Limitations of monetary policy

According to a report published in The Business Post on Monday, Bangladesh Bank (BB) on Sunday unveiled the monetary policy for the second half of FY23 with little measure at a time when the country’s economy is facing mountainous inflationary and foreign currency exchange rate pressures.

In it, the central bank tried to make funds costlier by increasing the policy rates by 25 basis points to tackle the inflationary pressure but it will not bring any effective result since the lending rate cap remained unchanged.

The Bangladesh Bank governor seems to be in an upbeat mood though, claiming that the country’s economy will not worsen further. The governor of the central bank told the media that the resilience of Bangladesh’s economy is quite strong. We have to agree that the shock absorbing capacity of the country’s economy is impressive to say the least.

However, we believe that there is no room for complacency. This newspaper has identified three key challenges for the economy– prolonged Ukraine-Russia war, interest hike by the US Fed and the possible re-emergence of the pandemic. In particular, a prolonged war in Europe may well make the threat of a recession a reality.

Whether the just declared policy will help curb inflation is a matter of conjecture. Eminent economist Zahid Hussain, told The Business Post that the new monetary policy would not be able to control high inflation. The inflationary pressure will, instead, increase further due to some measures taken in the policy, he added. “If the lending cap is not lifted, the credits will remain very cheap compared to inflation.”

Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Monetary policy generally boils down to adjusting the supply of money in the economy to achieve some combination of inflation and output stabilisation.

On the other hand some experts have said that for too long, we have relied solely on monetary policy to control demand and inflation to cool down the heated economic activities. However, the inflation we are facing is rather cost-push inflation which may not be effectively addressed by monetary policy alone. We believe that the central bank should be focused on maintaining price stability, besides supporting growth, when so many government departments are already focused on promoting growth, and none on maintaining price stability.

Also must have a targeted short-term policy to reduce imports on an emergency basis until we secure financing and work on medium to long-term policies to curb the trade deficit on a sustainable basis.

A central bank can promote growth in the short run but as soon as growth nears its potential, excessive money and credit spill over to produce high inflation, rather than increasing output. The relationship between money and growth is for the short term, while that between money and inflation is of a long-term nature.

In the policy the central bank’s repo and reverse repo rates have been increased. However though these rates have been increased the highest interest rate for bank loans has been kept at nine per cent. But in case of consumer loans the banks have been allowed to increase the interest rate up to 12 per cent. The central bank raises the policy rate to prevent the economy from overheating and ward off hyperinflation.

Currently, banks in Bangladesh are in the midst of a serious liquidity crunch. The rise in repo rates may further exacerbate the situation.

However, the central bank has established a special fund of Taka 50,000 crore to increase the flow of money into the market.