The Politicisation of Inflation7 min read

Sri Lanka’s is currently in the process of amending its monetary policy. We are moving towards an inflation targeting central bank. The proposed new law is at the stage where the dinosaurs in parliament oppose it on grounds of tradition[1]. Quoting from the referenced link;

The requirement that a particular policy be adapted by the MLA severely restricts the CBSL’s ability to respond to different macroeconomic and financial market conditions by adopting alternative monetary policy frameworks, it is prudent to give the Monetary Board of the CBSL the power to adapt the flexible inflation targeting framework rather than incorporating it into the MLA,” the memo to the Cabinet said.

On the removal of the secretary to the treasury from the CBSL governing body the link quotes the memo as saying;

‘Authors of the proposed MLA have failed to appreciate the requirement for co-operation between the Government and the CBSL, and instead taken a very narrow view of the perceived independence of the CBSL.’

To translate the first point, the President does not feel it is essential for the Central Bank to stay true to a previously stated objective. He thinks the Central Bank should take a line closer to an election manifesto. The second point is about hierarchy (conflated with the term co-operation) vis-à-vis the position on the governing body. The President in a convoluted sense is saying that monetary policy should serve the policy directive of the treasury.


What is really being proposed was something that developed nations had implemented widely as far back as the 1990s. It is quite simply a separation of treasury and central bank. The central bank will be restricted from financing government excesses on the short term and will have to set monetary policy on the basis of long run average inflation.

The context in the words of W A Wijewardene[2];

To give strength to the flexible inflation targeting program by making the bank independent from fiscal dominance, a new Monetary Law Act is said to be presented to Parliament for approval soon. They would certainly make macroeconomic stability measures sustainable but do not assure it since the present Government cannot make unchangeable rules for future governments. That should come from ‘political consensus building’ and that is completely outside the purview of the Central Bank.

This is just a truism as all laws are permeable. The final sentence is completely untrue as the Central Bank has a considerable advertising budget and an entire department focused on communications. They are unable to do anything because they are incompetent. If the referenced section was true, the opposition party to which the President has aligned himself would be unconcerned with a law they feel is misguided. The reason this is contentious is because it is a good law.

It is more difficult for a government to overturn good law. Take the abolition of the death penalty or the right to information. These laws are difficult to overturn without being seen to be acting against the interests of the people.

Nationalization Policies of the SLFP

The SLFP is an antiquated and overtly racist political party. Their ideological beliefs are inconsistent when taken as a whole and also with the policy proposals they put forward. Modern economics does not hold a central tenant on the virtuous nature of the ownership of an asset. Put in other words you can approach investment both through; the government and private enterprise; foreign and local; for profit and not for profit.

Communism failed a long time ago and is no longer even relevant in contemporary economic discourse. The SLFP must wake up. This is the same party that advocates high protectionist tariffs but on the other hand firmly believes in having an overvalued exchange rate. Anyone monitoring global trade would see that China is combating any US aggression on the tariff front with a corresponding devaluation of their currency[3].

Recent articles[4] claiming that the Central Bank had not planned or discussed publicly this change for over a year conveniently forget that this reform was due at the start of this year. It had been fiercely debated in the financial press and this can be confirmed by a Google custom search on the Daily FT site.

The reason the SLFP hates inflation targeting is because such a project would place employment creation and price stability as the objectives of monetary policy. This would reduce the dependence of the general public on availability of state sector employment and politically driven price reduction. In other words the entire SLFP electoral strategy would be called into question.

Our Monetary Policy Has Been Bad

The Central Bank in an article[5] claims the following;

“In fact, the Central Bank has been following a de facto flexible inflation targeting regime for some time. The intention now is to institutionalize this in law.”

Another statement by the Central Bank even cited European and US Federal Reserve actions in expanding their balance sheet. The Central Bank is displaying considerable knowledge on what the right thing to do in a downturn is but doesn’t seem to be doing it.

In other words the Central Bank can easily expand its balance sheet without following the disastrous policies of continuously funding budget deficits. These movements in the market would clear the glut and get the economy rolling again. For instance the Central Bank could have easily helped recapitalize the development banks (DFCC and NDB) which failed to raise capital. They could have then unwound these investments when capital market conditions were not as depressed.

More importantly, we have been missing the inflation target for quite some time[6]. Inflation is 3.3 percent while the target is 5 percent. The desire for Central Bank employees to return to the robber baron regulation during the previous government is reflecting itself in unusually high rates. This is as the US goes into an election cycle and has already reduced rates!!!

Inflation Targeting Isn’t Completely Apolitical

The inflation targeting framework proposed isn’t as suggested a complete apoliticization of monetary policy. Rather it would be conducted in a manner whereby the treasury and the Central Bank agree on a long term objective of monetary policy. This would prevent the Central Bank in the future from reducing interest rates for instance to win an election.

The treasury would still play a huge role in setting monetary policy through this process of agreement. The treasury as a short term fix could still reduce taxes on inflation indexed goods to reduce rates. The treasury can throw off kilter any forecast done by the Central Bank by signaling different policies.

If the monetary board fails to meet the inflation target it must resign

This is what actually following inflation targeting would entail. It has long been the calling of the general public to reduce rates so as to at least meet the lower bound of the inflation target. The monetary board has failed to reach target.

This is the most salient thing the Central Bank has to respond to. Instead of spending time responding to articles of little merit the Central Bank should justify as to why inflation remains below target. Inflation under Arjuna Mahendran was also muted so in terms of long run averages the rate of inflation has been incredibly low for the period.

At the very least the payments made to the monetary board must be based on the successful achievement of the set out objectives in the inflation targeting framework. They shouldn’t be paid this month and should have deductions made on previous payments.



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