Thread by @ChayuDamsinghe

Okay Hanke is giving his inflation numbers and asking for a currency board again, so let's talk about inflation and what all of this is about before this ends up at a #GoHomeGota #GoHomeGota2022 protest

#SriLankaEconomicCrisis #SriLankaCrisis

(1/25)

Okay first, we know that inflation is an increase in prices, but what exactly are these numbers floating around?

The main measures are an inflation index, and they measure how different prices are this month, compared to a year ago (and you can also compare monthly).

(2/25)

So when you hear "March 2022 inflation is nearly 18%" that means an average item that was 100 rupees in March 2021 is nearly 118 rupees in March 2022.

But wait, surely prices are far higher than just 18%?

(3/25)

Yes, and that's because inflation numbers are an average of price increases within a "basket" or an average set of items that a consumer is supposed to use.

Within this basket, some items go up 100%, some go up 2%, some even fall a bit

(4/25)

These price changes are then "weighted" by how big a percentage of the basket that item is.

Eg - Toffee might rise by 300%, but realistically, noone spends a lot of money on toffees, so it matters less than say bread going up 50% for example.

(5/25)

There are definite questions about whether the items in this basket are accurate. But assuming they are, the inflation numbers we see are accurate, there doesn't seem to be any fake numbers.

Food inflation alone is closer to 30% compared to the 18% of the full basket.

(6/25)

Why is this inflation rising in the first place?

There are many reasons - some are due to demand factors, others due to supply.

(7/25)

Global prices of lots of items have gone up, so that gets reflected here. Similarly, there are supply issues in Sri Lanka from shortages of fuel etc, making it harder and more expensive to transport goods.

(8/25)

But the big reason why inflation is rising higher than many places in the world is money printing. This has happened in 2 ways.

First, people having more money means they demand more for the same amount of products.

(9/25)

So if there is only 100 items to be sold, and 1000 rupees with people, each item will be sold for 10 rupees each.

But if people have 2000 rupees and still really want these items, then they're willing to spend more to get it, upto 20 rupees each per item.

(10/25)

But by far the biggest way we've had inflation is because money printing leads to more money in people's hands, which is then used for imports - both consumer (18% of imports), intermediate (60%), and machinery (22%)

More imports=more dollars going out=more depreciation

(11/25)

This outflow of money AND the fact that we've not been able to get new money after we cut down taxes and made our debt unsustainable, means we're just losing dollars more, and we've seen the 50% depreciation we saw now.

(12/25)

Remember though, a lot of imports were coming in through the unofficial market at higher prices, so it's not a full 50% increase immediately.

Also remember, not everything is imported. My personal rule of thumb is that inflation is roughly around 40-60% of depreciation.

(13/25)

So that's where the current inflation came from, and why the impact of this will continue for some time, before hopefully, things turn around and reverse as currency stabilizes, money printing reversed, etc.

(14/25)

Okay then what's this 69% that Hanke is talking about?

A word on Hanke himself before we start. He's a Senior Fellow for a group called the Cato Institute, and his life's work is currency boards.

(15/xx)

Cato is a libertarian think tank. Libertarianism, simply, is reducing government as much as possible, whenever possible. Combined with the fact that his pet research topic is currency boards, useful to look at what he says after understanding this bias.

(16/25)

Hanke's own inflation index is based on the idea of "purchasing power parity". That's essentially how much someone who earns in rupees can buy compared to someone who earns in another currency, usually against the USD.

(17/25)

So Hanke's index measures something closer to the loss of this ability on top of inflation - so how poorer are we as Sri Lankans and THEN how much have prices risen by.

So calling it inflation, in my view, is misleading.

(18/25)

It's a useful thing to know for sure, but it only really matters if we talk about things in dollar terms alone. In that context, yes, our ability to buy things in dollar terms is equivalent to a 69% increase in prices.

But we don't use dollars. We use rupees.

(19/25)

Then why does he talk about this so much? That's where his currency board proposal comes in.

A currency board is essentially where a country has in its reserves, enough dollars to fully convert all rupees in the country to dollars.

(20/25)

This requires no central bank, just a currency board, and pegging the currency and no interest rate adjustments among other factors.

So if we do this, of course, then Hanke's index matters, since we're running on dollar terms essentially.

But we aren't. So it doesn't.

(21/25)

Doing a currency board now needs something like 6bn more dollars, not practical at all

But is it worthwhile for later?

My personal view is no, it leaves us at the mercy of another country's currency/rates/inflation, it removes ability of CB to help banking system, etc

(22/25)

But that's another debate - because there ARE advantages, such as making it harder for CBs to manipulate local systems.

But whether it actually works in a non-tiny economy is a question. Eg- Argentina's peg, Hanke's crowning achievement, failed.

(23/25)

Right now, that's a debate for far later.

Right now, we address our inflation through rate hikes, improving confidence with IMF and debt restructuring, and then rebuilding our economy. I don't think we have the time or money to spend on a currency reserve.

(24/25)

Inflation will continue to rise for a while like the new governor said. But afterwards, it should begin to fall IF we continue to take the right actions.

But broadly, I'm confident we won't go to hyperinflation. I'll end with that.

(25/25)