Policy approach, FY11
outcome, outlook for FY12
1. Policy approach: Besides employing policy interest rate (repo, reverse repo rate) interventions to influence real sector price levels via financial sector prices, 88's monetary policies seek to influence real sector prices also via quantity theory based money stock targeting; monetary programmes chalk out target growth paths for broad money (M2) and its sub-aggregates, implemented by day to day management of growth path of reserve money (RM, currency in issue and balances of banks with 88).
This approach is felt necessary because of inadequacy of well functioning transmission channels from financial prices to real sector prices in domestic markets still at early stage of development, and also because unlike economies fully open on capital account, money stock targeting is feasible in economies like Bangladesh maintaining controls on capital flows. The annual average CPI inflation level projected for a fiscal year in the annual national budget is taken as the target real sector price level for monetary policies. In stakeholder consultation sessions on monetary policy stance questions were raised about why BB does not set low inflation targets on its own instead of adopting the rather high inflation projections of national budgets. Also, in the backdrop of monetary growth and inflation outcomes persistently exceeding program targets in recent periods, questions were raised about relevance of the methodologies now in use, Brief observations on these issues will be in order here.
As regards why BB doesn't set inflation targets on its own, even in the advanced economies where central banks are specifically mandated to pursue Inflation targets, the inflation levels to be targeted are set by governments answerable to their electorates, not by the central banks themselves. In other words, those central banks enjoy operational independence but not goal independence, just as in Bangladesh. Inflation levels projected in the annual national budgets are not numbers drawn off the cuff; these are outcomes of careful interagency deliberations actively participated interalia by relevant BB staff. As for why inflation targets thus chosen are on the high side compared to global inflation, it needs to be noted that within the 'global composite, developing economy inflation levels are in general substantially higher than in mature advanced economies, IMF and other multilateral agencies report inflation levels separately for these two country groups. Trade globalization has by now broadly equalized prices of tradable in developed and developing economies; price levels of non-tradable (such as personal and professional services etc.) are still on path of gradual convergence, rising from the much lower levels in developing economies. The rising trends in prices of non-tradable will keep Inflation in developing economies higher than in advanced economies until full convergence with the stable but higher price levels of the latter.
Besides this inherent divergence in inflation dynamics, the other compel1ing reason for not choosing lower single digit inflation targets is that in developing economies such low inflation levels are growth inhibitive rather than growth supportive.
Growth of Bangladesh economy in the early low inflation years of this century was not spectacular, while the economies of China and India worrying over high and rising inflation continue on roaring growth pace. Empirical studies with cross country data find moderate inflation growth
supportive up to a certain inflexion point, beyond which further rise in inflation starts hurting growth. A recent estimation by 88's PAU following  methodology developed by Khan M 5 et al1 finds this inflexion threshold for Bangladesh at around eight per cent; although the adverse effect on growth may not always show up immediately (chart 4 ).  As to whether the monetary programming exercise now in use in Banglade5h i5 any longer relevant given the overshoots of both monetary growth and inflation beyond targeted levels in successive recent periods, it may be noted that these recent periods were not quite the normal trend periods when monetary and other programmes based on many simplifying assumptions produce expected outcomes. The significant growth slowdown of FY09 and the recovery speeding up sharply in FYl1 required policy interventions of opposite kinds towards relieving the stresses and maintaining
 balance. During such episodes when other imperatives override monetary program objectives, overshoots from programmed monetary and inflation targets are unsurprising and do not nece5sarily indicate 10$5 of relevance of monetary programming exercises. On the contrary, the evidence of declining non-food CPI inflation and slower rise of headline CPI inflation in FY11 indicate continued relevance and effectiveness.
(To be continued)

News: The Independent/ Bangladesh/ July-31-2011