Money is no problem?

The central bank is a key institution in the modern economy. Its function is to maintain stability in the macroeconomy and the financial system. In the advanced capitalist world, macroeconomic stability has come to mean maintaining price stability while growing the economy as close to its potential pace as possible. In addition to these, for a developing economy, macroeconomic stability could also mean exchange rate stability or maintaining solvency of the government. Financial system stability means maintaining a functioning banking system, keeping the credit flowing, and acting as the lender of the last resort.

During the COVID-19 pandemic, central banks around the world have had to balance all these tasks, and the Bangladesh Bank is no exception. In its latest Monetary Policy Statement, issued for 2020-21 financial year, the central banks states that —monetary policy stance monetary programs for FY21 are essentially expansionary and accommodative for all growth support needs without impairing attainment of the targeted inflation containment.

With inflation hovering around 5-6% (Chart 1) and expected to remain moderate into the foreseeable future, supporting economic growth has, quite rightly, been the central bank’s focus.

Has money been a problem for the economy during the pandemic?

Wiggly party?

Couple of months ago, I analysed some indicators used by the Economist to see whether the Bangladeshi economy was overheating.  The verdict was that ‘it was getting hot’.  An overheated economy is not only more vulnerable to an external shock, it also usually leaves the policymakers with less options to boost the economy in case of adverse shocks. 

In addition to their vulnerability indicator, the Economist also has a ‘wiggle room’ index for monetary and fiscal policy in 27 emerging markets.  The concept is explained here, while here are country details.  As of January, Egypt, India, Poland, Argentina, Brazil, Hungary, Turkey, Pakistan and Vietnam had little policy tools spared for a downturn.  

That is, according to the Economist’s analysis, Argentina, Brazil, India, Turkey and Vietnam are economies that were dangerously overheated in mid-2011, and whose governments had little policy options to combat a downturn earlier this year.  You wouldn’t want to be an econocrat in those countries!

What about Bangladesh?  Over the fold, I look at the indicators for Bangladesh.  Short answer: no room for monetary policy, but fiscal policy has spare capacity.

It’s getting hot in here

I have a vague recollection of CPD’s Debapriya Bhattacharya talking about Saifur Rahman attempting to drive a big car in a narrow alley.  He was talking about the late finance minister’s policy settings, which saw Bangladesh economy accelerate.  If I remember correctly, Mr Bhattacharya’s point was that the economy was accelerating too quickly while structural problems were not addressed, and like a car in a narrow alley, speed could mean accident up ahead.  Fortunately for Bangladesh, the economy didn’t suffer a crisis under BNP (or the army, or under the current government, until now).

What happens when an economy grows too fast relative to its capacity?  Typically, imbalances start developing — inflation sets off, the country runs up large external deficits, private and public sectors become too leveraged, asset prices enter bubble territory.  Economists typically call such economies overheated.

The London Economist has an index that checks the ‘temperature’ of 27 emerging markets.  The concept is explained here. Essentially, the index is based on six indicators: inflation, GDP growth, unemployment, credit growth, real interest rate, and current account.  As of June 2011, they considered seven countries — Vietnam, Turkey, Indonesia, India, Hong Kong, Brazil, Argentina — to be in the ‘red hot’ territory, at risk of a crisis.

Bangladesh wasn’t in their list.  I decided to look at the data using their methodology to assess its risks.  Short answer?  It’s definitely getting hot in here.  Fortunately, it’s not in the red zone yet, and policymakers can make a difference.  Long answer, over the fold.