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Tuesday May 17th, 2022

Sri Lanka inflation soars as Modern Monetary Theory demon roars

REGIONAL VIEW: Some ministers have blamed ‘world market prices’ for inflation but in most countries with better central banks prices are lower.

ECONOMYNEXT – Sri Lanka’s inflation has hit double digit and is just behind Pakistan after two years of activist monetary policy from February 2020 which has been described as ‘modern monetary theory’, despite having a pegged exchange rate.

Pakistan also has a ‘flexible exchange rate’ with contradictory policy involving foreign reserve collection while printing money to target a policy rate, which has led to currency crises in quick succession in Sri Lanka.

Sri Lanka began the current round of inflationary policy around August 2019 buying back bonds from commercial banks with printed money.

From February 2020 Sri Lanka started injected large volumes of money into the banking system in what was later described as Modern Monetary Theory, a throwback to theories proposed by classical Mercantilists like John Law and later Keynesians.

Sri Lanka’s 12 month inflation hit 12.1 percent in 2021 measured by the official Colombo Consumer Price Index.

The food sub-index is up 22 percent. Over the past two years food prices have risen 33 percent.

Since July when inflationary policy began, food prices are up 41 percent according to the index.

Economists had warned that the MMT was like demon which cannot be controlled.

“…The present Government’s reliance on MMT is like getting a demon to work for it. If it does not play the game within limits, the demon will turn back and swallow it,” former Deputy Central Bank Governor W A Wijewardene wrote in his regular column in Sri Lanka’s DailyFt newspaper more than a year ago, when inflation was still low.

“This should be properly understood by the present Government’s top policymakers who advocate printing of money to pay for Government spending.”

Sri Lanka was printing money supposedly to follow the ‘developmental state’ and ‘alternative framework’ which was claimed to have been followed in East Asia. The region however has some of the best reserve collecting pegs (with deflationary policy) in the world.


Sri Lanka Modern Monetary Theory experiment could be an untamed demon: economist

The credibility of Sri Lanka’s peg with the US dollar at 200 had been hit badly with parallel exchange rates of around 240/250 to the US dollar.

Sri Lanka has blamed global commodity bubble fired by the Federal Reserve for rising prices, but domestic government credit and broad money supply has also grown.

The lowest inflation in South Asia has been generated by the Maldives Monetary Authority’s rufiyaa of about 0.1 percent by November.

Maldives Rufiyaa is also derived from the Indian rupee which was around 4.70 to the US dollar when the region got independence from Britain. The MMA was set up in 1981 and has non-activist policy and its peg rarely breaks.

Until 2004 President Abdul Gayoom was governor and maintained monetary stability unlike the region’s other central banks staffed with Keynesian economists who engaged in aggressive open market operations.

It is the general practice to blame politicians for currency collapses rather than aggressive domestic operations ordered by interventionists.

The Bangladesh Taka, which has been kept around 85 for almost a decade had generated around 5.9 percent inflation. The currency had come under pressure after a rate cut in July amid an economic recovery, and the peg has been defended by Bangladesh Bank leading to a rise in overnight rates.

The Reserve Bank of India, which targets a Consumer Price Index with sporadic interventions, has generated 4.91 percent inflation.

Nepal and Bhutan which have non-activist policy and is pegged to the Indian rupee has also generated similar levels of inflation. (Colombo/Dec05/2021)


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