Assignment

On
Inflation and its impact on Bangladesh

Prepared for
Prodip Chandra Bishwas
Lecturer
Department of Finance & Banking
Faculty of Business studies
Jahangirnagar University

Prepared by
Anika Tasneem Hridi
ID: 1658, Batch: 10th
Department of Finance & Banking
Faculty of Business studies
Jahangirnagar University

Date of submission: 12th June, 2023

Inflation
Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad
measure, such as the overall increase in prices or the increase in the cost of living in a country.
But it can also be more narrowly calculated—for certain goods, such as food, or for services,
such as a haircut, for example. Whatever the context, inflation represents how much more
expensive the relevant set of goods and/or services has become over a certain period, most
commonly a year.
In broader terms, inflation is a rise in prices, which can be translated as the decline of purchasing
power over time. The rate at which purchasing power drops can be reflected in the average price
increase of a basket of selected goods and services over some period of time. The rise in prices,
which is often expressed as a percentage, means that a unit of currency effectively buys less than
it did in prior periods. Inflation can be contrasted with deflation, which occurs when prices
decline and purchasing power increases.
Key takeaways
 Inflation is the rate at which prices for goods and services rise.
 Inflation is sometimes classified into three types: demand-pull inflation, cost-push
inflation, and built-in inflation.
 The most commonly used inflation indexes are the Consumer Price Index and the
Wholesale Price Index.
 Inflation can be viewed positively or negatively depending on the individual viewpoint
and rate of change.
 Those with tangible assets, like property or stocked commodities, may like to see some
inflation as that raises the value of their assets.
Causes of Inflation
An increase in the supply of money is the root of inflation, though this can play out through
different mechanisms in the economy. A country's money supply can be increased by the
monetary authorities by:
 Printing and giving away more money to citizens
 Legally devaluing (reducing the value of) the legal tender currency
 Loaning new money into existence as reserve account credits through the banking system
by purchasing government bonds from banks on the secondary market (the most common
method)
In all of these cases, the money ends up losing its purchasing power. The mechanisms of how
this drives inflation can be classified into three types: demand-pull inflation, cost-push inflation,
and built-in inflation.
Demand-Pull Effect: Demand-pull inflation occurs when an increase in the supply of money and
credit stimulates the overall demand for goods and services to increase more rapidly than the
economy's production capacity. This increases demand and leads to price rises.
When people have more money, it leads to positive consumer sentiment. This, in turn, leads to
higher spending, which pulls prices higher. It creates a demand-supply gap with higher demand
and less flexible supply, which results in higher prices.
Cost-Push Effect: Cost-push inflation is a result of the increase in prices working through the
production process inputs. When additions to the supply of money and credit are channeled into
a commodity or other asset markets, costs for all kinds of intermediate goods rise. This is
especially evident when there's a negative economic shock to the supply of key commodities.
These developments lead to higher costs for the finished product or service and work their way
into rising consumer prices. For instance, when the money supply is expanded, it creates a
speculative boom in oil prices. This means that the cost of energy can rise and contribute to
rising consumer prices, which is reflected in various measures of inflation.
Built-in Inflation: Built-in inflation is related to adaptive expectations or the idea that people
expect current inflation rates to continue in the future. As the price of goods and services rises,
people may expect a continuous rise in the future at a similar rate. As such, workers may demand
more costs or wages to maintain their standard of living. Their increased wages result in a higher
cost of goods and services, and this wage-price spiral continues as one factor induces the other
and vice-versa.

What Are the Effects of Inflation?

Inflation can affect the economy in several ways. For example, if inflation causes a nation’s
currency to decline, this can benefit exporters by making their goods more affordable when
priced in the currency of foreign nations.
On the other hand, this could harm importers by making foreign-made goods more expensive.
Higher inflation can also encourage spending, as consumers will aim to purchase goods quickly
before their prices rise further. Savers, on the other hand, could see the real value of their savings
erode, limiting their ability to spend or invest in the future.

Is Inflation Good or Bad?

Too much inflation is generally considered bad for an economy, while too little inflation is also
considered harmful. Many economists advocate for a middle ground of low to moderate
inflation, of around 2% per year.
Generally speaking, higher inflation harms savers because it erodes the purchasing power of the
money they have saved; however, it can benefit borrowers because the inflation-adjusted value
of their outstanding debts shrinks over time.
Why Is Inflation So high right now?
 In 2022, inflation rates in the U.S. and around the world rose to their highest levels since
the early 1980s. While there is no single reason for this rapid rise in global prices, a series
of events worked together to boost inflation to such high levels.
 The COVID-19 pandemic in early 2020 led to lockdowns and other restrictive measures
that greatly disrupted global supply chains, from factory closures to bottlenecks at
maritime ports. At the same time, governments issued stimulus checks and increased
unemployment benefits to help blunt the financial impact of these measures on
individuals and small businesses. When COVID vaccines became widespread and the
economy rapidly bounced back, demand (fueled in part by stimulus money and low
interest rates) quickly outpaced supply, which still struggled to get back to pre-COVID
levels.
 Russia's unprovoked invasion of Ukraine in early 2022 led to a series of economic
sanctions and trade restrictions on Russia, limiting the world's supply of oil and gas since
Russia is a large producer of fossil fuels. At the same time, food prices rose as Ukraine's
large grain harvests could not be exported. As fuel and food prices rose, it led to similar
increases down the value chains.

Advantages of Inflation
 Individuals with tangible assets (like property or stocked commodities) priced in their
home currency may like to see some inflation as that raises the price of their assets,
which they can sell at a higher rate.
 Inflation often leads to speculation by businesses in risky projects and by individuals who
invest in company stocks because they expect better returns than inflation.
 An optimum level of inflation is often promoted to encourage spending to a certain extent
instead of saving. If the purchasing power of money falls over time, then there may be a
greater incentive to spend now instead of saving and spending later. It may increase
spending, which may boost economic activities in a country. A balanced approach is
thought to keep the inflation value in an optimum and desirable range.
Disadvantages of Inflation
 Buyers of such assets may not be happy with inflation, as they will be required to shell
out more money. People who hold assets valued in their home currency, such as cash or
bonds, may not like inflation, as it erodes the real value of their holdings. As such,
investors looking to protect their portfolios from inflation should consider inflation-
hedged asset classes, such as gold, commodities, and real estate investment trusts
(REITs). Inflation-indexed bonds are another popular option for investors to profit from
inflation.
 High and variable rates of inflation can impose major costs on an economy. Businesses,
workers, and consumers must all account for the effects of generally rising prices in their
 buying, selling, and planning decisions. This introduces an additional source of
uncertainty into the economy, because they may guess wrong about the rate of future
inflation. Time and resources expended on researching, estimating, and adjusting
economic behavior are expected to rise to the general level of prices. That's opposed to
real economic fundamentals, which inevitably represent a cost to the economy as a
whole.
 Even a low, stable, and easily predictable rate of inflation, which some consider
otherwise optimal, may lead to serious problems in the economy. That's because of how,
where, and when the new money enters the economy. Whenever new money and credit
enter the economy, it is always into the hands of specific individuals or business firms.
The process of price level adjustments to the new money supply proceeds as they then
spend the new money and it circulates from hand to hand and account to account through
the economy.
 Inflation does drive up some prices first and drives up other prices later. This sequential
change in purchasing power and prices (known as the Cantillon effect) means that the
process of inflation not only increases the general price level over time. But it also
distorts relative prices, wages, and rates of return along the way. Economists, in general,
understand that distortions of relative prices away from their economic equilibrium are
not good for the economy, and Austrian economists even believe this process to be a
major driver of cycles of recession in the economy.
Inflation in Bangladesh
The volatility of commodity prices in both global and local markets has put ordinary people in
Bangladesh in an uncertain situation as we slowly recover from the economic effects of the
pandemic. The World Bank is already worried about famine in some countries. Given
Bangladesh's food reserves, we may not face a famine threat. However, the abnormal rise in food
prices and the fall in real income for the average individual is placing significant strain on their
ability to obtain necessary food. This pressure may become more pronounced in the coming
days.
The annual inflation rate in Bangladesh picked up to 9.94% in May 2023, the highest since May
2011, from 9.24% in the prior month. Upward pressure came from both prices of non-food
products (9.96% vs 9.72% in April) and food (9.24% vs 8.84%). Inflationary pressure was
slightly higher in urban areas (9.97% vs 9.68%) than in rural areas (9.85% vs 8.92%). On a
monthly basis, consumer prices fell by 0.35% in May, for the first time in five months, after a
0.64% increase in the previous month.
Consequences of Inflation in Bangladesh
 Food inflation has a profound nexus with poverty and inequality. Food inflation hits the
poor hardest since their purchasing power decreases due to the erosion in real income.
From the economics theory, when the real wage decreases demand for labor increases.
Therefore, the employment should rise since there is a tradeoff between inflation and
unemployment. The result depends on whether the employment effect of inflation
 outweighs the real wage effect on poverty. But in Bangladesh empirical data indicates
that the real wage effect on poverty outweighs the employment effect of inflation (Matin,
2011). There exists a positive relationship between food inflation and poverty. As the
food inflation increases, the additional number of people goes under the poverty line. The
rising trend of food prices and unemployment make the problem even more complex. As
the food prices are in the rising trend it may pave the way for more people to go under the
poverty line while they were above the poverty line before the food price rises. In
Bangladesh 40 percent of 160 million people live on less than one dollar a day. A rapid
population growth, rising food prices and unemployment as well as the threat of climate
change turns Bangladesh into a more food insecure state (Matin, 2011).
 Excess inflation has its negative impact on savings and investment. Impact on savings has
its direct reflection in the area of investment. Investment, both domestic and foreign, is
essential for Bangladesh and it is important for growth and economic development.
 An unfavorable and unpredictable movement of inflation often creates lack of confidence
amongst the investors. Many potential investments face bleak prospect and avoid the
game of facing risk and uncertainty. This has been hindering potential private investments
on different sectors in Bangladesh.
 Inflation has its implications for the banking sector as well. Both for the banks and their
customers inflation causes a reshuffle in the flow of activities. Rates of interest offered by
the banks seem less attractive to the depositors. Bank lending has also a great role in the
economy. In recent years there is an increasing trend of providing consumer credit by the
banks. It will add to the demand side. But if its contribution to the supply side remains
weak there will be a lack of balance and the banking industry will face challenge. Other
saving lending channels also face the same consequences from supply side to handle their
investment demand. The challenge of central bank is to balance between growth and
inflation. High inflation always put central bank under pressure to take contractionary
monetary policy that might reduce growth.

Steps to reduce inflation in Bangladesh

The persistent inflation at 9% in Bangladesh over the past eight months is hurting the poor, the
low income and the middle-income groups fairly substantially. This must be tackled upfront
without further delay. It is particularly important to lower inflation urgently in an election year.
Inflation will not go away on its own and will be especially stubborn if accommodated further
with credit growth and bank financing of Treasury deficits.
In all countries, inflation management is the topmost priority for the Central Bank. To
depoliticize inflation management, most advanced economies have an independent Central Bank
who can control the growth of credit to manage inflation through its interest rate policies.
Bangladesh Bank must act fast and with determination to lower the growth of credit by
abandoning the 6/9 interest rate policy and using interest rate flexibly. It should also fast track
the development of a secondary market for T-bills to facilitate interest rate based monetary
policy management. The government should support this inflation control strategy of the
Bangladesh Bank by keeping fiscal deficits below 5% of GDP, phasing the implementation of
large capital-intensive projects, and mobilising low-cost foreign financing for the budget deficit.