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Price increases arising particularly from the high cost of imports led by rising crude oil prices pose a significant threat to Sri Lanka’s economic stability. Imposing tight monetary control measures is believed to be the indispensable remedy to prevent Consumer Price Index from submitting to these imported inflationary pressures. However, a little reflection demonstrates that increasing interest rates and statutory reserve ratio of commercial banks to prevent world prices from influencing internal price structure of the economy, fails to adjust market forces in line with Sri Lanka’s economic priorities, which are invariably growth oriented. Increasing interest rates to combat high cost of imports is nothing other than shrinking internal investment and consumption and therefore economic growth, with the good intention of controlling price relationships that are externally established and determined. For since the price of imported article such as crude oil is determined objectively from the aggregate demand function in domestic economy, any monetary measure which attempts to subjugate inflation that is arising from external supply issues is futile and detrimental. While monetary policy can be used to stabilize the economy in the face of aggregate demand fluctuations within the economy, it is not useful in confronting aggregate supply fluctuations especially when the latter is externally determined.
It should be noted that the desire to demand an increased yield for financial assets by banking & non-banking financial institutions in the face of an externally derived supply constraint, is arising from the specific and unique design of the economic relationships which are now operative. Each individual entrepreneurial decision that is made adhering to the prevailing economic relationships, is essentially discrete to each other and hence lack vital cohesion. This would at times miscalculate and underestimate the need of realizing a general requirement over and above an individual gain with respect to achieving equilibrium in the system. Hence, the subjugation of a general requirement with a view to achieve the individual or the particular necessity of a specific interest group of the economy will disturb the process of reaching equilibrium in the system and may intensify conditions that could lead the economy to a phenomenon known as stagflation. Importance of Fiscal over Monetary measures in stabilizing internal prices. This helplessly vulnerable situation of an economy to international market forces is believed to be an objectively governed condition and hence it is assumed that there is very little it can do to insulate itself from high import prices. This belief simply implies that domestic resource allocation must be governed by world prices, whatever be the economic and social costs of such a policy.
Is it indisputable that the internal price structure of a country should reflect the external price relationships? If the foreign prices of import commodities are high Sri Lanka would naturally be able to buy less of them with the limited foreign exchange it possesses. Hence these commodities would be scarce in the economy.
In the contrary, as Dr. G. V. S. De Silva who served as the Director of Economic Research in the Industrial Development Board of Sri Lanka has illuminatingly inquired, why would the economy permit this physical fact of scarcity to manifest itself in the monetary phenomenon of high internal prices? The phenomenon of scarcity has been invariably associated with high prices and this has been uncritically accepted as an implicit premise in economic thinking.
Dr. De Silva pointed out that the connection between scarcity and high prices is not an absolute relationship but one that is just as relative. Herein lies the need of containing inflation though it is impossible to completely sever the scarcity – inflation link. Though the pricing system cannot be totally controlled, there is a possibility of partially harnessing it to serve specific economic purposes.
Therefore, a mechanism is needed to sustain a pricing policy to determine the internal pricing structure independently of international prices and in accordance with what the economy considers to be national priorities. We could certainly do so, subject however to the operation of two constraints; namely the foreign exchange balance and the rupee balance requirements. The first restriction implies that if the foreign prices of country’s imports are high it can buy a relatively small quantity of them due to the requirement that the foreign exchange expenditure must balance the foreign exchange receipts, if the country is not to incur a foreign debt.
The second restriction implies that the total rupee value of the imports must equal that of exports and it necessitates that if the rupee prices of some imports are to be fixed low relatively to their foreign prices, (in our case crude oil) to partially free the internal price relations of the economy from being subjected to the sway of world prices, then the rupee prices of other imports should be correspondingly higher. This indicates that the existence of a privileged import sector such as luxury goods is an absolutely necessity for the creation of a low priced essential goods import sector. And in this way, the link between scarcity and high internal prices can be partially severed and a contagion price increase can be permanently withheld without having to increase the external debt level of the economy. This is vital to relieve the pressure on rupee prices of essential goods imports such as crude oil and essential food items and thus gain some control over the internal pricing structure and the direction of economy. To the extent that privileged imports are used as an absorbent of world inflation, the rupee prices of essential imports could be kept within desired limits.
Hence, the need to revise interest rates and the whole sack of negative impacts that such a monetary measure is capable of yielding is negated by altering the fiscal measures rather than the monetary policies adopted by the government. Therefore, implementing a carefully measured fiscal policy, as opposed to activating monetary instruments, bears the capability of partially subjugating the adverse effects of world inflation without having to sacrifice post-war economic growth while curbing an increase in national debt level.
It should be noted that the desire to demand an increased yield for financial assets by banking & non-banking financial institutions in the face of an externally derived supply constraint, is arising from the specific and unique design of the economic relationships which are now operative. Each individual entrepreneurial decision that is made adhering to the prevailing economic relationships, is essentially discrete to each other and hence lack vital cohesion. This would at times miscalculate and underestimate the need of realizing a general requirement over and above an individual gain with respect to achieving equilibrium in the system. Hence, the subjugation of a general requirement with a view to achieve the individual or the particular necessity of a specific interest group of the economy will disturb the process of reaching equilibrium in the system and may intensify conditions that could lead the economy to a phenomenon known as stagflation. Importance of Fiscal over Monetary measures in stabilizing internal prices. This helplessly vulnerable situation of an economy to international market forces is believed to be an objectively governed condition and hence it is assumed that there is very little it can do to insulate itself from high import prices. This belief simply implies that domestic resource allocation must be governed by world prices, whatever be the economic and social costs of such a policy.
Is it indisputable that the internal price structure of a country should reflect the external price relationships? If the foreign prices of import commodities are high Sri Lanka would naturally be able to buy less of them with the limited foreign exchange it possesses. Hence these commodities would be scarce in the economy.
In the contrary, as Dr. G. V. S. De Silva who served as the Director of Economic Research in the Industrial Development Board of Sri Lanka has illuminatingly inquired, why would the economy permit this physical fact of scarcity to manifest itself in the monetary phenomenon of high internal prices? The phenomenon of scarcity has been invariably associated with high prices and this has been uncritically accepted as an implicit premise in economic thinking.
Dr. De Silva pointed out that the connection between scarcity and high prices is not an absolute relationship but one that is just as relative. Herein lies the need of containing inflation though it is impossible to completely sever the scarcity – inflation link. Though the pricing system cannot be totally controlled, there is a possibility of partially harnessing it to serve specific economic purposes.
Therefore, a mechanism is needed to sustain a pricing policy to determine the internal pricing structure independently of international prices and in accordance with what the economy considers to be national priorities. We could certainly do so, subject however to the operation of two constraints; namely the foreign exchange balance and the rupee balance requirements. The first restriction implies that if the foreign prices of country’s imports are high it can buy a relatively small quantity of them due to the requirement that the foreign exchange expenditure must balance the foreign exchange receipts, if the country is not to incur a foreign debt.
The second restriction implies that the total rupee value of the imports must equal that of exports and it necessitates that if the rupee prices of some imports are to be fixed low relatively to their foreign prices, (in our case crude oil) to partially free the internal price relations of the economy from being subjected to the sway of world prices, then the rupee prices of other imports should be correspondingly higher. This indicates that the existence of a privileged import sector such as luxury goods is an absolutely necessity for the creation of a low priced essential goods import sector. And in this way, the link between scarcity and high internal prices can be partially severed and a contagion price increase can be permanently withheld without having to increase the external debt level of the economy. This is vital to relieve the pressure on rupee prices of essential goods imports such as crude oil and essential food items and thus gain some control over the internal pricing structure and the direction of economy. To the extent that privileged imports are used as an absorbent of world inflation, the rupee prices of essential imports could be kept within desired limits.
Hence, the need to revise interest rates and the whole sack of negative impacts that such a monetary measure is capable of yielding is negated by altering the fiscal measures rather than the monetary policies adopted by the government. Therefore, implementing a carefully measured fiscal policy, as opposed to activating monetary instruments, bears the capability of partially subjugating the adverse effects of world inflation without having to sacrifice post-war economic growth while curbing an increase in national debt level.
