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Inflation was once described as “taxation without legislation,” by
Milton Freedman, the Nobel laureate and father of
monetary economics.
So did Ronald Regan, legendary former president of the US, eloquently
describe the development of inflation to be “as
violent as a mugger, as frightening as an armed
robber, and as deadly as a hit man.”
When inflation becomes out of control it is not only agonising but
could also be degrading.
Due to soaring food and oil prices, the old nemesis is bouncing back in
many emerging economies. Policymakers, including
those in China, Vietnam, India, and Brazil, are torn
between worries over growth and inflation.
Like many emerging economies, Ethiopia’s GDP growth continues to be
eye-popping, as is also the case with its rate of
inflation. Policymakers, who thought they had
successfully banished inflation, are vexed by its
return. Double-digit inflation is spoiling the
party; former exuberant mood.
These days, any conversation in Addis Abeba easily turns into a
discussion about the rising cost of living. Not only
is this a worrying factor, but the cost of dying has
also become disturbing.
Year-on-year rate of inflation reached 17.1pc in February 2011, up from
7.1pc in February 2010. The consumer price index is
an indicator of the average change in prices. The
real increase in the price of many consumer goods is
much higher than these average percentage changes.
Prices of cereals have been declining for a year and half, despite a
build-up in the cost of fuel and fertiliser. This
should be alarming because it affects the income of
rural households.
In the past, the government has taken a host of policy measures to cool
down the overheating economy. As part of monetary
policy action, the reserve requirement commercial
banks are made to deposit in the central bank has
been jacked up from 15pc to 25pc. The central bank
introduced a credit cap and has been policing
commercial banks month by month and one by one.
While it has not been making a dent, the deposit rate has been revised
upwards, first from three per cent to four per cent
and recently by another one percentage point.
Yet, in another attempt to tame inflation and break the “pricing power”
of a few unscrupulous traders, the government put a
price cap on selected consumer products at the end
of December 2010.
Many low-income earners and the urban poor were jubilant following the
freeze. Even if it is not a magic wand, a temporary
price cap can protect the poor from traders who
would like to see the prices of commodities
skyrocket faster than the speed of production.
However, introducing caps on prices is very complex and requires a
thorough understanding of the subject. Unless it is
based on rigorous analysis, it could cause more harm
than good. The flipside of a hastily imposed price
cap includes shortages of supplies and market
imbalances.
Subsequent to the price caps, some mid-level government bureaucrats and
self-proclaimed economists confidently claimed the
caps would soon quell inflation and improve the
purchasing power of the many on the lower rungs of
the income structure to ensure the affordability of
consumer goods.
Only days later, the revision and re-revision of prices were witnessed
while many of the goods that had been subjected to
caps disappeared from supermarket shelves. Even the
policing of prices by low-level officials have
failed to make the goods reappear.
Ironically, and in an attempt to compensate for their “forgone
profits,” traders increased prices on non-capped
goods. Yet, it must be admitted that the caps have
improved the affordability of goods such as meat,
which has become available at 52 Br for a kilogramme.
Nonetheless, the bravado and confidence have disappeared and been
replaced by the offering of murky reasons and blame
directed toward traders for being the cause of all
the ills in the economy. This is reminiscent of the
young man who killed both his parents and pleaded
for clemency on the grounds that he was an orphan.
Sadly, in Ethiopia, it has become the norm to judge polices not by
their results but their intentions.
The price caps would have worked better if they had been meticulously
designed beginning at “X” factory and “Y” farm and
moving to the origins of imports in a bid to
understand the cost build-up at every step in the
supply chain. Astonishingly, the country has no data
on prices of domestically traded goods and imported
items.
Despite prudent fiscal policy responses, inflation is galloping, an
indication of the need for effective monetary policy
action. Broad money is growing faster, hovering
around 30pc of the GDP. The same is true for the
annualised growth of reserve money, which is
reaching 59pc as a result of the increase in net
foreign and domestic assets or an increase in credit
supply by banks, in particular by the state owned
Commercial Bank of Ethiopia (CBE).
There is no doubt that the inflation versus growth dilemma will
continue in the months ahead.
Several economic factors are responsible for the spike in the rate of
inflation. An economy could experience high growth
without an increase in inflation if its productive
capacity expands rapidly and supply keeps pace with
demand.
However, if effective demand continues to grow at a faster rate and the
productive capacity does not expand, the threat of
runaway inflation is simply unavoidable.
In Ethiopia, effective demand is growing faster than the supply of
goods and services. This is caused by a litany of
factors such as an expansionary fiscal policy,
rapidly raising private consumption and growing
investment, increased inflow of remittances and
revenues from exported items, as well as the
emergence of various financing schemes. Growth in
imports is surpassing the growth in exports as a
result of the large trade deficit, inviting imported
inflation.
The recent devaluation of the Birr against a basket of major currencies
followed by depreciation are contributing to paving
the way for cost push inflation. When the dollar
loses value, the Birr follows, becoming weaker and
intensifying inflationary pressure.
Inflation expectation is another major factor that exacerbates the rate
of inflation. Its impact is severe because runaway
inflation becomes locked into inflation expectation,
stirring another inflationary spiral with the new
inflation rate creating another inflation
expectation.
The jump in inflation rate is also caused by supply side shocks. The
rapidly increasing oil price is having a spill over
effect on the prices of most commodities in the
consumer basket. The difficulty with supply side
shocks is that they not only have an overflow effect
on other prices but they cannot be countered by all
demand management instruments, including monetary
policy measures.
It is important to understand that growth oriented policies are
supposed to put an upward pressure on prices,
particularly at the takeoff stage. However, the
tough question is not why inflation is high but
whether it is possible to keep a lid on the pressure
without jeopardising economic growth.
Monetary and fiscal policies play a key role in this. Although the
contribution of money supply to the rise in
inflation in Ethiopia needs a rigorous analysis and
a good data base, it has a hand in creating rampant
inflation. More calibration of monetary and fiscal
policies remains critical to keep inflation at bay.
Another factor that exacerbates inflation is Ethiopia’s exposure to
chronic supply side constraints in an environment of
constant excess demand. This is further complicated
by poor supply chain infrastructure and the
existence of an archaic retail system.
One way of improving the supply constraints is to improve and redirect
the flow of financial resources. More than 75pc of
loans from banks are for merchandise imports and
domestic trade. It is hardly possible to increase
supply without adequate provisions of finance to the
productive sector.
The authorities have to come up with incentives to coax banks into
redirecting the flow of funding to sectors such as
agriculture and industry.
The impact of attempting to suppress inflation with a price freeze is
limited. The best way to improve the availability of
consumer goods is by modernising the trading system.
The opening up of the domestic trading market to
foreign competition should be given priority.
As the economy shifts to a higher gear, the demand for all sorts of
goods is also increasing rapidly. Foreign traders
have a better capacity to supply goods than their
Ethiopian counterparts, and have the potential to
enhance competition and break up the monopoly of a
few traders. It no longer makes sense for the
government to play a game of cat and mouse with
those looking to increase their wealth in a crooked
manner.
Policymakers should introduce more development oriented financial
institutions and long-term financial instruments
such as savings, industrial mortgages, and bonds.
The introduction of a savings bond by Development
Bank of Ethiopia (DBE) is a step in the right
direction.
However, the establishment of a secondary market is essential for the
creation of a vibrant bonds market.
The increase in export income is one of the sources of the rise in
money supply, increasing the rate of inflation.
Unless the money is sterilised on time, it can cause
severe inflationary pressure. Policymakers should
mop up the money supply by introducing special
deposit schemes for exports, which could help to
quash the rampant inflation.
Unless the authorities put a brake on the runaway inflation rate, they
could end up becoming victims of their own success.
As Bob Marley once said, “The harder the battle, the
sweeter the victory.” |
