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The years after the great depression of the 1930s
were dominated by Keynesian economic thinking, which
suggests that there must be a continuous increase in
the level of inflation in order to achieve economic
growth and, hence, to reduce unemployment. In other
words, there exists a positive long-term
relationship between inflation and economic growth.
However, this thinking was questioned by monetarists
in the early 1970s when inflation could not reduce
the level of unemployment. Inflation has a negative
effect on the growth of the economy, the episode of
high inflation and high unemployment during this
period suggested. The leading economist at the time,
Milton Friedman, reckoned that “inflation is always
a monetary phenomenon.”
Is this saying true in the case of Ethiopia?
At least two pieces of evidence could help to reject
this. National Bank of Ethiopia (NBE) has the power
to craft the monetary policy of the country. The
mission of the Bank is to assist the economic growth
of the country and also reduce the level of
inflation.
However, the bank faces a problem in reconciling
these two conflicting targets due to the lack of
governmental commitment to keep it independent. Some
developing countries have shown great success in
reducing inflation and enhancing economic growth by
making their central banks independent from the
hands of government. Good examples include Ghana and
South Africa.
If the central bank is independent, the government
will be restricted from borrowing money from local
sources.
The Ethiopian government finances its expenditures
mainly through borrowing. This borrowing is both
from local and international lenders. The central
bank stands as the main source of the government’s
local borrowing.
Such financing, in return, is causing inflation in
the economy since it is only by printing money that
the bank finances the governments’ ambitious
expenditures. If the central bank was independent,
this problem would be solved, since government
borrowing would be restricted beyond a certain
limit.
Obviously, the measure could push government
expenditures down, with inflation reduced even
further, so as to assist the economy to grow at a
faster rate. The lack of independence at the central
bank, as it stands, is tempting the government to
finance its expenditures by printing money. This is
one of the reasons that inflation is not a monetary
phenomenon in Ethiopia.
However, it is very difficult to make NBE
independent unless it has professional staff. Lack
of professional manpower in the country might be one
reason not to extend independence to the Bank at
this particular moment.
But, the government should display a strong
commitment to reducing its direct and indirect
borrowings from the bank, in order to reduce
inflation. Expansionary fiscal policy must be
abandoned by the government.
The Ethiopian government has taken several measures
to reduce the level of inflation in past years. Most
of the measures are monetary in nature, including
raising the interest rate from three per cent to
four per cent to boost savings in the economy.
However, this has not curbed inflation.
The reserve requirement was the other monetary
policy of the central bank meant to reduce the
credit availability in the economy. However, this,
too, failed, by forcing the government to put a
credit cap on bank lending.
Dismayingly, it was also not able to reduce the
inflation rate. In fact, inflation reached 64pc
during the time of the credit cap on commercial
banks, the data reveals. It was evident that
monetary measures failed to control inflation.
The treasury bill market is the other monetary
policy instrument. Yet, it is not expected to reduce
inflation. Instead, it is expected to pour fuel on
the fire of inflation.
The market that restarted with the financial
liberalisation of 1991 is being used to finance the
government budget deficit.
Unlike any other developing country, the Ethiopian
government issues treasury bills in order to finance
its deficit. They are deployed to inject money into
the economy and liquidate it. Yet, the practice is
in complete contradiction with the theory.
If inflation in Ethiopia has always been a monetary
phenomenon, the policies taken should have curbed
it. But, these policies have not served this
purpose.
“What should be done in order to reduce inflation?”
one may ask. “Where does the large amount of money
in the economy come from? Does it exist because of
the large amount of credit available to the private
sector? Is it because of a reduced supply of goods?
Is it due to high government expenditures?”
Inflation is mostly caused by fiscal balance
deficits, much research undertaken in this area
indicates. It is almost impossible to find research
evidencing that Ethiopian inflation is a monetary
phenomenon or an imported one, except from
interviews of some government officials in the
media.
Inflation in Ethiopia is, thus, largely a fiscal
phenomenon. If there is a real commitment by the
government to reduce it, monetary policy must not be
used but, rather, fiscal policy.
Fiscal conservatism is the only choice that the
government has to reduce the level of inflation. One
thing must be noted in reducing the level of
inflation, though, and that is the sacrifice ratio.
Any economic policy might impose a negative impact
on one variable to achieve another targeted
variable. Similarly, if inflation is reduced through
fiscal conservatism, it is expected that economic
growth will decline, as well.
The question is which one is better. Even developed
and industrialised countries face this choice. But,
the way they resolve it is far different from what
has been done in Ethiopia. It is all about the costs
and benefits of the policy for each individual.
It is not the government that decides for the people
that economic growth is better than inflation or
vice versa.
In democratic systems, all choices, including
economic ones, are made based on the needs of the
people. As it appears, the basic objective of all
Ethiopian political parties is to have low and
stable inflation, together, with rapid economic
growth.
But, one cannot have their cake and eat it, too. The
choice is important.
In light if this, the EPRDF has a strong commitment
to economic growth, while the Ethiopian Democratic
Party (EDP) stands as the lone opposition party in
combating inflation. This was observed in the
previous Parliament, when Lidetu Ayalew, the
then-president of the EDP, compared inflation to
blood pressure, while Prime Minister Meles Zenawi
compared it to a simple seasonal flu.
The essential choice between economic growth and
reducing inflation can only be correctly made by the
people. Choosing on behalf of the people a complete
preference for economic growth will only make all
stakeholders lose in this game.
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