price inflation in bangladesh

7/28/2019 Price Inflation in Bangladesh

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Introduction:

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.

Till now, no concerted strategy has been adopted in Bangladesh in view of the ongoing

global economic crisis. This owes partly to the fact that the (negative) impacts are yet

be visible in the economy. Performance of Bangladesh in such areas as export,

remittance, share market, and aid has been along historical trends during the July-

December 2008 period. However, some of the early disquieting developments are

starting to emerge in some sectors (banking and finance, import duties). Government of

Bangladesh has set up a technical committee and The Central Bank (Bangladesh Bank) as

taken some precautionary measures through its monetary policy and has set up taskForce to review and monitor the situation.

In the following sections, under some broad headings, a number of initiatives

which concern the relevant areas, have been highlighted. However, as was pointed out

earlier, any of these initiatives that were taken in the recent past were not directly

related to e causes or consequences of the global financial crisis, and are in many


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instances, coincidental. Nevertheless, some of the very recent initiatives

(encouraging higher remittance, banking sector practices, reserve management)

appear to be inferred by concerns about possible impacts and consequences.

What is Inflation?

Inflation is the rise in general level of prices of goods and services. It can be said in other

ways that inflation is the decrease in value of money. It means that

each dollar can purchase fewer amounts of goods and service then previous.

It reduces the purchasing power of the currency.

Inflation does not mean that all prices are increasing, even during period of rapid

inflation; some prices may be relatively constant while others are falling.

The troublesome aspect of inflation is that prices rise unevenly, some raises sharply,

some slowly and some dont rise at all.

The main measure of inflation is the consumer price index.

Inflation in Bangladesh:

As we know Bangladesh is a country of middle income. Nearly 65% of total population

income is less than $1. Bangladesh is primarily an agrarian economy. 66% of in

Bangladesh people are work in agriculture sector. Nowadays price hike is one of the main

concerns of Bangladeshi people. Though their income is not increase as much as need but

their expenses are increases day by day. As a result people consume more than theirincome. And poor people are getting poorer day by day. Government has taken some

short-term policies but those are not paying off.

In this report we try to understand that why price hike in Bangladesh, what is the reason

behind it an, what consequent are arises among Bangladesh people for these


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unsustainable price hike in consumption goods and what are the initiative measures

government can take to at least make the price level sustainable.

Inflation rate Rural Urban

Food 8.79 9.44

Non-food 7.83 6.09

Background:


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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, 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 per cent 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 per cent to 4.39 per cent by January 2009 and

thereafter further to 2.43 per cent by end-February. In China, the inflation rate

dropped to the negative territory -1.6 per cent 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 6.0 per cent 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 programmes and adoption of fiscal

stimulus packages in both countries.


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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 its highest export dependence has suffered the most. Exports have fallen

by more than 25 per cent 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 per cent in January). In comparison, while exports certainly slowed down in

Bangladesh, export receipts still recorded modest growth in dollar terms (11.4 per

cent).

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 per cent over

the corresponding month of the previous year. In India, the corresponding decline in

January was 18.2 per cent, while imports remained steady in Bangladesh in dollar

terms. 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


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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 per cent in

2009.

Faces of Inflations/ Types of Inflations:

The most burning issue, at this time, in Bangladesh is the price inflation, it is too tough

and really hard to find any sector that is free from the impact of the inflation or find any

one who does not face the faces of inflation.

In the very recent, the prices of most things Bangladeshis buy more than doubled. Such a

general increase in prices is called inflation. Prices of selected goods may increase for

reasons unrelated to inflation: the price of rice may rise because unseasonably heavy

rainfall in the country that ruined the rice or the price of gasoline may rise if the oil-

producing countries set a higher price for oil. During inflation, however, all prices tend to

rise. Over the last 400 years there have been many periods of inflation. . Inflation hasbeen defined as "too much money chasing too few goods." As prices rise, wages and

salaries also have a tendency to rise. More money in people's pockets causes prices to rise

still higher so that consumers never quite catch up. Inflation can go on continuously year

after year so long as the money supply continues to increase. Continued inflation affects

people in diverse ways. Those who live on fixed incomes, or those whose incomes

increase very slowly, suffer most from inflation because they are able to buy less and

less. Those who lend money when prices are lower may be paid back in taka of reduced

purchasing power. Banks and savings and loan associations generally lose from inflation.

People who borrow money, however, may profit by paying their debts in taka that have

shrunk in purchasing power. Inflation thus encourages borrowing and discourages saving.

It also leads people to buy real estate and durable goods that will keep their value over

time. In Bangladesh this tendency is reinforced by the tax system, which allows taxpayers


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to deduct property taxes and interest payments from their taxable incomes. If inflation

continues for a long time, the country as a whole may begin to consume more and invest

less as people find it more profitable to borrow than to save. In other words inflation

causes society to use more of its resources for today's purposes and to set aside less for

tomorrow's needs

Rising rate of inflation has become a serious concern in Bangladesh in recent years. The

impact of rising inflation rate is being felt almost everywhere. The prices of essential

commodities have gone up, and so is the cost of living. Countrys vast multitude of poor

and unemployed people is having a difficult time to survive.

To talk about inflation and its effects on our every day life in Bangladeshis and to combat

it or cope with the present situation, we first in a very need of look at the faces of

inflation; Let us define what inflations are and what their faces are?

This Inflation is divided into two types-:

Price Inflation

Monetary Inflation

The first type (about prices) is when there is a rise in the general level of prices of goods

and services over a period of time, and

The second type (monetary) is when there is a rise in the quantity of money in an

economy.

Both types are in many times interrelated, and both have negative effects on the economy

and individuals. We will focus mainly on the price inflation.

Price Inflation The term inflation generally refers to a rise in the general level of prices

of goods and services in an economy over a period of time. If the price level increases,

one unit of currency can purchase fewer amount of goods and services. In order words, it

reduces purchasing power of money, the unit of

account of an economy


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Price inflation can also be seen in a slightly different form, where the price of a good is

the same year over year, but the amount of the good received gradually decreases. For

example, you may notice this in low-cost snack foods such as potato chips and chocolate

bars, where the weight of the product gradually decreases while the price remains the

same

There are four main types of inflation. The various types of inflation are briefed below-

1. Demand pull Inflation

2. Cost-push Inflation

3. Pricing Power Inflation

4. Sectoral Inflation

5. Fiscal Inflation

6. Hyperinflation

Demand-pull Inflation: Demand-pull or excess demand inflation is also called as

Wage inflation. This type of inflation occurs when total demand for goods and services in

an economy exceeds the supply of the same. When the supply is less, the prices of these

goods and services would rise, leading to a situation called as demand-pull inflation.


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The demand-pull inflation stems from a situation when aggregate demand surpasses

aggregate supply of the economy. When the income of the consumers increases due to

increased investment, government expenditure and exports, it leads to rightward shift of

the aggregate demand curve from D0 to D1. In response, aggregate supply (S) cannot

expand immediately. In the initial price level, it creases an excess demand pressure (y1

y0) at initial price levelP0, and prices begin to go up. This causes real income, investment

and real net exports to decrease, which ultimately lead to reduce in output to y1 with a

new price level P1 (Figure 3.1). The price increase generated by an upward shift in the

economys aggregate demand is referred to be demand-pull inflation.

This type of inflation affects the market economy adversely during the wartime.

Cost-push Inflation: As the name suggests, if there is increase in the cost ofproduction of goods and services, there is likely to be a forceful increase in the prices of

finished goods and services. For instance, a rise in the wages of laborers would raise the

unit costs of production and this would lead to rise in prices for the related end product.

This type of inflation may or may not occur in conjunction with demand-pull inflation.

cost-push inflation, which has its impetus on the supply side of the economy, results from

an upward or inward shift of the aggregate supply. The exogenous upward shift of the

aggregate supply curve from S0 to S1 due to demand for higher wage, higher price of raw


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material and fuel, etc. creates excess demand pressure (y1y0) at initial price P0, thereby

increasing price level but reducing equilibrium output level along the aggregate demand

curve.

Two measures are mainly used to indicate the changes in price level or inflation:

consumer price index (CPI) and GDP deflator.6 However, the former is the most widely

used method of estimating inflationary pressure where general, food and non-food

Pricing Power Inflation: Pricing power inflation is more often called as administered

price inflation. This type of inflation occurs when the business houses and industries

decide to increase the price of their respective goods and services to increase their profit

margins. A point noteworthy is pricing power inflation does not occur at the time of

financial crises and economic depression, or when there is a downturn in the economy.

This type of inflation is also called as oligopolistic inflation because oligopolies have the

power of pricing their goods and services.

Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes

place when there is an increase in the price of the goods and services produced by a

certain sector of industries. For instance, an increase in the cost of crude oil would

directly affect all the other sectors, which are directly related to the oil industry. Thus, the

ever-increasing price of fuel has become an important issue related to the economy all

over the world. Take the example of aviation industry. When the price of oil increases,

the ticket fares would also go up.

Some other type of Inflation is explained below:

Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This

occurs when there is a deficit budget.

Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation.


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This type of inflation occurs during or soon after a war.

Causes of Inflation:

Bangladesh has no specific reason of inflation at present. Inflation is increasing more and

more for several reasons. But all reasons are not equally important. Some reasons

influence more and some reasons influence less. It is obvious that inflation rate in the

recent period increased due to price hike of food items in both domestic and international

markets. Inflation in Bangladesh also surged due to increase in the prices of petroleum

products and natural gas by the government.

The reasons of inflation are:

1) Decreasing the price of money

2) Raising price in world market

3) Raising price of fuel

4) Lower growth in agricultural sector

5) Import cost

6) Supply Shortage

7) Market Syndication

8) Increase in wage rate

9) Exchange rate

10) Taking initiative against corruption

1) Decreasing the price of money:

The 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 inflation situation. 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


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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.

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.

2) Raising price in world market:

One of the causes of inflation 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 also went up.

3) Raising price of fuel:

The net impact of recent fuel price is unlikely to be significant but it would have effect

on poor people, whose livelihood depends on the use of kerosene and diesel. In order to

catch up with the cost of imported oil, domestic prices have gone up immediately. Higher

price, to some extent, is not domestically induced. Rather it is attributed to an increase in

international prices, particularly of several food items as well as items steel and oil. If we

look at the international price of the oil then we see that oil price has risen significantly,

which affects almost every sector such as industry, agriculture, transportation and is

increasing the cost of production.

4) Lower growth in agricultural sector:

Bangladesh is regularly hit by natural calamities like flood and cyclone, and these

hamper the agricultural production very much. And also mismanagement in fertilizerdistribution, insufficient electricity supply hampers production. Also lack of knowledge

in using and adapting to modern technologies and ideas in the agricultural sector limit

the chance of rapid improvement.


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5) Import cost:

Typically import occupies a significant place in the Bangladesh economy, most of the

essential food items (for example, sugar, rice, wheat, onion etc) and, more generally,

machineries, intermediate goods and raw materials used in production are imported. Cost

of imports can, therefore, be expected to have a substantial influence on domestic

inflation directly (through final goods) or indirectly (through intermediate goods).

According to available statistics, import price index (MPI) of Bangladesh has

continuously soared over time. Import is increasing gradually day-by-day and sudden

hike international price or decrease in real interest raise the price of the goods.

Bangladesh Bank (BB) has projected continuous inflation in the domestic economy due

to constant external pressure on prices and demand side.

6) 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 inflation rate is the supply shortage of the agricultural and industrial goods.

7) Market Syndication:

Unfair cartel among the suppliers might seriously hamper the course of the economy by

engendering inflation via the creation of a false supply shortage even during a period of

robust growth in production. Such undesirable events have taken place in recent years as

food inflation remained high in the same time period despite the notable growth in food

production. Monopolistic control of several food items such as sugar, onion, pulses and

edible oil by market syndication seems to have led to this situation. Obviously such

manipulation is a type of supply side disturbance.

8) Increase in wage rate:

The role of inflationary expectations is also important in explaining inflationary process

in a given period. If workers expect a rise in the inflation rate, they will demand higher

nominal wage to keep their real wage stable. Once people come to expect high rates of


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inflation, the expectation alone will generate further inflation without any change in the

existing labor market conditions. In general, if there is a lack of confidence in monetary

policy, inflationary expectations are likely to be self-fulfilling.

9) Exchange Rate:

Exchange rate exerts inflationary pressure mainly via import prices. Historically,

exchange rate in Bangladesh exhibited steady increase over time. Exchange rate generally

increases the import cost and that cause inflation.

10) Taking initiative against corruption:

Taking initiative action against corruption and corrupted businessmen by the government

put fear among the businessmen. So most of themselves take away themselves from

normal business flow or import and this occur shortage in goods and create inflation.

Impact of price inflation in Bangladesh:

The effects of monetary inflation are three-fold;

First, it brings about an unwarranted transfer of purchasing power (resources) to the

creator of the new money and/or the first user of the new money. Another name for this

unwarranted transfer is theft.

Second, it has a NON-UNIFORM effect on prices, leading to mal-investment and the

wastage of resources. The huge amount of savings and resources squandered in real-

estate investments over the past several years exemplifies the havoc that can result from

monetary inflation and why its effects cannot simply be counteracted at some later time

by "withdrawing liquidity".

Third, it EVENTUALLY results in a broad-based increase in the prices of everyday

goods and services.


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Almost everyone focuses on the third of these effects, but the greatest injustices and

economic problems result from the first two. The "Keynesians" and the "Monetarists", for

instance, are generally unaware of the first two effects. In their fatally flawed views of

the economic world, monetary inflation either doesn't matter at all or doesn't matter

unless/until it causes the CPI to rise.

Inflation always hurts our standard of living. Rising prices means we have to pay more

for the same goods and services. If our income increases at a slower rate as inflation, our

standard of living declines even if we are making more. Inflation's main consequence is a

subtle reduction in our standard of living.Inflation doesn't affect everything equally.Gas pricescan double while our home loses

value. This makes financial planning more difficult.

Inflation is really bad for ourretirement planning because our target has to keep getting

higher and higher to pay for the same quality of life. In other words, our savings will buy

less. As a result, we will need to save more today to pay for higher priced goods and

services in the future. Since everything we buy today costs more, so we have less left-

over income available to save.

Inflation has another bad side-effect...once people start to expect inflation, they will

spend now rather than later. That's because they know things will only cost more lately.

This consumer spending heats up the economy even more, leading to further inflation.

This situation is known as spiraling inflation because it spirals out of control.

General effect:

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
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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 payment.

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 we take a loan where the stated

interest rate is 6% and the inflation rate is at 3%, the real interest rate that we are paying

for the loan is 3%. It would also hold true that if we had a loan at a fixed interest rate of

6% and the inflation rate jumped to 20% we 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:

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,


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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 fixedexchange rates are imposed, higher inflation in one

economy than another will cause the first economy's exports to become more expensive

and affect thebalance of trade. There can also be negative impacts to trade from an

increased instability in currency exchange prices caused by unpredictable inflation.

Positive:

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, andopen 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 aliquidity 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

TheNobel 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. The lower real rate of

interest would induce more borrowing to finance investment. In a similar vein, Nobel
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laureate James Tobin noted that such inflation would cause businesses to substitute

investment inphysical 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.). The two related effects are

known as the Mundell-Tobin effect. Unless the economy is already over investing

according to models ofeconomic growth theory, that extra investment resulting from the

effect would be seen as positive.

Instability with Deflation

Economist S.C. Tsaing noted that once substantial deflation is expected, two important

effects will appear; both a result of money holding substituting for lending as a vehicle

for saving. The first was that continually falling prices and the resulting incentive tohoard money will cause instability resulting from the likely increasing fear, while money

hoards grow in value, that the value of those hoards are at risk, as people realize that a

movement to trade those money hoards for real goods and assets will quickly drive those

prices up. Any movement to spend those hoards "once started would become a

tremendous avalanche, which could rampage for a long time before it would spend

itself." Thus, a regime of long-term deflation is likely to be interrupted by periodic spikes

of rapid inflation and consequent real economic disruptions. Moderate and stable

inflation would avoid such a seesawing of price movements.

Financial Market Inefficiency with Deflation

The second effect noted by Tsaing is that when savers have substituted money holding

for lending on financial markets, the role of those markets in channeling savings into

investment is undermined. With nominal interest rates driven to zero, or near zero, from

the competition with a high return money asset, there would be no price mechanism in

whatever is left of those markets. With financial markets effectively euthanized, the

remaining goods and physical asset prices would move in perverse directions. For

example, an increased desire to save could not push interest rates further down (and

thereby stimulate investment) but would instead cause additional money hoarding,

driving consumer prices further down and making investment in consumer goods
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production thereby less attractive. Moderate inflation, once its expectation is incorporated

into nominal interest rates, would give those interest rates room to go both up and down

in response to shifting investment opportunities, or savers' preferences, and thus allow

financial markets to function in a more normal fashion.

How to combat inflation:The three tools that the government used to combat inflation are:

1. Fiscal policy of the government

2. Monetary policy of the government

3. Direct action policy of the government

The tools are explained briefly below:

1. Fiscal policy of the government:

a. Increasing the rate of direct tax

When government increases the tax, available money in the hands of the

people decreases and thus buying power decreases for which demand

decrease.

b. Lowering the rate of indirect tax

When government lowers the indirect tax such as taxes on imported goods,

the price of those goods doesnt inflate.

c. Offering subsidy in production/import

Subsidy in the goods and services produced and also on the imported goods,

keep the price of those things in normal range

d. Contracting government development expenditure


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In economics, fiscal policy is the use of government expenditure and revenue collection

(taxation) to influence the economy.

Fiscal policy can be contrasted with the other main type of macroeconomic policy,

monetary policy, which attempts to stabilize the economy by controlling interest rates

and the money supply. The two main instruments of fiscal policy are government

expenditure and taxation. Changes in the level and composition of taxation and

government spending can impact on the following variables in the economy:

Aggregate demand and the level of economic activity;

The pattern of resource allocation;

The distribution of income.

Fiscal policy refers to the use of the government budget to influence the first of these:

economic activity.

Stances of fiscal policy

The three possible stances of fiscal policy are neutral, expansionary and contractionary.

The simplest definitions of these stances are as follows:

A neutral stance of fiscal policy implies a balanced economy. This results in a large tax

revenue. Government spending is fully funded by tax revenue and overall the budget

outcome has a neutral effect on the level of economic activity.

An expansionary stance of fiscal policy involves government spending exceeding

tax revenue.

A contractionary fiscal policy occurs when government spending is lower than tax

revenue.

However, these definitions can be misleading because, even with no changes in spending

or tax laws at all, cyclical fluctuations of the economy cause cyclical fluctuations of tax

revenues and of some types of government spending, altering the deficit situation; these

are not considered to be policy changes. Therefore, for purposes of the above definitions,
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"government spending" and "tax revenue" are normally replaced by "cyclically adjusted

government spending" and "cyclically adjusted tax revenue". Thus, for example, a

government budget that is balanced over the course of the business cycle is considered to

represent a neutral fiscal policy stance.

Methods of funding

Governments spend money on a wide variety of things, from the military and police to

services like education and healthcare, as well as transfer payments such as welfare

benefits. This expenditure can be fundedin a number of different ways:

Taxation

Seigniorage, the benefit from printingmoney Borrowing money from the population or from abroad

Consumption of fiscal reserves.

Sale of fixed assets (e.g., land).

All of these except taxation are forms of deficit financing

Borrowing

A fiscal deficit is often funded by issuing bonds, liketreasury bills orconsolsand gilt-

edged securities. These pay interest, either for a fixed period or indefinitely. If the interest

and capital repayments are too large, a nation may default on its debts, usually to foreign

creditors.

Consuming prior surpluses

A fiscal surplus is often saved for future use, and may be invested in local (same

currency) financial instruments, until needed. When income from taxation or othersources falls, as during an economic slump, reserves allow spending to continue at the

same rate, without incurring additional debt.

Economic effects of fiscal policy
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Governments use fiscal policy to influence the level of aggregate demand in the

economy, in an effort to achieve economic objectives of price stability, full employment,

and economic growth. Keynesian economics suggests that increasing government

spending and decreasing tax rates are the best ways to stimulate aggregate demand. This

can be used in times of recession or low economic activity as an essential tool for

building the framework for strong economic growth and working towards full

employment. In theory, the resulting deficits would be paid for by an expanded economy

during the boom that would follow; this was the reasoning behind theNew Deal.

Governments can use a budget surplus to do two things: to slow the pace of strong

economic growth and to stabilize prices when inflation is too high. Keynesian theory

posits that removing spending from the economy will reduce levels of aggregate demandand contract the economy, thus stabilizing prices.

Economists debate the effectiveness of fiscal stimulus. The argument mostly centers on

crowding out, a phenomenon where government borrowing leads to higher interest rates

that offset the simulative impact of spending. When the government runs a budget deficit,

funds will need to come from public borrowing (the issue of government bonds),

overseas borrowing, ormonetizing the debt. When governments fund a deficit with the

issuing of government bonds, interest rates can increase across the market, because

government borrowing creates higher demand for credit in the financial markets. This

causes a lower aggregate demand for goods and services, contrary to the objective of a

fiscal stimulus. Neoclassical economists generally emphasize crowding out while

Keynesians argue that fiscal policy can still be effective especially in a liquidity trap

where, they argue, crowding out is minimal.

Some classical and neoclassical economistsargue that crowding out completely negates

any fiscal stimulus; this is known as the Treasury View which Keynesian economics

rejects. The Treasury View refers to the theoretical positions of classical economists in

the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same

general argument has been repeated by some neoclassical economists up to the present.
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In the classical view, the expansionary fiscal policy also decreases net exports, which has

a mitigating effect on national output and income. When government borrowing increases

interest rates it attracts foreign capital from foreign investors. This is because, all other

things being equal, the bonds issued from a country executing expansionary fiscal policy

now offer a higher rate of return. In other words, companies wanting to finance projects

must compete with their government for capital so they offer higher rates of return. To

purchase bonds originating from a certain country, foreign investors must obtain that

country's currency. Therefore, when foreign capital flows into the country undergoing

fiscal expansion, demand for that country's currency increases. The increased demand

causes that country's currency to appreciate. Once the currency appreciates, goods

originating from that country now cost more to foreigners than they did before and

foreign goods now cost less than they did before. Consequently, exports decrease and

imports increase.[2]

Other possible problems with fiscal stimulus include the time lag between the

implementation of the policy and detectable effects in the economy, and inflationary

effects driven by increased demand. In theory, fiscal stimulus does not cause inflation

when it uses resources that would have otherwise been idle. For instance, if a fiscal

stimulus employs a worker who otherwise would have been unemployed, there is no

inflationary effect; however, if the stimulus employs a worker who otherwise would have

had a job, the stimulus is increasing labor demand while labor supply remains fixed,

leading to wage inflation and therefore price inflation.

2. Monetary policy of the government:

a. Increasing the bank rate of interest

When the rate of interest is low, people tend to withdraw the money from the

bank and spend in different ways which cause inflation. Government by

increasing the rate manages that.

b. Increasing the statutory reserve ratio
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Same goes for the RSS where the increase in the ration keeps the inflation

down.

Monetary policy rests on the relationship between the rates of interest in an economy,

that is, the price at which money can be borrowed, and the total supply of money.

Monetary policy uses a variety of tools to control one or both of these, to influence

outcomes like economic growth, inflation, exchange rates with other currencies and

unemployment. Where currency is under a monopoly of issuance, or where there is a

regulated system of issuing currency through banks which are tied to a central bank, the

monetary authority has the ability to alter the money supply and thus influence the

interest rate (to achieve policy goals). The beginning of monetary policy as such comes

from the late 19th century, where it was used to maintain the gold standard.

A policy is referred to as contractionary if it reduces the size of the money supply or

increases it only slowly, or if it raises the interest rate. An expansionary policy increases

the size of the money supply more rapidly, or decreases the interest rate. Furthermore,

monetary policies are described as follows: accommodative, if the interest rate set by the

central monetary authority is intended to create economic growth; neutral, if it is intended

neither to create growth nor combat inflation; or tight if intended to reduce inflation.

There are several monetary policy tools available to achieve these ends: increasing

interest rates by fiat; reducing the monetary base; and increasing reserve requirements.

All have the effect of contracting the money supply; and, if reversed, expand the money

supply. Since the 1970s, monetary policy has generally been formed separately from

fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most

nations would form the two policies separately.

Within almost all modern nations, special institutions (such as the Federal Reserve

System in the United States, the Bank of England, the European Central Bank, the

People's Bank of China, and the Bank of Japan) exist which have the task of executing

the monetary policy and often independently of the executive. In general, these
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institutions are called central banks and often have other responsibilities such as

supervising the smooth operation of the financial system.

The primary tool of monetary policy is open market operations. This entails managing the

quantity of money in circulation through the buying and selling of various financial

instruments, such as treasury bills, company bonds, or foreign currencies. All of these

purchases or sales result in more or less base currency entering or leaving market

circulation.

Usually, the short term goal of open market operations is to achieve a specific short term

interest rate target. In other instances, monetary policy might instead entail the targeting

of a specific exchange rate relative to some foreign currency or else relative to gold. For

example, in the case of the USA the Federal Reserve targets the federal funds rate, the

rate at which member banks lend to one another overnight; however, the monetary policy

of China is to target the exchange ratebetween the Chinese renminbi and a basket of

foreign currencies.

The other primary means of conducting monetary policy include: (i) Discount window

lending (lender of last resort); (ii) Fractional deposit lending (changes in the reserve

requirement); (iii) Moral suasion (cajoling certain market players to achieve specifiedoutcomes); (iv) "Open mouth operations" (talking monetary policy with the market).

Theory

Monetary policy is the process by which the government, central bank, or monetary

authority of a country controls (i) the supply of money, (ii) availability of money, and

(iii) cost of money or rate of interest to attain a set of objectives oriented towards the

growth and stability of the economy.[1] Monetary theory provides insight into how to

craft optimal monetary policy.

Monetary policy rests on the relationship between the rates of interest in an economy,

that is the price at which money can be borrowed, and the total supply of money.

Monetary policy uses a variety of tools to control one or both of these, to influence
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outcomes like economic growth, inflation, exchange rates with other currencies and

unemployment. Where currency is under a monopoly of issuance, or where there is a

regulated system of issuing currency through banks which are tied to a central bank, the

monetary authority has the ability to alter the money supply and thus influence the

interest rate (to achieve policy goals).

It is important for policymakers to make credible announcements. If private agents

(consumers and firms) believe that policymakers are committed to lowering inflation,

they will anticipate future prices to be lower than otherwise (how those expectations are

formed is an entirely different matter; compare for instance rational expectations with

adaptive expectations). If an employee expects prices to be high in the future, he or she

will draw up a wage contract with a high wage to match these prices. Hence, theexpectation of lower wages is reflected in wage-setting behavior between employees and

employers (lower wages since prices are expected to be lower) and since wages are in

fact lower there is no demand pull inflation because employees are receiving a smaller

wage and there is no cost push inflationbecause employers are paying out less in wages.

To achieve this low level of inflation, policymakers must have credible announcements;

that is, private agents must believe that these announcements will reflect actual future

policy. If an announcement about low-level inflation targets is made but not believed by

private agents, wage-setting will anticipate high-level inflation and so wages will be

higher and inflation will rise. A high wage will increase a consumer's demand (demand

pull inflation) and a firm's costs (cost push inflation), so inflation rises. Hence, if a

policymaker's announcements regarding monetary policy are not credible, policy will not

have the desired effect.

If policymakers believe that private agents anticipate low inflation, they have an

incentive to adopt an expansionist monetary policy (where the marginal benefit of

increasing economic output outweighs the marginal cost of inflation); however, assuming

private agents have rational expectations, they know that policymakers have this

incentive. Hence, private agents know that if they anticipate low inflation, an

expansionist policy will be adopted that causes a rise in inflation. Consequently, (unless
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policymakers can make their announcement of low inflation credible), private agents

expect high inflation. This anticipation is fulfilled through adaptive expectation (wage-

setting behavior);so, there is higher inflation (without the benefit of increased output).

Hence, unless credible announcements can be made, expansionary monetary policy will

fail.

Announcements can be made credible in various ways. One is to establish an independent

central bank with low inflation targets (but no output targets). Hence, private agents

know that inflation will be low because it is set by an independent body. Central banks

can be given incentives to meet targets (for example, larger budgets, a wage bonus for the

head of the bank) to increase their reputation and signal a strong commitment to a policy

goal. Reputation is an important element in monetary policy implementation. But the ideaof reputation should not be confused with commitment.

While a central bank might have a favorable reputation due to good performance in

conducting monetary policy, the same central bank might not have chosen any particular

form of commitment (such as targeting a certain range for inflation). Reputation plays a

crucial role in determining how much markets would believe the announcement of a

particular commitment to a policy goal but both concepts should not be assimilated. Also,

note that under rational expectations, it is not necessary for the policymaker to have

established its reputation through past policy actions; as an example, the reputation of the

head of the central bank might be derived entirely from his or her ideology, professional

background, public statements, etc.

In fact it has been argued[3] that to prevent some pathologies related to the time

inconsistencyof monetary policy implementation (in particular excessive inflation), the

head of a central bank should have a larger distaste for inflation than the rest of the

economy on average. Hence the reputation of a particular central bank is not necessary

tied to past performance, but rather to particular institutional arrangements that the

markets can use to form inflation expectations.
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Despite the frequent discussion of credibility as it relates to monetary policy, the exact

meaning of credibility is rarely defined. Such lack of clarity can serve to lead policy away

from what is believed to be the most beneficial. For example, capability to serve the

public interest is one definition of credibility often associated with central banks. The

reliability with which a central bank keeps its promises is also a common definition.

While everyone most likely agrees a central bank should not lie to the public, wide

disagreement exists on how a central bank can best serve the public interest. Therefore,

lack of definition can lead people to believe they are supporting one particular policy of

credibility when they are really supporting another.

Monetary decisions today take into account a wider range of factors, such as:

short term interest rates; long term interest rates;

velocity of money through the economy;

exchange rates;

credit quality;

bonds and equities(corporate ownership and debt);

government versus private sector spending/savings;

international capital flowsof money on large scales;

Financial derivativessuch as options, swaps, futures contracts, etc.

3. Direct action policy of the government:

a. Setting price ceiling

When the price of certain goods have gone up to an alarming high state,

government pts a ceiling in that products price above which the business arenot allowed to sell. For example in the recent days we have seen that

government has set sugar price and edible oil fixed to tk 65 and tk 109

respectively.

b. Confiscating legal tender
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c. Persuasive Policy.

Setting price ceiling:

When the price of anything goes very high, government sets price ceiling above which

businessmen are not allowed to sell that goods.

Setting the ceiling reduces the products price from the current market price for which

demand goes up. But due to the possibility of incurring loss, many of the businessmen

keep away from selling the product. So supply decreases. This excess demand and

decreased supply creates a shortage in the market.

In order to manage this situation, government takes up the following five measures:

1. Government becomes ready to supply the required quantity of products from its own

production.

2. Government supplies the required goods and by importing that from foreign countries

under its one command and thus manages the situation.

3. Government helps the indigenous producers to produce. It helps in setting up plants with

equipment and machinery so that they can produce it and supply.

4. Government also helps the private importers to import the necessary ready products or

raw materials to produce the product and sell through their own distribution channel.

5. Government also supplies from its own buffer stock created earlier Setting price floor:

When the price of something goes below its normal range, government sets up price floor

below which, businessmen are not allowed to sell it. We have seen in man occasions

where the farmers of Bangladesh are struggling to get at least the production expense in

order to avoid direct loss. It happens because of the syndication of middle men who buy

the products from the farmers and sell it to the retailers. Here government has a big role

to play to set the floor and monitor closely so that the poor farmers dont incur loss.

When the price floor is set, the price of the product goes up from the current price of it in

the market, so demand goes down again the business become interested to sell it since the

price is up and thus the supply overflows. These two incidents create a surplus.

In order to manage the situation, government does the following things:


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1. Government buys the stock and keeps it in stores.

2. Government buys the stock on the previous price and sells it to another country.

3. Government acquires the stock and destroys it.

A buffer stock makes use of the price floor and price ceiling below and above which,

product cannot be sold. These two boundaries upper and lower doesnt allow the price

to go above or below it. It protects the interest of the producers and the customers as well.

Remedy of Inflation:

Unfortunately, there is hardly any market oriented policy move on the part of fiscal or

monetary authorities that can be taken for checking the cost induced inflation. On the

fiscal side, although cutting down of the indirect tax on commodities is often proposed as

a remedial measure, it only makes a temporary contribution to reducing inflation. Long-

term continuation of such policy may cause continuous erosion of the government

exchequer. Some also argue in favor of government control on wage increases that are

not supported by the corresponding increase in productivity to resist wage-price spiral. In

Bangladesh, however, the presence of powerful trade unions tends to render the

implementation of such control almost impossible. On a positive note, however, our

analysis did not find any noteworthy impact of wage growth on inflation. It is widely

recognized, however, that government can effectively use its legal powers to break up the

market syndication and thus improve competitiveness of the distribution network.

On the monetary side, in the absence of any direct controlling instrument, Bangladesh

Bank can initiate some case specific counter-action. Bangladesh Bank can take over some

responsibilities such as monitoring modalities of Letter of Credit (L/C) operation so that

market forces determines the exchange rate in a process that remains free from much

speculative transactions.


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Renowned economist Prof Rahman Siobhan at a recent seminar organized by the Center

for Policy Dialogue (CPD) said inflation hurts ordinary people of the country. So,

monetary policy of the central bank should ensure their welfare. Appreciating

government measures after the devastating floods in 1998, he said the central bank should

take proper steps in line with those post-flood programmers.

Following the government move, Tk 2412 crore is going to be allocated in the

revenue budget for increasing agriculture production and to supply agricultural inputs at

low costs. Of this amount, Tk 350 core will be allocated for agriculture research, Tk 750

core for diesel supply and Tk 1312 core for supplying fertilizer and electricity at

subsidized rates.

The government has already taken some initiatives to check inflation. The chief adviser

in his address to the nation on Sunday mentioned some government programmers like

Open Market Sale (OMS). Price of rice under OMS has been fixed at Tk 19 a kg against

the import cost of Tk 25 per kg. Import of 900,000 tones of food grains under

government initiative during the current fiscal year is now being finalized.

The central bank can use two instruments interest rate hike and lower money supply

to curb inflation. Central bank can issue government bond and securities in the market to

reduce the money supply.

The import rate of Bangladesh is highest among other south Asian country [almost

35%], so the price of goods and services fluctuate based on the rise and fall in world

price. To stabilize rice price in domestic market, the government should import coarse

rice from Myanmar or Indonesia or any other country where rice is cheaper.

Stock market can play an important role in controlling inflation by easing the

investment policy and implying effective monetary control on the profit distribution of

companies to the investors.


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Government can imply the flexible terrify and quota system to control the import price

and make it stable in the domestic market.

Government should find the alternative country or place for importing goods rather than

depending only on India.

Unethical storing or warehousing should be controlled with developing new laws and

efficient apply of consumer law.

Government can establish new agencies like TCB or make sure their continuous

efficient operation.

And at last try to ensure the domestic production is increasing and take active and

elaborate plans for that and ensure the swift and smooth agricultural production.

Conclusion:

At the import of our report we can say that the main reason of inflation is our internal

capabilities of production. Thats why we have to import from abroad. And the main

reason of inflation is the huge amount of import. Other all causes like interest rate,

supply, exchange rate, and syndication are relative effect of the import. So our suggestion

to government will be that government should take the proper steps or plan that increase

the total internal production and that can be ensured by concentrate on both local industry

and agriculture so that capital per person or employment opportunity and Per capitaincome rise.

price inflation in bangladesh

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