In recent days, inflation has made news all over the world, even in wealthy countries where the average citizen is better able to cope with high prices. This is because the Russia/Ukraine war has resulted in what economists refer to as a “supply shock.”
War prevented Ukraine, one of the world’s largest and lowest-cost exporters of wheat and grains, from supplying its crops to importing countries like Bangladesh. The disappearance of Ukrainian grain from the international market caused a shortage, in which competing buyers were forced to bid up prices of whatever supplies were still available; hence food price inflation.
International sanctions on Russian oil and gas have similarly resulted in a reduction of fuel supply and a shortage of fuel in the international market; this means higher prices for fuel everywhere. With both international food and fuel prices skyrocketing, inflation is inevitable.
The above context is important to establish that the current inflation is due to international supply shocks for which no one in Bangladesh is to blame. The media in Bangladesh often points fingers at industries for price-fixing in order to obtain unfairly high prices and profits, but that is obviously not what is happening here. The food and fuel supply shocks caused by the Russia/Ukraine war are very clear reasons for the price of everything to rise.
Lower income people in developing countries naturally have difficulty sustaining themselves and their families in periods of rising prices. What is the government to do in periods of supply shock-led inflation?
Formulating the correct government response to a supply shock requires recognizing where the real problem lies. The main difficulty in a supply shock is that people earning the lowest wages can no longer afford essentials like food and housing.
The solution for these low income groups is higher minimum wages which provide them a living wage. In fact, employers have a moral responsibility to ensure that all their employees receive wages on which they can survive. Since minimum wages are usually decided by the government, that means that government intervention is now required in the wage market to prevent malnutrition.
In Bangladesh, the largest industry is RMG, and the government typically raises minimum wages in the sector every five years. The minimum wage of RMG workers was last increased by about 50% to Tk8000 per month in 2018. This implies that another adjustment of 50% or so normally would have to be made in 2023 (after a 5-year interval).
However, given the exceptional circumstances of the Russia/Ukraine war and the consequent worldwide food and fuel supply shock and inflation, it would be advisable for the government to raise wages within this year to prevent malnutrition among the working class. Other industries competing for workers with the garments industry will inevitably also raise minimum wages.
The other thing the government needs to do is to remove expectations of inflation, which can create further price rises. This happens because people, observing rising prices, see that the value of their money has gone down, and worry it may decrease further. People expecting that their money will be worth less tomorrow tend to use any available cash to buy whatever goods they can today.
But everyone competing to buy goods today just results in more money chasing the same goods, which results in higher priced goods and more inflation.
The rational way to cure the expectation of further inflation is for the central bank to raise bank interest rates. An interest rate is an objective measure of the value of money in the banks; when interest rates go up, people can see that the value of money is increasing, not decreasing, and will expect no further inflation. This is why the universal prescription for calming inflation is higher interest rates.
Central banks are often reluctant to increase interest rates as it slows down economic growth, since companies investing in new factories or projects always require banks to finance those investments. Unfortunately, there is no real option to control inflation. The government has to make a trade-off between economic growth and controlling price rises. Both can’t be accomplished at once.
Global supply shock driven inflation will never have an easy solution. However, prudent government policies can reduce the damage done by inflation on the most vulnerable members of society as well as shorten the duration and extent of price rises. The government should now increase minimum wages, and increase interest rates.
Zeeshan Hasan is a director of Kazi Farms Group and Kazi Media, the company behind Deepto TV. He is also the managing director of Sysnova.