JBS Vol 10. Num 2. 2008 - Understanding Inflation in Bangladesh

Inflation in Bangladesh increased steadily from 1.5 percent in FY01 to 7.2 percent in FY06. Subsequently, the year-on-year inflation reached a nine-year high of 11.6 percent in December 2007. It had a similar rising trend in both rural and urban areas with rural inflation generally higher than urban inflation. Food price inflation has dominated the increase in overall inflation since FY03. A positive feature of Bangladesh‘s inflation is its low and declining volatility. The paper notes that there is conclusive evidence internationally of a negative correlation between the level of inflation and income growth for all but low inflation countries. High inflation distorts decisions private agents make about investment, saving and production. There is also evidence that inflation hurts the poor relatively more. Given this strong socio-economic impact, it is understandable why inflation tends to worry governments more than any other economic issue. Bangladesh is no exception. Bangladesh's tolerance of inflation has a low threshold because of the risks it poses to social and political stability. The paper finds that international price increase and growth in domestic demand are mainly responsible for recent high inflation. The paper finds little evidence in support of the popular claim that inflation is driven by higher domestic costs of supply and collusion by key market players. The paper recommends a cautious monetary policy along with better market monitoring, information sharing, adequate supply of agricultural inputs, and restoring business confidence to curb inflation in Bangladesh. The paper concludes with a reminder of the limitations of how much government can do to contain inflation when it is driven primarily by international price increases.