By: Staff Writer
February 24, Colombo (LNW): The battle over Sri Lanka’s inflation target is not merely contemporary—it echoes centuries of monetary debate. As policymakers reconsider the 5 percent benchmark in 2026, historical parallels offer stark warnings about liquidity excess and currency fragility.
Sri Lanka’s 2022 default exposed vulnerabilities common to reserve-collecting central banks that extend credit cycles beyond global conditions. When rates fail to adjust in tandem with tightening abroad, forex shortages quickly materialize. Exchange controls then substitute for credibility, constraining economic freedom while masking underlying imbalances.
With inflation in 2026 near 3 percent and growth gradually resuming, the debate now centers on prevention. Should the target become a strict 2 percent ceiling, limiting discretionary stimulus? Or should policymakers retain flexibility under the oversight of the Cabinet of Ministers of Sri Lanka?
The answer may determine whether the next decade resembles East Asia’s stability or repeats past cycles of depreciation and austerity. Inflation control is no longer theoretical—it is the linchpin of sovereign resilience.
In the 1970s, the United States experienced the “Great Inflation,” eventually subdued under Federal Reserve Chair Paul Volcker through aggressive rate hikes. That decisive tightening restored credibility and stabilized the dollar. Sri Lanka, by contrast, moved toward greater exchange-rate flexibility in the 1980s, a shift that coincided with recurrent depreciation cycles.
Analysts note that before the early 1980s, inflation trends broadly mirrored advanced economies. The divergence began when liquidity management increasingly targeted domestic rates over external stability. The pattern resembles episodes in 19th-century Britain, when the Bank of England fueled credit booms after suspending gold convertibility.
During the 1825 crisis, Parliament refused to permit further sterling depreciation. The bank was compelled to secure gold from the Banque de France to restore convertibility an early demonstration of institutional accountability. Influential thinkers like David Ricardo argued that excessive note issuance inevitably weakened currency value, while financiers such as Alexander Baring understood the operational mechanics behind credit cycles.
Contrast this with the stimulus philosophy advanced centuries earlier by John Law, whose expansionary experiments ended in collapse. Modern critics argue that contemporary liquidity injections—particularly sterilized interventions and single policy-rate targeting echo Law’s flawed assumptions more than Ricardo’s discipline.
East Asia presents a different trajectory. Economies such as Singapore, Taiwan, Hong Kong, and South Korea prioritized exchange stability and conservative monetary frameworks during their high-growth decades. Their lower and more predictable inflation rates fostered export competitiveness and investor confidence.