Hyperinflation affects economic growth
When countries experience hyperinflation, the domestic prices of goods and services rise every minute and in such a situation no one wants to hold onto the local currency. This results in people rushing from the banks to the shops to buy goods, fearing their currency will lose value along the way, according to a senior government economist.
Even the banking system itself can collapse due to this, said Dr. P. Nandalal Weerasinghe, Senior Deputy Governor, Central Bank of Sri Lanka, delivering the Olcott Oration 2017 on the subject of "Evolution of Monetary and Exhange Rate Policy in Sri Lanka and the Way Forward" at the Ananda College Colombo auditorium last week.
The Olcott Oration is an annual event organised by the Ananda College Old Boys' Association to commemorate the achievements of Colonel Olcott and the Founders of the Buddhist Theosophical Society.
Dr. Weerasinghe said that the prime responsibility of any Central Bank around the world is to maintain price stability by way of maintaining low and stable inflation on a sustainable basis. Based on the experiences of many countries the level of inflation has been fluctuating from time to time at different time periods. "When people lose faith in local currency, the barter system or exchange of goods or services will become the norm, of the day making transactions more difficult." He said hyperinflation has adverse effects by destroying real value of middle class savings in local currency and fixed income of earners like workers and pensioners.
Citing an example, he said one can read horror stories o f hy p e r i n fl at i o n in Germany and Australia in the 1920s and more recently in several Latin American countries and also in countries like Zimbabwe. The hyperinflation episode in Germany is said to have facilitated the rise of Hitler and the global destruction that followed. He said the other extreme case of price movements, namely the deflation that affected Japan was known as the "lost decade" which is now termed as the "Lost 20 Years". Since the early 1990s Japan experienced a deflation that resulted in a continuous decline in prices of goods and services. Since then the Japanese economy has experienced a negative economic growth, a drop in nominal GDP and declining wages. However some sustained growth in Japan is seen only now.
Referring to Sri Lanka he said that the country fortunately never experienced such episodes in the past. "We do not want neither hyperinflation nor deflation in the future." However the double digit inflation hovering around 10- 20 per cent as experienced in Sri Lanka for several decades from 1970 is bad for sustained growth. He said the Central Bank here could only effectively control demand driven inflation but could do little to address the short term disruptions, due to adverse domestic supply developments or unexpected international commodity price movements.
The Sri Lanka monetary policy framework has evolved from a currency board arrangement before the establishment of the Central Bank in 1950. From 1950- 1977 Sri Lanka's monetary policy framework was based on maintaining a fixed exchange rate regime in terms of fixing the value of the Sri Lanka rupee first to the sterling pound and then to the US dollar. The system worked well as long as Sri Lanka ear ned foreign exchange to meet expenditure on imports without any restriction. During the periods of export booms in the early 1950' s the fixed exchange rate regime worked well, as foreign exchange earnings which arose due to external factors rather than domestic export promoting policies, were not only sufficient to meet current expenditure but also helped build up foreign reserves so that currency peg could be maintained without foreign grants or borrowings.
He said economies like Japan early on and later Hong Kong, Singapore, Taiwan and even China was, with strong export oriented policies, able not only to generate current account surpluses on a sustainable basis, but also see the value of currencies appreciating against major currencies like the sterling pound and the US dollar. During the period of Sri Lanka's fixed exchange rate regime, successive governments did not pursue export oriented policies continuously. However in November 1977, Sri Lanka embarked on a major economic liberalisation move from inward looking restrictive policies towards a liberal regime under which trade and payments were liberalised to a great extent and the Central Bank abandoned the f i xe d exchange rate and moved to a more market based system of exchange rate management.