Money supply needs to be curtailed to suppress domestic demand

The biggest problem the economy of Bangladesh is now faced with is soaring commodity prices.

Volatile global commodity prices coupled with increasing prices of the US dollar are currently fuelling inflation in the country. An increase in aggregate demand in the domestic market following the start of the recovery from Covid-19 fallouts also has contributed to the rising inflation.

In order to be successful in taming inflation, we have to address the root of the problem.

We do not have the capacity to control the world market situation. Both monetary policy and fiscal policy can do a lot to restrain domestic demand, even though the monetary expansion is not so far the main reason for the domestic demand. So far, monetary growth has been in a single digit.

The first thing we need to look at is what the various central banks around the world usually do to control inflation and what they are doing at the moment. Policy rates are rising sharply in different countries. It has been done in India too, and more will be done there. All countries, including America, are doing the same more or less.

A hike in the policy rate would influence aggregate demand if the interest rate is a market determinant. But, rate hikes would have little reflection on the market because of caps on all types of lending rates.

As such, if the policy rate changes, it will have an effect on interbank transactions even if interest rates do not fall in the market. Other than that, it has a signaling value. The signal is that if everyone thinks commodity prices will go up a lot in the future, then the demand will go up right away.

The central bank by changing the policy rate now can give the signal that they are monitoring the situation and that strict measures may be taken if necessary to control it.

Adjustment of lending rates will yield the fastest and most effective result in controlling domestic demand. It would not be right to lift the interest rate cap altogether, but it is possible to make the cap flexible. In this case, a range of interest rates can be fixed.

One last thing to keep in mind is that there is absolutely no room for expansionary monetary policy until inflationary pressures subside. The difference between the growth of the monetary expansion and the growth of the gross domestic product (GDP) should not be more than the rate of inflation fixed in the budget.

If GDP growth estimate plus inflation surpasses the monetary expansion rate, it might further stoke inflation.

Even in fiscal policy, the budget deficit cannot be allowed to be more than the actual deficit this time under any circumstances. This is because the tolerable limit of domestic demand has already been exceeded. In this case, a new deficit will provoke this demand as well as increase inflation.

Nevertheless, I am not recommending a contractionary monetary policy by reducing the budget deficit.

We may not have the capacity to take advantage of the opportunity to control inflation through tax structure in revenue policy. Generally, if tax rates are increased, the disposable income of the people comes down. As a result, as demand declines, so does inflation. If we want to reduce disposable income, we have to increase income tax. But, here we see people asking for reducing tax rates.

The government has said it will reduce project expenditures to minimize the budget deficit. This will reduce pressure on the foreign exchange market, but will not reduce the internal demand. Expenditures on many projects cause a rise in domestic demand. In this case, the cost of the projects funded internally under the ADP will have to be re-evaluated.