evolution of monetary and exchange rate policy in sri lanka and the way forward by dr. p. nandalal weerasinghe1 senior deputy governor central bank of sri lanka i am deeply honoured to have been invited to deliver the olcott oration 2017 and to join a list of great anandians who have delivered this oration before. i cannot think of a greater honour that my school could confer on me. i accepted this invitation with humbleness, with gratitude and respect, and with great pride. let me also take this opportunity to appreciate the support and guidance i received during my school career at ananda college. the guidance our teachers gave us laid the foundation for any success later on in our lives. my oration today, is on the rather technical topic of monetary and exchange rate policy. the biggest challenge that i have to face is to present such a topic to an audience with a majority who might not be familiar with the technical jargon involved. however, i will attempt to keep the discussion as simple as possible. central banking and price stability the prime responsibility of any central bank around the world is to maintain price stability by way of maintaining low and stable inflation on a sustainable basis. at the outset, i would like to discuss why low and stable inflation is important for growth and stability of the economy. based on experiences of many countries and different time periods, we have seen varying levels of inflation. when countries experience hyperinflation, domestic prices of goods and services will rise every minute. in such a situation, no one will 1 i would like to note that the views expressed in this oration are my own as an economist and do not necessarily reflect the views of the central bank of sri lanka. i also would like to acknowledge the technical support received in preparing the oration from dr chandranath amarasekara and his team at the economic research department of the central bank of sri lanka. want to hold the local currency, and people will rush straight from the bank to the shops to buy goods, fearing that their currency holding will lose value along the way. in fact, the banking system itself will collapse. as people lose faith in local currency, the barter system, or the exchange of goods for goods or services will become the norm, making transactions significantly more difficult. hyperinflation will also cause adverse redistributive effects, destroying real value of middle class savings in local currency and real incomes of fixed income earners such as workers and pensioners.

it has to adopt painful and unpopular measures. but such measures are taken for the interest and the long term well - being of the economy. if the economy is allowed to be hit by inflation continuously, it is the private sector which would suffer most. it would be reduced from a long term planner to an at the moment event manager. it would be pestered with numerous requests for wage increases by the employees. its profits would fall in real terms. hence, it is the private sector which has to extend its utmost cooperation to the central bank to implement the monetary policy measures most effectively. this understanding at all levels of the private sector is a must. the government ’ s contribution to inflation fighting the governments are usually faulted for making the biggest contribution to inflation. the blame here is usually directed to the running of a high budget deficit by the government. this criticism against the government is not at all perfectly accurate. what contributes to inflation is not the existence of a budget deficit, but the financing of the deficit through inflationary means, viz, borrowing from the banking sector. like the government ’ s deficit, the private sector ’ s deficits are equally contributory towards the raising of money supply and consequently to inflation. hence, any blame should be squarely leveled against both sectors. it is natural for any government to make use of the bank funding to fill budget deficits, because it is very convenient and cost effective. but, excessive use of bank funding leads to creation of additional money and through it, to inflation. hence, governments have to behave responsibly. when inflation sets in as a result of its irresponsible fiscal policy, it is the government which has to suffer the most. the government ’ s desire for bank financing has normally been equated to a child putting his fingers frequently into an open cookie jar. the duty of the central bank in such a situation has been to keep the lid of the jar tightly so that the child is unable to take out cookies at its own pleasure. this is not a popular measure, but central banks throughout the world have been found to keep the cookie jar in tight control for the benefit of the society. given the above economic costs, inflation is undoubtedly the public enemy number one.