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Such views represent the Monetarism that was so much in vogue in 1980s due to work of Milton Friedman who was awarded the 1976 Nobel Prize for Economics for his contribution to consumption analysis and to monetary history and theory. Although this old version of monetarism will not re-emerge in the foreseeable future, it is useful for the general public to know how a modern central bank treats the monetarism. Therefore, the purpose of this article is to diversify the debate in order to enhance the public awareness on this subject. In this article, I will show that practicing monetary policy or central banking is not a rocket science, but it is an art performed by the professionals of a central bank. The number crunching is not used in this article purposely not to confuse the public. Numerous statements made by various writers with reference to certain officials of the CBSL are ignored due to the non-economic nature of such statements.
Large positive relationship between inflation and net
credit to government by CBSL
According to one writer, the culprit for inflation is the money printed by the CBSL for the purpose of granting loans/credit to government (as measured by net credit to Government) and this is proved by the large positive correlation between inflation (change in consumer price index) and the change in the amount of net credit to government. The correlation is 0.54 in respect of inflation measured by CCPI and 0.75 in respect of inflation measured by SLCPI. However, his analysis is defective due to the following points.
= The net credit to government is only one factor determining the level of money printing or money stock and, therefore, it is wrong to link inflation only to net credit to government. Any one who goes to the market without knowing economic jargons knows that inflation is a result of a host of factors connected with demand for and supply of goods, services and factors of production that determine the general price level in the economy. The economy needs money to facilitate transactions and the CBSL being the monetary authority has powers to print money to fulfill its wider role in the economy and financial system. The credit facility to government is one factor representing monetary requirements of the country and it is wrong to interpret that such credit is bad because the government is operated by politicians and officials. This is a major misconception that the text-book-economists have. Most of our economists including the writer and the economic analysts in the media are the products of government’s education policy. Therefore, the economic role played by the government should be looked at in the national interest since there is no firm evidence to prove that market mechanism will satisfy the human needs or economic welfare of the general public.
= The correlation coefficients 0.54 and 0.75 are not high enough to establish such a strong and important argument. Especially, inflation is mostly understood from the change of CCPI and the correlation of 0.54 is not practically material. A simple correlation can be found in statistically measured variables and such correlation estimated (through statistical jargons) does not necessarily mean that those variables are correlated in the real world unless very sound interpretation is provided. The inflation cannot be explained completely through the net credit to government. Further, the values of such variables are determined jointly by known and unknown factors. Econometricians/statisticians can have their own academic exercises to estimate any value of correlation they wish through complex estimation methods.
= The estimate of total net credit to government should be used cautiously because total net credit to government is not the money printed by the CBSL only to finance the government. A part of it has been printed by the CBSL to meet the market liquidity requirements and monetary policy operations known as "open market operations". This can be understood by looking at the estimate. The net credit to government is estimated as the sum of provisional advances to the government and CBSL’s holding of government securities less deposits of the government kept at the CBSL. In terms of the section 89 of the Monetary Law Act, the government is entitled to receive direct provisional advances from the CBSL equivalent to 10% of the estimated revenue of the government in the current financial year provided that such advances should be repayable within a period of not exceeding six months. The Monetary Law Act was drafted by John Exter, an eminent American Economist serving the Federal Reserve Bank of New York in 1949. He did not include this provision inadvertently, but this was introduced consciously as a way for a developing country such as Sri Lanka to provide money and liquidity for economic needs. Money printing for provisional advances was capped at 10% of the expected revenue of the government so that the government could not abuse this facility. In terms of the section 91 (1) of the Monetary Law Act, the CBSL is empowered to undertake open market operations, that is to purchase and sell in the open-market securities issued by the government or securities fully guaranteed by the government and to issue, place, buy and sell freely negotiable securities of the CBSL itself (known as Central Bank securities). In terms of section 90(1), the open market operations could be conducted for the following two purposes
To be continued
