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Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value of money. Money is a means of exchange, a store of value, and a unit of account. The ability of an asset to act as a store of value is a necessary precondition to its fulfilling the role of a means of exchange. Hence, a falling value of money detracts from its desirability as a store of value and begins to affect for the worse the efficiency of the mechanism of exchange in a market economy. Money s role as a unit of account stems from its use as a means of exchange, and in this role too it is undermined by inflation. In particular its usefulness as a unit of account in transactions involving deferred payments is vitiated. Inflation thus has a potentially serious effect on credit markets.

!ne of the basic ob"ectives of sound macroeconomic policy is to maintain price stability as well as full#employment economic growth. In this context, the main contribution that monetary policy can probably make to economic management in the long#run is maintaining stable and low inflation rates. The popular opinion about the costs of inflation is that inflation makes everyone worse off by reducing the purchasing power of incomes, eroding living standards and adding, in many ways, to life$s uncertainties %&ipsey et al., '()*+. ,roadly speaking, the primary effects of inflation are the redistribution of income and wealth associated with unanticipated inflation, which is likely to affect economic activities and resource allocation of the country %Taslim and -howdhury, '((.+. In an open economy, the cost of inflation is even higher. If prices and costs in the domestic economy rise at a faster rate than that of trading partners, then all else equal, imports become cheaper and exports dearer, making it increasingly difficult to compete in world trade. /o, it is necessary to maintain price stability through controlling its channels or sources that are responsible for inflationary impulse, which can help the monetary authority in its policy making process.


0fter the independence in '(1', ,angladesh has been under a persistent inflationary pressure caused mainly by excess money supply, as mentioned in Hossain %'((.+. 2or this reason, in particular, price stability has become one of the most important policy ob"ectives of ,angladesh authorities over the years. That is presumably the reason why ,angladesh registered a favorable performance in terms of inflation rate compared to its neighboring countries during the period '((3#*334. 5uring this period, average inflation rate in ,angladesh was the lowest in /outh 0sia, at the same time, average 657 growth rate in the country was also high followed by that of India. ' However, financial deepening %as measured by broad money supply to 657 ratio+ in ,angladesh remained the lowest, with even comparatively lower exchange rate depreciation. 0ll of these factors appeared to have played a significant role for lower inflation rates in ,angladesh compared to its neighbors.

In recent time the situation in ,angladesh is like stagflation, because in last two8three years inflation has gone up as well as the 657 growth rate has gone down compare to previous year.


0nnex Table ' for the detail picture

2. Literature Review
The term inflation has probably given rise to one of the most significant macroeconomic debates in the field of economics. In general, the cause of inflation in developed countries is broadly identifies as growth of money supply, based on the famous monetary economist, Milton 2riedman :inflation is always and everywhere a monetary phenomenon.; 0ccording to 2riedman quantity theory of money there is a general agreement that growth in the quantity is the primary determinant of the inflation rate %Mankiew, '((1+. ,ut in the developing countries inflation not a purely monetary phenomenon but it is often linked with fiscal imbalanced and with internal economic policies. /easonal shortages pertaining to agricultural production and other supply sides, such as international oil price are also known as the common factors of inflation in developing countries. The rise in the inflation rate has prompted two views of the sources of higher inflation in ,angladesh. !ne is the cost-push inflation which is typically caused by supply shocks such as flood, draught and oil price hike. The other is the demand-pull inflation that occurs when the aggregate demand %05+ in an economy outpaces the aggregate supply %0/+.

Demand Pull Inflation The cause of demand#pull inflation is related to excess demand resulting from the components of aggregate demand, known as consumption, investment, government expenditure and net exports. 0ny causes an increase in any of these components will create an excess demand. The monetarists believe that the increase in aggregate demand is due entirely to the money supply increase in the economy. In this regard, especially in developing countries, they identify the budget deficit, as one of the main channels through money supply increases in the economy. They assert that increases in spending in excess of the full employment level of output will create shortages and firms will raise prices accordingly.


Cost-Push Inflation -ost#push inflation occurs when business respond to rising production costs, by rising prices in order to maintain their profit margins. There are many reasons why costs might rise= such as= # rising imported raw materials cost, rising labor costs, higher indirect taxes imposed by the government etc. -ost#push inflation may occur in the economy if there are increases in the cost of factor input, or if there are any kind of supply shock. In developed countries, supply shocks are known as the rise in world oil prices and increases in wage settlements that push up the cost of productions. 0long with higher oil prices and wages, factors such as a currency devaluation or depreciation, interest rate increase, indirect taxation or removal of subsides are referred to as sources to cost push inflation in developing countries. Taslim and -howdhury %'((.+ pointed out two aspects of inflation in an open economy. !ne is the transmission of trading partner$s inflation to the domestic economy and another is the impact of changes in the relative price of exports and imports, known as the terms of trade effect. 0n increase in the interest rate causes a rise in the cost of borrowing, which ultimately affects prices of the final goods. However, in developed countries, increase in interest rate causes a decrease in spending, which lowers the general price level. The role of inflationary expectations is also important in explaining inflationary process in a given period. If workers expect a rise in the inflation rate, they will demand higher nominal wage to keep their real wage stable. !nce people come to expect high rates of inflation, the expectation alone will generate further inflation without any change in the existing labor market conditions %Taslim and -howdhury, '((.+. In general, if there is a lack of confidence in monetary policy, inflationary expectations are likely to be self# fulfilling. 0 variety of channels potentially link inflation rates in different countries. 0 fixed exchange rate system, the ,retton >oods system, or the ?uropean ?conomic and Monetary @nion %?M@+Arequires participating countries to adopt similar monetary policies. ?ven in the absence of a de "ure fixed exchange rate regime, a desire to stabiliBe exchanges rates can prompt central banks to mirror each other$s policy shifts %-anBoneri and 6ray, '().C -alvo and Deinhart, *33*C 5evereux and ?ngel, *331+. -ommon

macroeconomic shocks, such as oil price shocks, also potentially generate positive covariation in international inflation rates. The fact that central banks may respond similarly to common shocks amplifies such comovements %Henriksen et al., *33)+. ?ven a macroeconomic shock that clearly originates in a particular country can spill over to other countries$ inflation rates through international trade in goods and services and assets. In summary, a variety of macroeconomic shocks, as well as economic and political pressures for central banks to respond similarly to shocks, are capable of producing comovements in inflation rates across countries. >hile such factors potentially create common fluctuations in inflation rates, a given country$s inflation rate can behave in a highly idiosyncratic manner if its central bank pursues monetary policies that substantially differ from those of the rest of the world. 2or example, a country might rely extensively on seignorage revenue to finance fiscal outlays. This dependence on seignorage might swamp most foreign influences on the country$s inflation rate. 2urthermore, political, cultural, demographic, and technological factors affect a country$s openness and therefore the degree to which trade channels link its inflation rate to foreign rates. In the context of ,angladesh Taslim %'()*+ attempted to analyBe the inflationary process in ,angladesh in light of the structuralist#monetarist controversy using the data for 2EF3 to 2E)3. The findings clearly indicate that the rate of change of money supply and devaluation are the most significant explanatory variables. 0ny devaluation of the domestic currency is followed by an almost equal proportionate increase in the rate of inflation, while an increase in money supply does not induce an equal proportionate increase in the inflation rate as would be suggested by an extreme monetarist view. In contrast, in formulating a model of inflation for ,angladesh, ,egum %'(('+ considers a detailed approach that concentrates both on aggregate supply and demand. The empirical test shows that the significant variables for inflation are agricultural and import bottlenecks, government expenditure, rate of interest, wage rate, bank credit and expected inflation. The results regarding agricultural bottlenecks, rate of interest and credit show the dominance of the supply#side cost#push effect, while the results regarding import bottlenecks, government expenditures, wage and expected inflation show the dominance of the demand side effect. .

!n the other hand, in investigating the relationship between money, prices, output and exchange rate in ,angladesh during the period '(14#(*, -howdhury et al. %'((.+ find that the inflationary process in ,angladesh cannot be explained exclusively by the monetarist or the structuralist factors. The paper noted that monetary shocks have a strong, but relatively short#run, impact on inflation, and therefore suggested that tight money may put a short#term dampening effect on inflation and help stabiliBe the foreign trade sector, but may also cause a slowdown in the economy. 0khtaruBBaman %*33.+ analyses trends and underlying factors responsible for inflation during the '(1<#*33* period in ,angladesh. @sing an econometric analysis, he showed that the rate of depreciation of the exchange rate, growth rate of money supply and the deposit interest rate have played significant roles in explaining the long run inflationary process in ,angladesh. He also observed that inflation is negatively correlated with real income. /everal studies have made an effort to understand the causes of inflation in ,angladesh. !smani %*331+ tries to explain the underlying factors using various hypotheses based on economic growth, growth in remittances, global inflation in food prices, accommodating monetary policy by the -entral ,ank and the exchange rate policy of ,angladesh. He argues that rising world prices, accommodating monetary policy by the -entral ,ank and the exchange rate policy, particularly the value of the Taka against the 5ollar all have probably contributed to the recent inflation in ,angladesh. MortaBa and Hasnayen %*33)+ observed that the poor are facing a higher rate of inflation than non#poor, because they spend almost two#thirds of their income on food items. They have argued that higher transport costs, inadequate infrastructure, and imperfect market organiBation are responsible for higher food prices in ,angladesh.

0. -howdhury and Taslim M. 0. %'((.+. Macroeconomic 0nalysis, /ydney= 7rentice Hall. 0khtaruBBaman, M. %*33.+ Inflation in the Open Economy: An Application of the Error Correction Approach to the Recent Experience in Bangladesh ! >orking 7aper /eries= >73F3*, Golume ', Humber *, ,angladesh ,ank= 7olicy 0nalysis @nit. ,egum, HaBma %'(('+. :0 Model of Inflation for ,angladesh,; "hilippines Re#ie$ of Economics and Business Gol. *), Ho. ' -alvo, 6uillermo 0. and -armen M. Deinhart %*33*+ :2ear of 2loating.; %uarterly &ournal of Economics -anBoneri, Matthew ,. and Io 0nna 6ray %'().+ :Monetary 7olicy 6ames and the -onsequences of Hon#-ooperative ,ehavior.; International Economic Re#ie$ -howdhury, 0bdur D., Minh J. 5ao and 0bu H. M. >ahid %'((.+. :Monetary 7olicy, !utput and Inflation in ,angladesh= 0 5ynamic 0nalysis,; Applied Economic 'etters Gol. *, Ho. < 5evereux, Michael ,. and -harles ?ngel %*331+ :?xpenditure /witching versus Deal ?xchange Date /tabiliBation= -ompeting !b"ective for ?xchange Date 7olicy.; &ournal of (onetary Economics Henriksen, ?., 2inn ?. Kydland, and Doman Lustek %*33)+ :The High -ross#-ountry -orrelations of 7rices and Interest Dates.; Manuscript, @niversity of -alifornia#/anta ,arbara. &ipsey, D., 7. /teiner and 5. 7urvis %'()*+. Economics 1th ?dition, Hew Eork= Harper -ollins 7ub. Inc. Mankiew, H. 6regory %'((1+. (acroeconomics Third ?dition, Hew Eork= >orth 7ublishers, Inc. MortaBa and Hasnayen /. %*33)+. Inflation Accounting Across Income )roups: *oes Inflation +urt the "oor (ore in Bangladesh, 7olicy Hote. Ho. 3)31. 5haka= 7olicy 0nalysis @nit %70@+, Desearch 5epartment, ,angladesh ,ank. !smani /. D. %*331+. Interpreting Recent Inflationary -rends in Bangladesh and "olicy Options. 7aper presented at the dialogue on MInterpreting Decent Inflationary Trends in ,angladesh and 7olicy !ptions$, organiBed by the -enter for 7olicy 5ialogue %-75+, at 5haka on ) /eptember *331.

Taslim M. 0. %'()*+. :Inflation in ,angladesh= 0 Deexamination of the /tructuralist# Monetarist -ontroversy; -he Bangladesh *e#elopment .tudies Gol. '3, Ho. '

Annex Table 1: Inflation and its Factors in South Asia: FY 199 ! FY " # A$era%e &an%ladesh India 'e(al Pa)istan Sri *an)a Period 199 -9+ 4.* '3.'F '3.. ''.1* (.)< Inflation 199,<.)* ..). F.4( 1..1 1.) " 1- # <.<( 4.3* <.)1 ..*) (.34 -DP /ate 0"1-DP /atio 199 -9+ 199," 1- # 199 -9+ 199," 1- # 4.F. ..*' ..'* *4.14 *).1* <F.)4 #3.*1 #*.1( #'.4< <.1( *.F* 4..' ..<< ..1( F.'( 4(.44 .F.4' 13.<F #4.)< #'.F. #'.4 #3.*4 *.3( '.). ..'4 4.)< *.(4 <<.3F 4'.(( .<.1) #<.4* #'.*. 3.<< #*.( #'.41 #3.14 4.F' <.*1 4.' 4<.1* 4..3< 44.33 #3.<' #..11 #3.*3 #3..< *.44 '.)< ...1 ..34 <..) <'.4( <..(* 43.<F *.'< #'.1( #3.'. *.F' '.(( #3.*<

199 -9+ 2xchan%e /ate 199,De(reciation " 1- # /eal Interest /ate 199 -9+ 199," 1- #

/ource= >orld 5evelopment Indicators, *33F %>5I *33F+, >orld ,ank %>,+ and International 2inancial /tatistics %I2/+, International Monetary 2und %IM2+.