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Sri Lanka firms should not raise wages steeply: Deputy CB Governor

ECONOMYNEXT- Sri Lanka’s businesses should not enter into wage contracts with employees which would steeply increase their salaries and cause higher inflation, a top central banker said.

“There’s a well anchored inflation expectation,” Senior Deputy Governor Nanadalal Weerasinghe said, speaking at the Third Annual Sri Lanka Investment Conference organized by Asia Securities.

“When you enter into a wage contract, don’t enter into a contract that will increase wages by 10 percent,” he said.

“If you give a 10 percent increase, that will then pass into other goods and services and that will create pressure on inflation.”

Cost-Push

Weerasinghe was articulating a theory of so-called ‘wage-spiral inflation’, a part of cost-push Mercantilism that became popular after World War II, as reserve currency central banks in the Bretton Woods system printed money and generated inflation, which led to the collapse of a gold peg.

Attempts to suppress real wages were also popular among REER targeters, as the objective of currency depreciation – which attempts to subsidize export firms at the cost of workers’ wages, foreign debt repayment ability and political upheavals or strikes – is lost when wages catch up.

Meanwhile Weerasinghe said sweeping tax cuts by Sri Lanka’s new administration was giving more money to rational private sector market participants to use in the most efficient manner.

In the same vein, firms should also be able to make rational decisions on wages, as they are most in tune with market forces which affect them.

Inflation indices which measure general price levels of goods and services may not be applicable to price increases in individual industries.

Firms may also pass on the tax cuts as extra wages to their employees.

Sri Lanka’s budget deficit is expected to pick up in 2020 due to the tax cuts.

Sri Lanka’s central bankers in the past have blamed ‘excess demand’ from budget deficits for inflation and economic instability.

But classical economists have pointed out that deficits cannot really cause inflation, since purchasing power is transferred from savers who buy bonds to finance the deficit to the government.

Inflation and currency collapses happen when the deficits are accommodated with central bank credit (printed money) either to directly finance the deficit through bond purchases or through liquidity injected to the banking system through open market operations to keep rates down.

Low Inflation

Meanwhile, Weerasinghe said the central bank has managed to keep inflation at around 4-5 percent through a ‘flexible inflation targeting framework’ since 2008, compared to levels which rose to around 24 percent in years before.

The link between currency depreciation and inflation has also been decoupled under the framework, he said.

“Over the last 10 years, even in 2018, currency depreciated 18 percent, but inflation was below 4 percent,” Weerasinghe said.

“This was because of the flexible inflation targeting framework and the pass through from the currency to inflation is much lower compared to the past.”

“In the past, you would see currency depreciate 10 percent, then inflation would also increase by 10 percent,” he said.

Analysts have warned that while currency collapses which are accompanied by liquidity shortages tend not to push up inflation too high in the immediate aftermath, inflation tends to pick up as the credit system and demand recovers and firms re-price goods to match altered price structures and restore profits.

In 2017 for example inflation rose 7 percent, though there was minimal currency depreciation.

Unlike in the 1980s and 1990s, Sri Lanka has also been re-basing the inflation index frequently, which critics say tends to understate inflation.

Global Central Banking

A part of Sri Lanka’s inflation however comes through the dollar peg, based on the activities of the US Fed and the health of the US credit system, which tends drive commodity prices.

When credit systems are busted, printed money are not loaned out through the credit system and inflation does not rise.

In the US, up to 2.3 trillion dollar injected to the banking system in the face of the 2009 credit collapse and bank run triggered by very low interests rates in earlier years, ended up back in the Fed.

Jim Walker, founder and chief economist at Asianomics Group, told the Asia Securities conference that said across most of the world, central bankers are keeping interest rates low to induce inflation, which is refusing to rise.

“…you would have theoretically expected a boom,” he said, speaking at a forum organized by Asia Securities.

“But in the last 10 years, we’ve generated less inflation than we’ve had with double digit interest rates.”

“I don’t know of any central banker looking at the performance over the course of the last decade who would say ‘We’ve made a real mess of this’.”

“I see plenty of them patting each other in the back every year and saying ‘Oh, see what a good job we’ve done saving the system. Let’s go out and try this even more’.” (Colombo/Dec12/2019)

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