the collapse of which led to unprecedented ‘macroeconomic’ policy involving ‘back-door money printing’ involving excess liquidity or an abundant reserve regimes.
The collapse of the Housing Bubble also had ripple effects especially in Europe which also ran an 8-year credit cycle. The original Mississippi bubble also had a devastating effect on the British financial system.
Ironically the Housing Bubble was fired by macroeconomists as the US got the ability to run budget surpluses for the first time since the collapse of the Bretton Woods amid monetary stability.
The Deflation Scare
The ostensible reason for macroeconomists to run the housing bubble was that by the late 1990s that the US was in ‘deflation’, as productivity gains of capitalism translated into lower consumer prices in the absence of a formal inflation target in the US.
The productivity gains came from 20 years of improving monetary stability from 1980 to 2000, known as the Great Moderation, where macroeconomics was defeated initially by Paul Volcker who favoured zero inflation and also by Alan Greenspan.
Central bank’s like those in Sri Lanka do not trigger a deflationary collapse leading to falling commodity prices and farmers losing land from foreclosures as in the Great Depression but an inflationary collapse, starving little children as food prices rocket.
Greenspan also tamped down on any emerging ‘Mississippi Bubble’ claiming among other things that there was ‘irrational exuberance’ in markets.
Classical economists who opposed policy rate and abundant reserves regimes had identified three consequences of money printing/open market operations which they called inflation: rising commodity prices (food and energy), asset prices bubbles and mis-allocation of credit which they called mal-investments which leads to bad loans in the subsequent stabilization crisis.
Governments are also ousted in each stabilization crisis that follows aggressive rate cuts.
The current administration has taken pains not to resort to inflationary financing, but the central bank has a five percent inflation target under flexible inflation targeting.
Each currency crisis or stabilization crisis that follows rate cuts from inflationary open market operations, then destroys the central government and state enterprises, shattering the parliamentary control of public finance.
A central bank could also mis-target rates and trigger economic and fiscal crises by ‘signaling’ without actually printing large volumes of money, provided there was a ‘transmission mechanism’ that responded to mis-targeted rate cuts of a ‘monetary cabinet’.
The housing bubble was originally fired by the Fed mostly through ‘signalled’ rate cuts, without running ARS frameworks or single policy rates which became commonplace after the collapse of the housing bubble.
In the age of inflation and policy rates, the countries that suffered worst were in Latin America, which were closest and most influenced by what came to be known as ‘Saltwater Universities’.
The few countries that escaped the carnage were Germany, Denmark, and a few East Asian nations that were influenced by classical theories filtering from German or Austrian economists and the GCC area.
In earlier ages, the collapse of an economy led to the collapse of the agency that produced it, along with the destruction of government debt it owned and inflation also stopped instantaneously.
A new money or currency competition by people, any legal tender law if it exists, then leads to a period of stability and prosperity.
However, since central banks were nationalized in the last century, the lost confidence in their money monopoly is restored by crushing private credit through high interest rates and the agency is preserved and allowed to trigger new crises.
In Sri Lanka the Port City special economic zone is free from OMO, and the 5 percent inflating money monopoly. (Colombo/Mar23/2025)
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