What can we do if inflation is back?

Why talk about inflation in the midst of the pandemic, one might ask. The answer is simple, if somewhat unpleasant. Inflation may soon be making a comeback! There is no question that while defeating the Covid-19 virus and cutting its hydra-like fangs are of utmost urgency, we might soon see a situation where the world is fighting multiple battles on several fronts. Some of the issues that policymakers are currently grappling with are a surge in the Delta variant or some other variant, a sluggish economic recovery compounded by unemployed and underemployed population, lack of skilled workers in developed countries, and inflationary pressures that might complicate the task of the central banks as they pursue expansionary monetary policy and keep interest rates low. To complicate matters, inflation is emerging as a major concern in both G7 and emerging market and developing economies (EMDE).

Fahmida Khatun, Executive Director of CPD, in reviewing the country's monetary policy cautioned that the Bangladesh Bank "will have to be vigilant in maintaining the stability of the financial market in such unusual circumstances to avoid any price bubble," (The Daily Star, August 2). Other economists knowledgeable about the Bangladesh economy, including Zahid Hussain and Ahsan H Mansur, are all unanimous that inflationary pressures unleashed by disruptions in the supply chain and the easy money flowing from the government's stimulus programmes are already evident in the price of food and other essential commodities. According to BSS, the average inflation in the just-concluded fiscal year was 5.56 percent, overshooting the government's target of 5.4 percent. June's inflation of 5.64 percent was the highest in eight months.

The spectre of inflation has been on the minds of central bankers and policy analysts in developed countries for some time, and this is reflected in the public discourse as well as in the print and online media. Inflation is also a constant fear in developing countries. For example, in Bangladesh, the total stimulus packages given during this pandemic by the government so far amount to Tk 128,441 crore (4.59 percent of GDP). Prices of almost all the commodities, including rice, pulses, flour, onion, vegetables, fishes and meat, are on the rise. This can be partially attributed to disruptions in the supply chain due to the pandemic, floods and market manipulation. However, inflationary expectations are rising too. "In addition to these, the increased flow of money into market from the stimulus packages has created fears of further inflation," according to Mansur.

I was recently searching for a topic for my next op-ed for The Daily Star. I started with the Wall Street Journal which has over the years been a reliable source of current news as well as emerging business issues. During the last few weeks, US Congress and the financial markets have consistently expressed their worries about the prospects of inflation. The lead stories and the opinions pages have kept on chirping about inflation. Regardless of the constant denials from the Federal Reserve, the central bank of the USA, one can be sure that just as the US and the global economy appear to be bouncing back from last year's slowdown, the fear of inflation will be a dominant theme.

Inflation phobia is obviously the result of our past experience, and theoretical discussions about the effect of increased money supply on inflation. Inflation—or the rate of change in prices over time—is not a simple phenomenon to measure or interpret. In general, a swiftly growing economy, a tightening job market, and continuing supply-chain issues seem a ripe environment for prices to keep on rising.

The prognosis is in sharp contrast to recent low inflation in most countries. Until 2020, inflation has averaged just above 0.5-1 percent over the past decade, well below the US Federal Reserve's target of 2 percent. Low inflation for such an extended stretch is quite unusual if we consider the post-World War II record. "With the current unemployment rate near historic lows, the persistent soft readings on inflation pose a puzzle and challenge for economists, financial market participants, policymakers, and the general public," according to Dan Sichel of Wellesley College, USA.

Let us now look ahead. The trillions of dollars of stimulus money that have been pumped into the global economy over the last 18 months are bound to trigger inflation. "Too Much Money Portends High Inflation. The Fed should pay attention to Milton Friedman's wisdom", write economists John Greenwood and Steve H Hanke.

According to Milton Friedman, an economist who won the Nobel Prize, the relationship between money supply and price level is captured by a simple equation, known as the Quantity Theory of Money. Friedman's disciples, known as monetarists, believe that a higher rate of inflation is coming, and inflation will remain high in the coming years.

For Bangladesh, economists caution the government to remain alert in the face of rising commodity prices, including that of daily essentials, "in the face of already existing excess liquidity which has reportedly reached Tk 2.31 trillion." Experts everywhere are somewhat in double minds about the future inflationary trends, though. Central bankers are not sure and forecasters in some instances stand at opposite ends of the spectrum.

One commentator jokingly quotes the poet Robert Frost, who said, "some say the world will end in fire, some say in ice". Robert Frost wasn't writing about the inflation debate, but he might as well as have.

Strong economic rebound and lingering pandemic disruptions fuel inflation forecasts above 2 percent through 2023, according to a survey of economists. Developing countries such as Bangladesh have managed to live with a higher level of inflation, as well as with a degree of uncertainty over inflation that would be politically unacceptable in the high-income economies.

Some cautionary words

Inflation measures in both developed and developing countries have been found to have underestimated price rises during the pandemic. Spending on "food at home" is up and spending for "transportation" is down as a result of the pandemic, but the CPI weights of these categories are unchanged. Alberto Cavallo of Harvard Business School found that in 10 of the 16 countries, inflation rates during the pandemic were higher than the official rates.

The IMF suggests seven possible measures to curb inflationary surges. In its report "The Impact of Covid-19 on Inflation: Potential Drivers and Dynamics", the IMF suggests international coordination to secure food and medical supplies, especially for low-income and fragile countries, checks on speculative price hikes and hoarding, and "targeted transfers—like food stamp programmes—to address the needs of the most vulnerable populations at the country level." 

 It is possible that the rise in prices as lockdowns start to be lifted may be "transitory", as many central bankers are hoping. The government can reduce uncertainty and the extent of pent-up demand which fuels inflation by announcing a credible plan to open up the economy to mitigate both deflationary pressures due to lack of demand during the containment and the inflationary pressures due to a rebound in demand during the reopening.

Moreover, to avoid creating inflationary pressures, appropriate monetary and fiscal policy after the end of the pandemic should be data-dependent and based on the strength of the rebound in supply and demand. This calls for watchful eyes from the policymakers, economists, and statisticians alike.

Dr Abdullah Shibli is an economist and IT consultant. He is also Senior Research Fellow at International Sustainable Development Institute (ISDI), a think tank based in Boston.