Macroeconomic stability for economic growth and employment

In recent weeks and months, the issue of macroeconomic stability has received a good deal of attention in Bangladesh. The concern appears to have arisen from a number of relatively recent developments in the economy that include: (i) persistence of high inflation, (ii) excessive government borrowing from the banking system, (iii) depreciation of the domestic currency, (iv) decline in foreign exchange reserve, and the (v) continued ill health of the country's stock market.
The government has persuaded itself to consider the overall macroeconomic situation as unstable and is devoting attention to attain stability. And with that end in view, a restrictive monetary policy has been adopted. Views of independent economists/observers have ranged from terming the situation as one of crisis to one of challenge. In the entire debate, the issue of economic growth appears to have taken a back seat and that of employment is conspicuous by its absence.
Moreover, the discussion on all sides appears to be based on the conventional approach to macroeconomic stability in which double digit inflation is considered to be high and hence undesirable, a budget deficit of over 5% of GDP is also considered to be bad for an economy, and macroeconomic stability is considered almost synonymous with low inflation and low budget deficit. In this conventional approach, macroeconomic stability is necessary for achieving sustained growth, and hence needs to be pursued even at the cost of a negative short term impact on growth. That has been the approach taken by the government.
Over and above the restrictive monetary policy, the government is also being advised to adopt a similar approach in fiscal policy. A number of questions may be raised in the context of the situation and policies mentioned above.
* In a developing country like Bangladesh, should macroeconomic stability be the goal of policy making or an instrument for achieving goals like economic growth and employment?
* Should macroeconomic stability by defined narrowly as one of low inflation and low budget deficit or in a broader framework?
* Inflation is considered to be bad for an economyboth in terms of its impact on economic growth and cost of living, especially of the poor. But how much inflation is bad for growth? And is inflation always bad for the poor?
* What kind of inflation are we fighting in Bangladeshdemand-pull or cost-push? And how effective is restrictive monetary policy likely to be in fighting the latter variety of inflation?
* Could one think of an alternative approach to macroeconomic policy, especially with economic growth and employment as the goals rather than stability itself?
While it would be foolhardy even to think of trying to address all the above questions in a short article like the present one, the list is provided in the hope that it might spark off some re-thinkingboth amongst policy makers and specialistsabout the goals and instruments of macroeconomic policy making in the country.
As for the first question, I guess there would be no major disagreement on the suggestion that in a country like Bangladesh, macroeconomic stability should be an instrument (rather than an objective by itself) for achieving the goals of economic growth and employment. Moving on to indicators of macroeconomic stability, while inflation and budget deficit are important basic indicators, it is important to look at the broad situation with respect to variables like (i) changes in real exchange rates, (ii) foreign exchange reserves in relation to import requirements, broad money, and short term debt, (iii) external debt as percent age of GNP/GNI, (iv) short term capital inflows in relation to GDP, (v) growth of exports, (vi) ratio of current account balance to investment and GDP, (vii) real estate prices, and (viii) real stock prices.
If one adopts a longer term view of the economy, one will note that the macroeconomic situation of Bangladesh has been quite stable for a considerable period of time in recent years. For example, inflation had been around 6% per annum until the economy was hit by the global food price crisis in 2008. While inflation increased sharply since then, much of that rise was due to a rise in the prices of food in the global market, and non-food inflation remained lower than food inflation (except in recent months). Budget deficit remained within manageable limits. Foreign exchange reserve rose to a healthy level in 2009 and declined only in 2011. In fact, foreign exchange reserve has remained well below short term debt, and there is no major reason for confidence in taka to be shaken. External debt in relation to national income is well below 30%, which is considered to be a reasonable level for developing countries. On the whole, the situation was one of reasonable stability on the macroeconomic front. What, then, is the problem? More particularly, what has been the change?
Admittedly, there has been excessive borrowing by the government from the banking system, which could potentially be inflationary. But inflation had risen even before the increase in government borrowing, and much of that earlier inflation was food inflation. Only since December 2011, non-food inflation has been showing a sign of increase. Important questions to ask are: what rate of inflation is likely to hurt economic growth in Bangladesh and what is so sacrosanct about single-digit rate of inflation? Recent reviews of the relationship between inflation and economic growth do not support the contention of a negative relationship between the two variables. Instead, it is found that both very low and very high rates of inflation may be inimical to growth, and there is a range of inflation rate within which growth can continue unhindered. In fact, many economists consider some degree of inflation as necessary to grease the wheel of economic growth in developing countries. Even within an organisation like IMF, there seems to be some rethinking going on regarding how low inflation rate should be in order to maintain macroeconomic stability.
There are also examples of countries (e.g., Republic of Korea and Indonesia during the early periods of growth) where fairly long periods of high economic growth have been associated with high (double digit) rates of inflation. Actually, it is hyperinflation that is dangerous for investment and growth. For Bangladesh, empirical exercise (undertaken by the present author) covering the period 1981-2006 shows that the relationship between economic growth and inflation was statistically insignificant. Of course, such exercises should be updated to see if the relationship has changed. However, casual observation would indicate the opposite: the rate of economic growth since 2008 has not declined although the rate of inflation has been higher than before.
What about the fear that inflation hurts the poor? This certainly is a major concern, especially if it is food inflation. And in Bangladesh, it is food inflation that was dominant since 2008. But such inflation is primarily of cost push variety and influenced more by supply side factors. Measures aimed at curbing demand (e.g., through monetary policy instruments) are unlikely to have much impact on such inflation. In India, interest rate was raised 13 times between March 2010 and December 2011, and yet, there has not been much success in reducing inflation. Instead, economic growth is slowing down.
In fact, a degree of food price rise is even considered desirable from the point of view of maintaining incentives for producers of food grainsas long as the poor consumers can be protected through other means (e.g., public food distribution, cash transfers, food stamp, etc.). Even non-food inflation need not always hurt the poor. If credit growth supports increased production that is employment intensive and creates jobs, and if real wages of workers increase, inflation may not hurt the poor.
Availability and growth of credit is an important factor for a developing economy like that of Bangladesh. Of course, if credit growth is spurred by government borrowing and that in turn is mostly for meeting costs of importing fuel for energy generation, it would not contribute directly to production. But with the current monetary policy stance, the pendulum is likely to swing too far in the opposite direction. If the annual credit growth is brought down from 28% to around 20% and the burden falls primarily on the private sector, the growth of credit to the private sector may go down to around 18% or even less. And that may really hurt growth (and employment).
It would be important to find a way out of the dilemma of maintaining a healthy growth of credit for productive purposes without creating a bubble in the economy (especially in the real estate sector and the stock market). Likewise, it would be important to maintain public sector expenditure, especially in infrastructure and other development oriented activities, without giving rise to excessive deficits, although I wouldn't say that there is anything sacrosanct in keeping the deficit to within 5% of GDP. If budget deficit can be financed through means other than borrowing from the banking system (e.g., by mobilising private savings), it need not add to inflationary pressure. All these are in the realm of what I would call development oriented macroeconomic policy. That, of course, could be the subject matter of another article in future.

The writer, an economist, is former Special Adviser, Employment Sector, International Labour Office, Geneva.