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‘Govt. spending will determine policy’

The government spending and inflation direction in the coming months will be key determinants of policy, Central Bank Governor Dr. Indrajith Coomaraswamy said.”My gut reaction is that we are close to the top of the interest rate cycle, Governor Coomaraswamy told the media recently at Central Bank auditorium. He said if there is a ‘significant fiscal slippage’ the Central Bank will have to respond with monetary policy.

As inflation around the world ratcheted up after World War II with the failed Bretton Woods soft-peg system of depreciating currencies and later fully fiat money, all kinds of excuses were given for inflation, including droughts, floods, wage-spiral inflation, economic growth, oil shocks and even interest rate hikes, he added.

” if headline inflation goes up due to supply side effects, there will have to be a monetary policy response to avoid secondary effects through wages for example, “he said.Inflation may spike in the months ahead, but fall back to the lower side of the 4-5 percent target in the first quarter of 2018, Coomaraswamy said.Coomaraswamy said he always complained that budget deficits was the key trigger of economic instability of Sri Lanka but from 2016, fiscal consolidation has been on the corrective path, though there may debate about individual spending decisions.” At the moment state enterprises were among borrowers,” he said .Sri Lanka’s credit bubble seems to be abating but it is right to be vigilant about persistent rises in inflation, whether they seem on the surface to be ‘supply’ related or otherwise.

Sri Lanka currently has a flood, but with credit moderating, and the Central Bank sterilizing forex purchases there is less inflationary pressure, though currency depreciation is continuing to push up prices and destroy real wealth.While temporary supply shocks can happen, where a price of one or more goods go up, it does not necessarily make all prices in the economy to go up over any significant period. In general, infltion occures when a Central Bank accommodates a supply shock with monetary loosening.If supply side or cost-push inflation in general was true, it should have happened before the 21st century also, when there was no fiat money, no US Fed and the Bank of England was private.Supply side inflation is a type of excuse that became popular as part of the post-second World War neo-Mercantilist cost-push inflation myth.’’

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