This year was characterised by a low rate of inflation. It was the lowest in the last five years. In the past four years the rate of inflation averaged an annual 15 percent. Significantly in this period the rate of inflation accelerated from 10 percent i 2004, to 11 percent in 2005 and then to 15.6 percent in 2007. Last year was the year of highest inflation of 22.6 percent, mainly caused by the escalation of commodity prices. In the first half of this year the rate of inflation was 12.5 percent compared to 21.5 percent in the first half of last year.
There has been a declining trend in inflation this year. In its latest statement of inflation, the Central Bank has said that the annual average inflation rate, decelerated to 4.1 per cent in November 2009 from 5.2 per cent in October 2009, for the thirteenth consecutive month since November 2008. At the end of the year the annual rate of inflation is expected to be of single digit proportions. This is likely to be the lowest rate of inflation the country has achieved in recent years.
These statistics of the lower inflation rate is received with scepticism by the general public. There are many reasons for this. The public perception of these trends is one of scepticism partly due to a fuzzy understanding of the statistics on inflation. The deceleration in inflation is not believed as it is often understood as a decline in prices. This is certainly not the case.
What it means is that the rate of increase has declined. Prices are still continuing to increase though at a lower rate. When people experience further increases in prices, they tend to disbelieve that the rate of inflation has declined as prices of commodities have not decreased. If the annual rate of inflation were to be 9 percent this year, what this means is that average prices rose by 9 percent. This is much lower than that of last year, but it is an increase on top of last year’s increase in prices.
A further reason for this scepticism arises owing to a suspicion that the calculation of the index does not use actual market prices. They are probably collected from a few selected places that are not representative of general market prices. There is also some doubt as to whether certain commodities are dropped from the index when their prices rise on the spurious grounds that these are not bought by people. In spite of these factors it has to be admitted that the rate of inflation this year is less, though perhaps not by as much as depicted by the indices.
Besides these misconceptions on what inflation means and its measurement, there is also a current debate as to whether we are at the end of the declining trend and whether the rate of inflation would rise in 2010. This discussion has a direct relevance to the issue of whether the monetary policies in place could cope with a possible resurgence in inflation and when a reversal in policy is appropriate. As is usual in discussions on inflation, there are varied views on the control of inflation.
The one significant agreement among most modern economists is that inflation is bad for the economy and should be kept in check. How inflation could be controlled is a much debated and disputed one.
The high rate of inflation last year was largely due to a sharp increase in oil and food prices that increased costs of imports and consequently raised prices of domestically produced items as well. While this was an important factor, the nature of public spending and the large fiscal deficit spurred inflation. As Milton Friedman pointed out repeatedly, inflation is, and is always a monetary phenomenon, and unless monetary measures support the rise in prices it cannot go on.
The large fiscal deficits caused mainly by “unproductive expenditure” such as on defence, salaries and wasteful public expenses and subsidies to corporations have been the root cause of the domestic inflation. Public spending that exceeds revenue by a large amount creates serious inflationary pressures in the economy.
This year’s declining inflation was partly due to international commodity prices declining. The global recession had much to do with the abatement of worldwide inflation that had its effect on depressing prices.
These trends may well change. In fact there are signs of a reversal. There is some controversy about the prospects of inflation decelerating in 2010. Although the ever optimistic Central Bank Governor expects inflation to be down to 5 percent in 2010, it is more likely to be more than twice his fond expectation...
There are several factors that are likely to increase prices. There is a trend of increase in oil prices that would also have an effect on other imports as well. This is admitted in the Central Bank’s own publication Recent Economic Developments that says, “There are some downward risks as well.
Though the external price pressures are expected to be minimal during the rest of 2009, recent fuel price revisions and its spillover effect on domestic prices may result in a gradual increase in inflation……the global economy is beginning to pull out of the recession though the recovery is expected to be sluggish. An increase in world food prices resulting from higher demand with the recovery from the global recession and rising international oil prices is likely to create external pressures on domestic prices…. A rebound in inflation is possible unless the aggregate demand and inflation expectations are prudently managed.”
In addition to these external factors, there is a likelihood of increased public spending. Wage increases, continuing losses in public enterprises, further increases in public service employment and the massive costs of reconstruction in the East and North are likely to exert serious inflationary pressures. This implies a need for a reversal in monetary policy.
The question is when should there be once again a tight monetary stance. Some think it is too early, some think a failure to act early may result in an inability to control inflation in 2010. Whatever the timing there is no doubt that “unless the aggregate demand and inflation expectations are prudently managed”, the spectre of inflation my haunt us again. Containing the fiscal deficit to manageable proportions is vital as the capacity for monetary policy alone to tame inflation is limited and often harmful to economic growth.