©Nepal Rastra Bank Samachar No.

55 Year 2010

The New Concern of Inflation in Nepal: Does Environment affect the Supply?

Shashi K. Chaudhary

Introduction

Since few years back, the inflation has become among the foremost economic issues of Nepal. The
concerned authorities are even blamed for not being able to control the rate of inflation to the desired
level. This does not mean at all that they have not put their efforts to do so, but all the efforts seemed to
go into vain as the experienced rate of inflation has remained far above the target rate. This kind of
experience has brought challenges to the concerned authorities.
In addition to hoarding and black marketing, theoretically there are two reasons for increasing inflation.
One is increase in the aggregate demand and other is insufficient aggregate supply. Increase in aggregate
demand comes from increase in incomes and increase in money supply. Such type of inflation is called
demand pull inflation. Insufficient supplies or increase in cost lead to cost push inflation.
The macroeconomic policies, in fact, work through the aggregate demand side part. Therefore, change in
the macroeconomic policies tends to change the level of aggregate demand in the economy. For example,
tight policies would reduce and loose policies would boost the level of aggregate demand. In spite of
suitable policies, the target rate of inflation and the actual rate of inflation have differed significantly in
recent years indicating that the inflation might be caused by the supply side part. In the mid-review report
of Budget 2066/67, once again the prices of agricultural products and petroleum have been blamed for
causing high rate of inflation in Nepal. So, the poor production of the agricultural sector in the country
due to delayed monsoon was partially responsible for high inflation.
Here it is important to mention that how long the environment would be blamed for all these things.
Hasn’t it been time to incorporate the changing environmental factor into the policy making process?
Therefore, in this paper, I have tried to bring a new concern of inflation into the discussion while making
the suitable macroeconomic policy for price stability.

Environment as production factor

In a traditional production function, output is a function of two inputs: labor (L) and capital (K), and
therefore, it is represented in Cobb-Douglas production function as -
Q = ALα Kβ
In this relation, all other factors are assumed to be given.
In agriculture sector, though environmental factors have very important role, their pattern used to remain
almost constant in the past, and so was the agricultural pattern in the economy. But, the pattern of
environmental factors has been found to be changing at present and it has direct impact on agricultural
yields. In fact, environmental quality acts as a nonmarket, or unpriced, production input. Damage to the
environment reduces the supply of this input, and as a result production falls. Conversely, programs to
improve environmental quality can benefit environmentally sensitive forms of production by raising the
supply of such inputs. This is especially likely to be the case in developing countries, where sectors such
as agriculture, forestry, and fishing typically account for a larger share of overall economic activity than
in developed countries.
Hence, incorporating the environmental factor in the Cobb-Douglas production function, it takes the
following form:
Q = ALα Kβ Eγ
where E is the environmental factor.
It is clear that change in the environmental quality of the economy would affect the aggregate supply of
the agricultural product inversely.

Vulnerability of Nepal and Supply shortage of Agricultural Products

Nepal, by geography lies between two giant economies: China and India. In the ranking of total carbon-
dioxide emitter per year, China (21.5%) and India (5.3%) occupy the first and the fourth place
respectively. It is important to remember that both the economies have target of attaining stable double
digits economic growth rate. Therefore, in the future, there is no symbol of improving ranks of these two
countries. If so, the environmental conditions of Nepal is highly vulnerable to global warming and climate
change caused by emission of greenhouse gases by the neighboring countries in course of their economic
development.

Conclusion
For a long time, the effect of global warming on agriculture and food supply was believed to be a positive
one on the assumption that the rising level of carbon-dioxide resulted for global warming, would help the
plants for photosynthesis. Thus there might be a rise of agricultural production and food supply. But,
more recent experiments and researches have revealed that the effects of global warming on agriculture
and food supply are not that good after all.
On the light of these facts, it becomes clear that the agricultural products would fall short creating
shortage in the Nepalese economy. This situation would be very much crucial for the price stability
objective in the time to come. Therefore, while making macroeconomic policy for Nepal, environmental
factor, now no more should be neglected.

References
1. Brown, S., & Kennedy, G. (2005). A case study of cash cropping in Nepal: Poverty alleviation or
inequity? Agriculture and Human Values, 22: 105–116.
2. MOF (2010). Mid review of the Budget 2009/10. Kathmandu:G/N.
3. Nordhaus, W. (2007). The Challenges of Global Warming: Economic Models and Environmental
Policy. New Haven, CT: Yale University Press.
4. Vincent, J.R. (2008). The Environment as a Production Input: A Tutorial. Working Paper No. 32-
08, South Asian Network for Development and Environmental Economics (SANDEE).

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