The price of everything

There is a major difference of views among the official prognosticators about Bangladesh’s economic recovery from the pandemic recession. The 2020-21 Budget projected return to 8% GDP growth in the current financial year, while the World Bank doesn’t see even 4% growth in next financial year, with the IMF and the ADB being somewhere in between. No such difference, however, when it comes to inflation projection. All three international financial institutions expect inflation to hover around 5.5-6% range over the forecast horizon, not too dissimilar to the 2020-21 Budget (Chart 1). 

Further, thus far, actual inflation has remained very much within that range (Chart 2, source: CEIC Asia database). Contra fears, food price inflation, while experiencing a modest uptick, remains moderate compared with the rates experienced in 2013 or 2017. Globally, food and energy prices remain low. As Tyler Cowen, an American economist, puts it: It is not likely that the next major macroeconomic problem will be inflation. 

Nothing to worry about inflation then?

Well, maybe, but…..

In a recent cover story, the Economist lists three sets of reasons for being wary of inflation when the pandemic is over. Firstly, there might be a lot of pent up demand, which might outpace supply when the lockdowns end, and consumers rush to buy goods and services. Even if this were to happen, however, this will mean that the economy is experiencing a solid V-shaped recovery. And there is no reason for this kind of inflation to be prolonged. So, this, in itself, shouldn’t be cause of worry.

A different argument is that there might be structural reasons in the global economy for persistent inflation in the medium term. For the past few decades, the world economy experienced cheaper goods and services thanks to globalisation, as millions of workers in Asia took advantage of new technologies. With ageing of societies around the world, and deglobalisation, prices of goods and services may well start rising. Even if this were the case, however, this will not happen immediately after the pandemic ends. This a longer term, late 2020s worry, not something for 2021.

The third argument is that politicians and governments are complacent. They have pumped tremendous amount of money into the economy. Institutions are reeling from political uncertainty. Charles Goodhart, a British economist, argues that: The correlation between monetary growth and inflation has an historic pedigree as long as your arm. Olivier Blanchard, former chief economist of the IMF concedes that inflation could return if: public debt were to rise much more than currently expected; real interest rates were to rise sharply to be above real growth rate, making it expensive to service the debt; and governments started printing money to devalue the debt. 

Blanchard says this is unlikely, and perhaps is right when it comes to the advanced western economies. But what about elsewhere?

According to the IMF’s latest World Economic Outlook, Venezuela is experiencing hyperinflation, and triple digit inflation expected in Zimbabwe and Sudan in 2020. Inflation of over 20% is projected for the year in Lebanon, Suriname, Iran, South Sudan, Yemen, Haiti, Libya, Angola, and Ethiopia. Some of these countries are, of course, at war. But not all. What factors drive high inflation in these countries? 

Noah Smith, another American economist, frames the issue as:

One key question is whether runaway inflation happens slowly enough that the government can reverse course in time, or whether it’s instantaneous and catastrophic. Another question is whether direct monetary financing of new government borrowing is a trigger for hyperinflation. A third is whether and how capital flight is involved. A fourth is how the type of government spending changes whether markets expect deficits to be temporary or permanent.

Turning Smith’s questions around, let’s weave a scenario.

The government is running a large budget deficit, while the economy is already in the middle of a recession, making a tax rise politically unlikely and economically counterproductive. Government expenditure is dominated by sensitive items such as wages and salaries of public servants or armed forces, or procurement from elite-connected firms, or infrastructure projects in regions of political importance. As a result, the budget deficit is ballooning. At some point, the government loses access to the financial market — no one wants to buy its bonds, while banks are already reeling from non-performing loans owed by oligarchs. Meanwhile, with slump in exports, the currency starts depreciating, causing import prices to rise as well as increasing the burden of the debt owed to foreigners. The government has no recourse but to force the central bank to print money. As the supply of currency rises, but that of goods and services don’t, prices of everything rise. And people expect prices to rise continuously. Hyperinflation ensues, like love and bankruptcy, first slowly, then suddenly.  

Oscar Wilde is meant to have said that: A fool is someone who knows the price of everything and the value of nothing. However, only a fool will claim that inflation — a general rise in prices of everything — doesn’t matter. It’s not just the inconvenience to consumers. High and rising inflation damages the confidence in future that is essential for a modern economy to function. According to the official projections, the above scenario is not likely in Bangladesh. But to the extent that several elements of that story are very much plausible, it is only sensible to worry about inflation.