In July 2005, the annual inflation rate for such necessities as rice, wheat, petroleum products, house rent, and transportation costs rose to 7.68% -- an increase of 2.06% from three months earlier. To preempt the inflationary dynamics, the Bangladesh Bank (BB) espoused IMF's contractionary monetary policy in May 2005.

It was a prudent policy if the inflationary pressure was as diagnosed demand propelled, caused by real income (purchasing power) rising faster than inflation rate. Did the policy work?

Empirical studies have long established that monetary policy affects the macroeconomy with a long and variable lag (meaning, for example 30% effects of a policy action may be realised in 3 months, 50% in 6 months, with the peak effect realised in about 12 months and the full effects spread over 24 months).

Although BB's tight policy continued, there wasn't any relief from the scourge of inflation in 3 months, or even after 24 months. Inflation rate on a point-to-point basis in June 2007 stood at a 10-year high of 9.20%, and threatens to climb to double-digit being compounded by the catastrophic flood-induced supply-shock.

The IMF and ADB interpret price increases of daily essentials as demand-pull inflation driven by rising income. The essence of this argument, when applied to daily edibles, amounts to a notion that people are spending their income on eating rice, flour, and other edibles not two or three times a day, but rather several times a day.

The IMF and the ADB are being shortsighted in not recognising the staggering shortfall of supplies and rising input costs. Further, there's no evidence that real income is rising faster than inflation, either. Of course, there're always new consumers emerging as income increases.

The recent chorus of disapproval of business leaders against IMF's diktats has long been over-due. However, the suggestions advanced by former BB governor Dr. M. Farashuddin and former Tariff Commission Chairman Dr. MA Taslim are worth noting.

While Farashuddin favours picking and choosing of appropriate policy recommendations of lending agencies, Taslim stresses the development of self-reliant study and research capabilities for preserving domestic policy independence.

However, in the current context, the possible precursors to the untamed price spiral as diagnosed by Sajjad Zahir of the Economic Research Group appear conceptually contentious.

Sajjad's contention that deployment of law enforcers to regulate the supply has broken down the traditional market chain is weakly premised. The government hasn't yet enforced the market regulation and price monitoring countrywide, so it would be premature to call it off.

Both Sajjad's and ADB's advice to let the markets for necessities function on their own overlooks the reasons that led to the failure of market discipline.

The microeconomic settings of firms and businesses in Bangladesh do not quite conform with many of the western free market models. Here, the government is involved in producing and providing multifarious goods and services -- a policy contrary to the laissez faire paradigm of a market economy.

As argued in my March 25 piece, "Market failure and price spirals," when everything else, prior to the 1/11emergency, had nearly failed then why would the market function normally? The government's recent selective intervention is simply geared towards restoring some -- not all -- of the missing tenets of a self-regulating market.

Zahir also contends that the ongoing anti-graft drive encouraged ill-gained money to flee abroad through hundi, only to return under the guise of remittance. Such a practice, he argues, could add to inflationary pressure. This scam seems too far-fetched for just buying daily edibles. Besides, where would the ordinary consumers get ill-gotten foreign currencies to pursue this convoluted money laundering sham?

ADB's resident director argues that foreign remittances are fueling inflationary pressure, since remittances often result in increased consumption -- not always in increased investment. Hua's consumption -- investment dilemma fails to recognise that over 80% of these remittances support the remitters' low-income (or no income) families. Some of the remittances, of course, are invested in the education of the remitters' children plus the repair, or building, of houses.

Hua's other policy statements also suffer from institutive inconsistencies. For example, she espoused BB's contraction policy but in the same breath advised BB to maintain the credit flow to the private sector. Doesn't increased business investment expand employment opportunities? Wouldn't that foster income growth and aggregate demand and add to the inflationary pressures?

I'm of the view that any policy recommendations from lenders must be debated by the country's economists to reach a consensus prior to their implementation.

The IMF's insistence on higher gas and energy prices is another contentious issue. Since gas is a domestically produced input, its price should be raised not to the international level, but by the marginal cost pricing rule (P = MC) -- one that is frequently found in public utilities and services in the US and elsewhere. This rule sets the selling price of an additional unit equal to the costs of producing that additional unit. The P = MC rule attains both productive and allocative efficiencies.

The policy debate between IMF and CPD, about raising the prices of energy products seems more deeply ingrained in the school of economic philosophy each professes.

The monetarists' school led by Milton Friedman argues that increases in the cost of goods and services do not lead to inflation without the central bank increasing the money supply.

They argue that if the money supply is held constant, increases in the cost of a good or service will decrease the money available for other goods and services. As a consequence, the price of some of those goods will fall and offset the rise in price of the other goods. Monetarists, therefore, believed that the rise in the cost of oil was not a direct cause of the inflation of the 1970s in the western economies.

Keynesians, by contrast, believe that in a modern industrial economy, many prices are inflexible downward, so that instead of prices falling, a supply shock (increases in gas and energy prices) would cause a recession (rising unemployment and falling output). It is the costs of such a recession that causes central banks to increase the money supply, which in turn fuels inflation

My guess is there're more Keynesians than monetarists in our macroeconomic discipline -- the IMF, for sure, is a heaven for monetarists, but the realm of macroeconomics is overwhelmingly colonised by hybrids.

Dr. Abdullah A. Dewan is Professor of Economics at Eastern Michigan University.