When psychology drives up inflation

It is usual for product prices to go up before Eid. However, in the ordinary scenario, prices are adjusted after Eid to some extent. But this Eid saw a very spicy price for green chillies. The price per kg of green chillies rose to Tk1,000 within only three days — more than 10 fold the usual. 

Ceteris paribus would indicate around 1000% inflation in the market. This is not just alarming or unusual, but also a very interesting fact to analyse. This unusual price hike for one of the products of the commodity market is not an unprecedented incident. Bangladesh had seen such an unusual price hike for onions and salt not too long ago. So, an in-depth study of why this happens and to what extent inflation is responsible for is a necessity.

Inflation is defined as a rise in prices over time that reduces the buying power of a currency. Undoubtedly, Bangladesh is now in a critical period for controlling or containing inflation. Last month, the country's inflation rate was 9.94%, well above the desired amount. Even while worldwide inflation has been blamed for high inflation in Bangladesh, the internal rationale behind the increasing rate cannot be ignored any longer.

Domestic price increases are usually caused by two forms of inflation: structural inflation and bottleneck inflation. Structural inflation is common in underdeveloped countries, owing to the weak structure of their economy. However, the most common sort of inflation is caused by a lack of supply while demand remains steady: bottleneck inflation.

Globally, the central bank is responsible for curbing inflation. Likewise, in Bangladesh, the central bank is responsible for controlling inflation. Recently, the Bangladesh Bank has taken a contractionary monetary policy restricting the excess money supply in the economy to control inflation and also acknowledged that the goal is a challenging one to achieve. It has raised policy rates and lending rates to discourage borrowing, launched agricultural initiatives to promote agricultural production, and is moving toward a single foreign currency rate. 

As a result, the central bank is leaving no stone unturned. However, these programs indeed have little impact on what happens in the commodity market. But again, the Bangladesh Bank has just one tool to combat inflation, and it is making full use of it. So, what is the problem?

In reality, the policy is strong enough to limit, solely, structural inflation, which it is doing. This month, inflation has decreased to 20 basis points and stood at 9.74%. In the commodity market, supply has not decreased severely either. After visiting the local markets, the Directorate of National Consumers Right Protection said the supply of pepper was normal across the country. If there was no structural inflation and no significant reduction in supply, then why did the price of chilli go up by 10 times? 

The answer is "psychological inflation".

The psychology or behaviour of the market participants has a lot to do in shaping prices in the market. When everyone in the economy assumes that the price of a certain commodity might go up, they start purchasing more than they require and start stocking up. This suddenly places the demand curve high and the price rises. 

But when they assume the price may fall soon, they stop purchasing, which drives the demand curve lower and the price falls. This is the basis of behavioural finance. 

Similar to that, in "psychological inflation", a large portion of stakeholders decide to quote a higher price thinking the price is justified because of inflation, which then by force, injects inflationary pressure in the market.

In the past, what syndicates used to do was to pile the products in their storage, create an artificial shortage of supply and then charge a high price. But now, just using the psychology and ill motivation of profit, the price is easily manipulated in the market.

The psychology of the business person of the country is responsible for this type of sudden price hike in any specific product. By making the 10% inflation liable, they, without any hesitation, quote a price three-four times the current price. They have developed a mindset that by investing Tk100 they can earn a profit of Tk900. And this psychology of the businessman is responsible for not just domestic inflation but is also responsible for the failure of the country not being able to benefit when the global inflation goes down. 

The most relatable example of this is the price of fuel. When globally the price of oil, gas, or other fuels goes up, the price is adjusted in the country. But when the price comes down globally, authorities in the country don't adjust the price again.

This isn't only about the businessman, the syndicate, or the producers though. Even service providers are succumbing to psychology. When observing the behaviour of a typical rickshaw puller, one notices the psychology of blaming a 10% inflation for boosting the fee to 100%. 

For example, if the rickshaw puller previously charged Tk20, he or she may now charge Tk30 or, to a lesser extent, Tk40 for the same distance. As a result, the inflation rate in his mind is 50% to 100%. When a businessman rides on that rickshaw, he receives a signal that the economy's income level has increased, allowing him to raise the price of his items even further.

Had there been a solid ground of fundamental reason for charging a high price i.e. green chilli, the price wouldn't have sharply fallen with the announcement of importing the products at a large scale from India. Unlike other times, steps have been taken very promptly by the authorities. On  25 June the government had already given authorisation to private firms for the import of green chilli. On 5 July, the Directorate of National Consumers Right Protection conducted drives in 41 districts and fined 118 businesses around Tk6.21 lakh for not displaying a price chart and overcharging customers. On the previous day, the directorate fined 148 traders around Tk3.39 lakh.

But even after such measures, no concrete or permanent solution has come to notice. The consumer rights directorate needs to conduct strict drives regularly, rather than waiting for the price hike of a specific commodity to become a burning issue. Then again, the Krishi Shomprosharon Odhidoptor can also aid in solving the problem by looking for ways to ensure undisrupted supply in the rainy season from high-located areas. 

However, for that, the portion of inflation that arises from psychology needs to be handled from a very critical point of view to find a suitable solution.

Dr. Ashraful Alam Chowdhury is an independent researcher and columnist. He completed his MSS in economics from Dhaka University. Then, he pursued post-graduation and PhD in economics from Emory University, Georgia, US. He has experience of working in the US, Bangladesh, Myanmar, and India.