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Sri Lanka should not pander to stability through inflation control in Covid-19: CB Governor

ECONOMYNEXT – Sri Lanka should not pander to stability through inflation control but should engage in monetary and fiscal policies that drive growth, Central Bank Governor W D Lakshaman said.

“Covid 19 has made an unprecedented global shock which carried widespread socio-economic implications,” Governor Lakshman said in a webinar with Asian Development Bank Institute.

“Like other central bank in wer sri lanka too provided liquidity and reduced borrowing costs to ease the burden on the public, businesses, financial systems and fiscal authorities.

“It is high time to give greater to prominence growth without pandering to stability. That is for normal times.”

After the “supposedly conclusive destruction of the hypothesis underlying” the Phillips Curve in the “mainstream” had followed policies where “stability in price inflation was given priority”, he said.

The Phillips Curve emerged as inflation gradually picked up after the post World War II, when Bretton Woods system gradually came under pressure from loose ‘growth policies’ of the US Fed which was incompatible with maintaining gold convertibility.

The demise of the Bretton Woods system in 1971 then led to a period of un-anchored inflation under floating rates in 1970s giving rise to the so-called Great Inflation period involving stagflation (high inflation and low growth). Sri Lanka then closed the entire economy.

In the latter part of the 1970s after the so-called second oil shock and the UK also went to the IMF, prudent monetary policies were followed under the President Ronald Reagan (Paul Volcker/rate targeting) and Prime Minister Margarat Thatcher (Gordon Richardson/quantity targeting) bringing down commodity prices and inflation.

Meanwhile Governor Lakshman said this was not a time to worry about inflation.

“In the arguments involving stability and growth, one of the elements of stability, perhaps the most important one highlighted in the mainstream is price inflation,” he said.

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“But If easing money and expansionary fiscal policy are needed to revive economic activity in a time of deflationary pressures or at a time of low investment, not to take such action to promote growth for fear of inflation is nothing but ideological dogmatism.”

He said “rightly or wrongly due to IMF intervention or otherwise the inflation dragon was supposed to have been slayed” in most countries from the 1980s.

“The widespread assertion that price stability inflation was a pre-condition for growth is a period where inflation was supposed to have been contained but conditions of low inflation have only produced stagnation in these countries,” Governor Lakshman said.

“It is high time to give greater to prominence growth without pandering to stability. That is for normal times.”

Sri Lanka’s private credit was negative in May and June 2020, data show following sudden spike in March as liquidity was injected and the rupee fell. The country is now under import controls not seen since the collapse of the Bretton Woods in the 1970s.

Classical economists have traced thinking behind a liquidity bubble fired by the Fed that led to the Great Recession to the so-called Bernanke Doctrine, found in a speech he made in 2002 (Deflation: Making Sure “It” Doesn’t Happen Here) when he was just a member of the Fed Board.

The collapse of the asset price and commodity bubble that was subsequently fired as the US economy recovered from a milder so-called dotcom bubble, led to a greater collapse where unprecedented liquidity was injected. (Colombo/Aug06/2002)