Rising price levels, monetary and financial stability and public understanding

Continuous rising price levels are devastating, it affects the disposable incomes of people, savings are depleted, elderly and the poor are forced into difficulty. Lenders are made to suffer losses; in summary there’s a gradual decline in the quality of life. But of course the richer may gain by rising real estate prices as we rightly observe in Sri Lanka.

For the alternate government bringing down prices is a popular slogan to topple the government in power. But despite government changes price levels continue to soar amidst many explanations dished out by economists. Escalating oil prices, a disproportionate level of defence expenditure and unproductive government expenditure are major catalysts of inflationary trends.

There are also larger lessons. Core inflation which is the CPI minus food & energy prices may remain stable but what about food and energy two ingredients we consume most.”

Sri Lanka scenario is no different often we hear growth is improving, The trade balance is narrowed down and even inflation is subsiding; what does these mean to the general public whose main concerns are the prices paid for essentials; aren’t they rising forever with interest rates too moving upwards.

We all know no short term solutions exist to remedy these situations. Upward adjustments to oil prices which have now become a monthly feature has a spiralling effect on most consumable items the majority of which doesn’t form part of the CCPI. Costs of electricity, LP gas, water, telephone and fuel more or less occupies good percentage of an individual’s disposable income thus confirming the “Samuelson” theory.

Last week in Colombo Peter Sinclair, Professor of Economics University of Birmingham, delivered a lecture on “Price Stability and Financial Stability” at the Central Bank. Perhaps his visit to Sri Lanka was timely given the inflationary trends and the rising interest rates and the public outcry. According to Prof Sinclair too many deviations in the rate of inflation were not healthy and the authorities should take a longer term view of the trend and not today’s situation.

Comparing rising prices to a snake and ladder situation he suggested to concentrate on the ladder and not the snake. Prof Sinclair was of the view that policy rates were the best treatment to control inflation and called the periodic adjustment a “pill” made up of basis points. His categorization of the treatment was 25 good, 50 bad, and 75 really bad and 100 as terrible, perhaps this prescription gives a good measure of the Sri Lankan economy.

In conclusion Prof Sinclair went on to say that many Asian economies particularly China and India have made remarkable economic progress in recent years.

One factor in both China and India and perhaps even in Sri Lanka, has been the replacement of the socialist principle of income equalisation by the canon of aggregate economic efficiency in the allocation of capital. In the old days you kept feeding up lame ducks, industries or enterprises or regions, that is which were handicapped by low values of product prices or technology, to allow them to deliver close to the economy’s average level of income per head pay. This was achieved by taxing the more fortunate and channeling funds through state banks. Now you seek to equalize capital value of marginal product across economy.

This switch gives rise to raising income in the strong sectors, cuts income in the weak sectors, raises aggregate income however over a period of time.

In Sri Lanka during the past few years the Central Bank has taken stern measures to ensure financial discipline in the financial sector thus resulting in a gradual stabilization of the financial stability. Similarly even at present some healthy anti-inflationary measures are adopted continuously through open market operations and periodic policy rate adjustments. However we are yet to see expected budgetary discipline in government expenditure.