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OP-ED: Hyperinflation is coming

  • Published at 05:33 pm November 25th, 2021
PRAYERS FOR LOWER INFLATION
Syed Zakir Hossain/Dhaka Tribune

When people demand more goods and services due to a general increase in wages, it leads to what is called wage spiral inflation

Inflation refers to the general rise in the price of goods and services over a given period of time.

There are two things that cause this kind of inflation: an increase in money supply and an increase in aggregate demand (overall demand).

Increase in aggregate demand: When people's income increases they usually buy more goods and services, this leads to an increase in demand.

If more and more people demand certain goods and services, then it only stands to reason that the price of said goods and services will also increase.

So, when people demand more goods and services due to a general increase in wages, it leads to what is called wage spiral inflation.

An increase in money supply: The only reason money has any value is because its supply is limited.

If there's more money in circulation, then it stands to reason that each individual unit of money will be less valuable especially if the rate of increase in supply of money outpaces the rate of increase in demand for money.

When governments print a lot of new money in a very short period of time, it is usually followed by a rapid rise in price (first in the price of assets and then in the price of goods and services.

This is a big part of the reason we've seen massive gains in the price of stocks, cryptocurrencies and real estate worldwide including Bangladesh before we saw a rise in the price of goods and services).

This effect is more pronounced in countries where there's rampant corruption.

In corrupt countries, it's easier for people to dodge income taxes and since you have to pay your income taxes in your local currency, in countries where it's easier to dodge taxes, there's less demand for the local currency.

The lesser the demand for money, the higher inflation will be due an increase in money supply.

Keeping inflation in check

Now, one of the prescribed methods for keeping inflation in check and ensuring that it doesn't spiral out of control is to match the increase in demand with increased supply of goods and services.

This sort of approach is known as supply side policy.

This is easier said than done in poor countries with little resources and rampant corruption.

In many countries where access to the legal system is limited for a vast majority of the population, it's hard to ensure optimal supply because the barriers to production are huge.

It's impossible to ensure full production when a lot of your entrepreneurial energy has to be devoted towards paying bribes, paying "protection money", dealing with goons etc.

It's also very hard to increase production by encouraging new entrepreneurs to come into the scene since people don't have too much faith in a broken legal system.

In countries where there's little accountability, people will feel like there is no one to ensure that powerful rival businessmen closer to the government won't unfairly harm your business operations.

When double digit inflation first starts to take hold, such countries usually fail at coming up with supply side remedies.

They can't just get rid of the "bad actors" since sometimes their grasp on power partially depends on the well-being of these individuals.

As prices keep rising, workers eventually are driven to bargain for higher wages.

This eventually leads to an even faster rise in prices triggered by wage spiral inflation.

In a country with a large informal sector, wages rise pretty quickly under these circumstances.

Obvious measures

If history is any indication, then the next step governments usually take after this is quite obvious, they try to contain the price of the US dollar (price in terms of local currency) within reasonable limits.

This is especially important for countries like Bangladesh since we import a lot of essentials from abroad (as such, devaluing the currency to boost export is not an option. It'll only make essentials more expensive).

In order to do this, we have to buy up a lot of foreign currency and this is where years of corruption may come back to haunt us.

Corrupt countries have dangerously low reserves.

In most cases, it turns out to be lower than what the public was ever aware of.

When all else fails, such countries usually resort to what they've always resorted to, easy fixes to complicated problems.

We've seen this time and again in history. In these cases, governments usually resort to printing more money.

This leads to a faster rise in inflation which quickly spirals out of control.

This is the worst-case scenario for Bangladesh when it comes to the current rise in prices.

If we can't control the price of US dollars and if we can't use expansionary supply side policy (fiscal) to fix the problem, then don't be surprised if the Tk1 crore you have in your savings account becomes worthless within just a few years.

 

The author is a freelance contributor

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