Is contractionary monetary policy failing to curb inflation?

Since our macroeconomics classes in the late 1970s and early 1980s, we have been taught that raising policy interest rates is a fundamental tool for controlling inflation. Yet recent experience in Bangladesh suggests that this prescription—often advocated by the International Monetary Fund and a few other like-minded economists—has not delivered the intended outcome. 

Inflation has once again moved upward, rising from November to around 8.5% in December. The measures taken by the government and Bangladesh Bank to contain inflation have clearly fallen short.

The contractionary monetary policy pursued over the past two-plus years has instead strained the supply system. Higher lending rates have weakened the private sector by restricting access to credit. As employment opportunities narrowed, people's purchasing power declined further, compounding pressure on household finances.

In theory, when excess liquidity fuels inflation, policy interest rates are raised to reduce the money supply. Higher rates discourage banks from borrowing from the central bank and push up commercial lending rates, thereby cooling demand. 

Acting on this framework, Bangladesh Bank adopted a contractionary monetary stance in 2023. Following the mass uprising in July and August 2024, the policy rate was raised further to 10%. Even so, inflation remained stubbornly high.

This outcome underscores a critical reality: inflation in Bangladesh has been driven less by excess money supply and more by failures in market management. As a result, higher policy rates have had a limited impact. Supply chain disruptions during the mass uprising pushed inflation to a record 11.66% in July 2024. 

Although inflation declined afterwards and reached 8.17% in October—the lowest level in 39 months—the trend soon reversed. Inflation rose to 8.29% in November and further to 8.49% in December. 

Many believe actual market prices exceed these official figures. Under such conditions, relying solely on contractionary monetary policy without strengthening market management risks further destabilising the economy.

Meanwhile, higher interest rates have slowed overall economic activity by reducing credit flows to the private sector. Credit growth weakened significantly last year as lending declined amid policy tightening and market uncertainty. Investment also suffered. New investments failed to materialise, particularly in capital machinery imports, raising concerns about long-term growth prospects. 

High inflation pushed up the prices of essential goods and eroded purchasing power, while business operating costs rose sharply. Political instability and several policy decisions of the interim government further undermined private sector confidence.

According to Bangladesh Bank data, private sector credit growth fell to just 6.23%in October 2025, reflecting a clear confidence crisis. Businesses postponed investment and expansion decisions. 

Between July and November 2025, settlement of letters of credit for capital machinery imports declined by 16.77%, raising serious questions about the future pace of industrialisation. At the same time, new foreign direct investment in equity capital fell by 16.90% in the fiscal year ending June 2025.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            Throughout the year, vegetable prices remained elevated. Even during the winter season, prices did not decline significantly in November and December. Although prices fell sharply at the farm level towards the end of December, consumers did not benefit. Prices of rice, pulses, sugar, flour, fish, meat, LPG, and most essential goods increased over the year. As a result, inflation could not be reduced to the expected level.

This occurred despite a significant decline in global fuel prices, along with lower prices for rice, wheat, soybean oil, powdered milk, spices, and other commodities. Global shipping costs also fell. Yet Bangladeshi consumers saw little relief. 

As in the previous two years, they continued to bear the burden of high inflation. Even modest increases in global prices tend to translate into sharp domestic price hikes. Under such circumstances, controlling inflation solely through higher interest rates becomes extremely difficult.

Concerns have also persisted regarding the accuracy of inflation data published by the Bangladesh Bureau of Statistics. Even based on official figures, Bangladesh recorded the highest inflation rate in South Asia last year. 

Sri Lanka's inflation stood at 2.10% last month. Despite declaring bankruptcy two and a half years ago and experiencing inflation close to 70%, Sri Lanka managed to bring it under control within two years. Pakistan has also achieved notable success, reducing inflation to 5.6% last month from a peak of 38% in April 2023. India's inflation last month stood at 0.71%.

Containing inflation, therefore, requires addressing structural weaknesses alongside monetary measures. Restoring discipline in the domestic market must be a top priority. This demands more than routine monitoring. Price-fixing syndicates must be dismantled. Adequate supplies of essential goods must be ensured through multiple sources in line with demand. 

Where domestic production is insufficient, imports should be arranged and import-related complexities resolved. Above all, corruption and irregularities in market management must be eliminated so that consumers can benefit.

Market management and oversight in Bangladesh remain weak. Some market operators continue to create artificial shortages and exploit crises to raise prices irrationally. Such practices must be stopped. While contractionary monetary policy has worked in many economies, it has been far less effective in Bangladesh. 

A large informal sector, a dysfunctional market structure, and the nature of bank financing—predominantly wholesale—limit its impact. Inflation cannot be controlled simply by following the legacy prescription of raising interest rates. 

To bring inflation down to a tolerable level, breaking syndicates, strengthening market management, improving and diversifying supply chains, and thinking beyond conventional approaches are essential.

Mamun Rashid is an economic analyst and chairman at Financial Excellence Ltd.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard