CONTROLLING INFLATION - FROM THE PERSPECTIVE OF A GOVERNMENT

I recently read this article by Frederic S Mishkin on strategies to control inflation, where he identified 3 strategies that the central banks should adopt to do the “magic” to curb ongoing inflation, i.e. :

a) exchange rate pegging

b) monetary targeting

c) inflation targeting

When Malaysia was faced with an economic attack/turmoil in 1997, the then Malaysia’s Prime Minister has adopted the exchange rate pegging – the Malaysian Ringgit with the US Dollar. And no one can say that the decision was a bad one as Malaysia managed to recover from the downturn faster than its neighbouring countries.

Controlling inflation forms a significant part of the economic activities of a nation. It is important as unrestrained increase of the prices may culminate in Hyperinflation, and an excessive fall in the prices may lead to Deflation. Both the situations are not healthy and sound for the overall growth and development of a country's economy.

In fact, keeping a strong control over Inflation has turned out to be one of the primary objectives of the governments of different countries across the globe. To this effect, efficacious economic policies are being formulated, which mainly concentrate on the fundamental causes of inflation in an economy, and try to improvise methods to keep the inflationary conditions under control.

It is worth to also highlight some methods, which have proved to be highly effective in controlling inflation to large extents:

Fiscal Policies:

Fiscal policies are effective in increasing the leakage rates from the circular income flow, thereby rejecting all further additions into this particular flow of income. This brings about a reduction in the Demand-Pull Inflation, in terms of increasing unemployment and slackening the economic growths. Following are a few types of fiscal policies commonly employed:

• Lowering the expenses on governmental level
• A fall in the borrowing amounts in the government sectors, on an annual basis
• High direct taxes, for reducing the disposable income

Monetary Policies:

Monetary Policies have a great role to play in controlling Inflation. These are policies which can actually control the rise in demand, by increasing the rates of interest and reducing the supply of real money. An escalation in the interest rates brings about a reduction in collective demands, in the following three ways:

• A rise in the interest rate discourages borrowing from both companies and households. When interest rates increase, it simultaneously encourages the savings rate, owing to an escalation in the opportunity cost of expenditure.
• Rise in the interest rates is a very useful tool for restricting monetary inflation. Increase in the real rates of interest decreases the demand for loans, thereby limiting the growth of broad money.
• There may also be a fall in the commercial investments, due to a rise in the costs of borrowing money. This exerts a direct influence on a handful of planned investment-related projects, which turn out to be unprofitable . This leads to a fall in the collective demand.
• An increase in the payment of mortgage interests automatically decreases the real 'effective' disposable income of the house owners, as well as their spending capacities. Escalation in the mortgage costs also decreases the demand generated in the housing markets.

Exchange Rates:

An escalation in the exchange rate is possible by increasing the rates of interest or buying money through the central bank interferences in the foreign exchange markets. Mentioned below, is a short-term mean by which inflation can be controlled through exchange rates:

• Income policies or direct wage controls: Setting restrictions on the growth rate of wages may decrease cost push inflation. On governmental level, an attempt to influence the growth of wage leads to limit the rise in the pay in public sectors, as well as initiates cash restrictions for making payments to the employees of public sectors.

As far as the private sector is concerned, the government attempts to convince the commercial firms and its employees to implement self-controls at the time of negotiating wages. Generally, there is a fall in the wage inflation when there is an economic depression, leading to a rise in the unemployment rates.

The long-term means of controlling Inflation are as follows:

• Supply-side Reform Policy: According to this policy, if more output is produced at a low per unit cost, there are chances for the economy to attain persistent economic growth and development, without being affected by inflation.
• Policy regarding labour market reforms: If an increase in the flexibility of the labor market permits the commercial firms to put a check on labor costs, it can lead to a reduction in the pressures created by Cost-Push Inflation.
  

CAN ISLAMIC ECONOMY CONTROLS INFLATION?

What is inflation?

At its most basic level, inflation is simply a rise in prices. Over time, as the cost of goods and services increase, the value of a currency is going to go down because we will not be able to purchase as much with the same amount of currency as we would last month or last year.

How aspects of Islamic economy can control inflation :

One : Hard currency is tied to gold or silver standard

The Islamic system requires currency / medium of exchange to be based on the gold and silver standard which have an intrinsic value. Notes can be used to represent the precious metals instead of carrying gold and silver around, but they must be backed up by them. Due to the intrinsic value in the precious metals stability is achieved and devaluation and inflation controlled.

In Islam, currency is treated as a medium of exchange/store of value and should not be treated similar to commodity (i.e., that can be traded at anyone’s whims).

Two : No artificial money

The Islamic system does not only forbid riba, but also does not allow us to loan what we do not own or have. Banks cannot produce money at any time, as and when they like.

Three : No hoarding to manipulate supply and demand

The Islamic system abhors hoarding and the artificial manipulation of supply and demand.

Four : Ownership of natural resources

Islam’s solution is based on its view of ownership and permissibility of generating profits from natural resources. Islam is the only system that defines 3 types of ownership; individual, public and state property. The Prophet SAW in his Hadith has included natural resources that combust (oil field, gas field, coal mine, etc) as public property as well as other natural resources. Public property can not be transferred to the state or private sector, but remains the property of the public (Muslim Ummah) and is run by the Islamic state for their benefit on a no profit, no tax basis. Any profit generated by selling surplus oil to friendly non-muslim countries must be spent on the Ummah.

Hence the Islamic view on natural resources would be a pivotal factor in reducing prices and controlling inflation

Fifth : Revival of dead land

The Prophet SAW informed us that a Muslim who revives a dead Khiraji land, which was never cultivated since Muslims opened it, would own the neck as well as its produce. The Prophet SAW also informed us any Muslim or Zimmi (non-Muslim citizen of the Islamic state) who revives a dead Khiraji land on which Khiraj was applied in the past would own the produce, whilst the neck would remain with the State.

The concept being whoever revives a dead land can benefit from it. This presents a great incentive for poor farm workers and others to take advantage of this Islamic rule and revive dead land and the whole state would benefit. Poverty would be reduced, employment would increase and so would production. Increased production leads to increased supply and therefore cheaper prices and lower inflation.

Based on the 5 pertinent points above, we could conclude that if the Muslim nations of the world could work together to control the global inflation and thus, save the humankind from starvation and work towards better living standards. It is very sad indeed to see that the rich are getting richer and the poor are getting poorer and the gap between these two classes is widening in each passing day…when will it end? Or will it ever end…Only God Knows Best (wallahualam).