Inflation and Economic Growth Prospect in Ghana. A Paper Presented at the Chartered Institute of Economist Ghana s Seminar on the

Transcription

1 Inflation and Economic Growth Prospect in Ghana A Paper Presented at the Chartered Institute of Economist Ghana s Seminar on the Theme: Environment, Investment and Economic Growth in Central University College September 4, 2010

2 Overview of This Presentation 1. Introduction 2. What is Inflation 3. Misconceptions about Inflation 4. Causes of Inflation in Ghana 5. Why can t we keep Inflation Down 6. Benefits of Low Inflation [Type the document title] Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 2

3 Introduction They say inflation is going down, but the price of a ball of kenkey is still going up What comes into mind? You might have heard it once or umpteen times, on radio, TV, or elsewhere, say campaign grounds. Our politicians and political commentators say it all the time. Some deliberately intend to mislead us the public into thinking that declining inflation means prices are falling, just for their (selfish) political gains. Definition Inflation is the persistent increase in general prices of goods and services in a country within a specified period of time as a result of increases in the determinant of prices in that economy. Inflation is a rate of change (as opposed to change), and has to do with persistence. A onetime price hike is not inflation. Inflation does not refer to individual prices; it refers to the general (aggregate) price level as measured by, say the Consumer Price Index (CPI), which takes into account a market basket of goods and services that a typical family (especially in urban areas) buys. So it is possible that whilst the price of kenkey is going up, some other prices in the basket are going down. Comment [l1]: Strong words in academic papers must be avoided to make it open enough for people to be neutral and acquire knowledge Comment [l2]: Sources of definitions of this nature are important. Because your definition does not justify your next paragraph Comment [l3]: Is the basket of goods concentrated in the urban areas only? That seems to be urban inflation or? Misconceptions about Inflation What is even more subtle is the fact that inflation can be reducing even when prices are increasing. How? Because it is a rate of change, when prices increase but by less than preceding rates, inflation declines. Let s see how. Assume that the general price level increases from 100 to 150, and then to 240, and then to 450, in that increasing manner. The rate of change will thus be 50%, 60%, and 87.5%, respectively. Because the rate of change is increasing, inflation is going up. Now suppose the price level increased from 100 to 150 (50%), then to 210 (40%), and then to 273 (30%), etc. What we see in the latter hypothetical example is that even though the price level is increasing, the rate at which it is increasing if falling (from 50% to 40% to 30%), and so inflation is dropping! Therefore, falling inflation does not mean that prices are falling. It just tells us that prices are increasing at a decreasing rate. Let s not allow the politicians to swindle us. Members of this Institute must be seen contributing in shaping the misconceptions about Economic issues in this country especially in the area of inflation. One other thing I wish to clarify: Do we eat inflation? You would hear this but only from the politicians. Will falling inflation put money in our pockets? Well, the short answer is YES. Falling inflation won t come to us directly as a meal on the table, but when prices are increasing at a reducing rate, we are all happier. Inflation erodes the value of our salaries, and reduces our purchasing power. What Gh 10 could buy in October of 2009, as it stands now, cannot buy the same quantity of that good today. To the extent that falling inflation Comment [l4]: What do you think they mean by eat? Literally you cannot eat inflation! Comment [l5]: It is possible that the price of an item could be the same today as the case of Oct as sited. Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 3

4 reduces the rate at which the worth of our money gets swept away, we eat inflation, and so it should be a matter of concern to us in our quest to improve on the lot of our citizenry. Why do politicians make noise about inflation? We recorded 11.66%, and 9.52% inflation rates in April, May and June 2010 respectively (Ghana Statistical Service Website), which is still pretty much high, but nowhere near our all time record of 123% in How about the inflation rate in Mugabe s Zimbabwe, which is in excess of 230 million percent? That s the world s record, no one ever desires that. A teacher s salary can t even transport him to and from school for a month, as it stands now in Zimbabwe. Inflation has determined the outcome of elections in some countries in the past, and a good example has been Argentina in the 1980s with inflation hitting a high of 4,923.3% in December, In contrast, inflation has been under 5% (from January 2000 till date) in the US. In fact, the figures are even negative for March, April, May 2009 (what is called deflation). The story is not different in the Euro Zone where since 2001, 3.1% was a record high in November Comment [l6]: Sources should be properly sited Comment [l7]: Source Comment [l8]: source Causes of Inflation in Ghana The main causes of inflation in Ghana are increases in monetary aggregates (money supply), petroleum price increases, exchange rate depreciation, and poor agricultural production. One does not need detailed regression analysis to know this. Simple eye-balling of data available from Institute of Statistical, Social and Economic Research ISSER, Bank of Ghana & the Statistical Service of Ghana tells us the extent to which these variables determine inflation. For instance, since 1992, the highest rate of inflation recorded was 74.4% in 1995 when money grew at 46% in Petroleum prices had increased by 20% in 1993, 18% in 1994, and 24% in The Cedi had depreciated by 25% in 1994, and 28% in Agricultural output had worsened, etc. When the rate of money growth slowed down, coupled with relatively stable exchange rates and improved agricultural productivity between 1996 and 1999, inflation had declined to 12.6%. Comment [l9]: Good analysis but no source What happened in 2000? Increased money supply, increased fuel prices, and depreciation of the Cedi, worked in synergy, to trigger inflation to 40.6%. The rates were better between 2002 and 2007 as inflation fell to 15.2% in 2002, shot up to 23.6 in 2003, down to 11.8% in 2004, up to 14.8% in 2005, down to 10.5% in 2006 and a little up to 12.7% in 2007 went up to % in 2008 and currently below 10%. Why can t we keep Inflation Down? Some of the causes of inflation are exogenous, so there is very little or nothing we can do about them, e.g. petroleum prices. At least for now, until sometime in October, we don t produce oil. So we have to take the world prices as given, thanks to deregulation. But this is the one cause that cuts us deep. Because increases in petroleum prices translate into higher transportation costs, and into higher food prices, each time petroleum prices increase, we feel it in the market basket (and the CPI for that matter). Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 4

5 Money growth: Very unfortunately, our Central Bank does not have autonomy! The government of the day manipulates it the way it deems fit. If we can keep money supply growth at minimum, it will curb inflation, but of course, not by increasing the prime rate. It is sad that whereas the federal funds rate is under 1% in the US, and the benchmark rate set by the European Central Bank is 1% in the Euro Zone (since May 2009), we (Ghana) still have our prime rate at 13.5%. Exchange rate depreciation: We experiencing a free fall of the Cedi relative to major convertible currencies. We are worried. But we are all part of the problem. Exchange rate is a price! And prices are powerful. Do not temper with it. The Central Bank has been doing its part in trying to stabilize it in what is called dirty-floating exchange rate regime. But I guess what we need to do is to re-orient our tastes. Our penchant for imported products is way above the sky (e.g. we prefer perfumed rice to locally produced rice, imported chocolate to Golden Tree Chocolate, etc), and as long as this continues, we would always need more Dollars, Euros, and Pounds to import. And this will continue to depreciate our Cedi especially if we are unable to export more to generate foreign exchange. Currently Ghana imports $800million worth of perfumed rice into the country annually, so if we reduce our import bill on perfumed rice by even 50% which we have the capacity to produce. Comment [l10]: Is the author attributing growth in money supply only to the prime rate? That totally out of place Comment [l11]: Papers are not mere guesses but scientific. Therefore objective/positive economics not subjective/normative economics Post harvest losses take a chunk of farm produce every year. Efforts have been made over the years and are being made to deal with storage problems and road networks to the farms, but there s still more work to be done. An overhaul of our agricultural sector is critical to our development. But we need to ensure that we minimize post harvest losses, and at the same maximum general agricultural productivity. Mechanization of the agriculture sector and agro based businesses are imperative to our quest to curb inflation in Ghana. Benefit of Low Inflation There are many benefits of low inflation. Firstly, if inflation is low and stable firms will be more confident and optimistic to invest; this will lead to an increase in Long Run Aggregate Supply (LRAS) and enable higher rates of economic growth in the future. Also, if the Gov t is committed to keeping inflation within a certain target this may help inflation expectations to remain low. Comment [l12]: No empirical justification of your views Comment [l13]: Its not always the case. It depends on the kind of inflation. Remember producers are interested in higher prices for their goods If inflation is allowed to increase because Monetary policy is too lax, there could be an economic boom; but if this is above the long run trend rate of growth this is likely to be unsustainable and the boom will be followed by a bust (recession). This occurred in the UK in 1991 after the Lawson boom of the 1980s. Therefore, maintaining low inflation will help avoid cyclical fluctuations in the economy which can cause booms and then negative growth and unemployment. Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 5

6 High inflation has other costs such as Menu costs; this is the cost of changing price lists. If inflation in Ghana is higher than other countries, Ghana s goods will become uncompetitive causing a fall in exports and possibly deterioration in the current account of the Balance of Payments. Comment [l14]: Uncompetitive relative to Monetarists believe that inflation can be reduced without conflicting with other macroeconomic objectives. This is because they believe that the LRAS is inelastic, therefore in Aggregate Demand will only cause a temporary fall in Real Gross Domestic Product (GDP) but after a short period the economy will return to the full employment level of National Output. Therefore the gov t should not worry about a temporary rise in unemployment as a result of tight monetary policy because the economy will soon return to equilibrium at full Employment. However this view is not shared by all economists. Keynesians argue that if the economy can be below full capacity for a long time, to keep inflation within its target it may be necessary to have a significant tightening of monetary policy which could cause a recession and persistent unemployment. Figure 1 Comment [l15]: The axis has not been fully labeled. What is Y? The above diagram shows a fall in inflation as a result of higher interest rates; however it has caused a fall in AD and lower Real GDP. Keynesians argue that the economy may take a long time to recover because the negative multiplier effect will magnify any fall in AD. Also if confidence is low consumers may be reluctant to spend. Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 6 Comment [l16]: Nothing shows from the figure that the fall in inflation is as a result of interest rate. What kind of interest rate are you talking about?

7 The experience of Japan in the 1990s shows that low inflation can cause many serious economic problems. Inflation has been very low, but Japan has suffered from growth far below its long term average and has seen unemployment rise. Rising unemployment has many serious costs such as increased inequality, higher gov t borrowing and a rise in social problems. In this case, economic growth is arguably a more important objective - even if it conflicts with higher inflation. Comment [l17]: With japan s experience-by how much is inflation considered to be too low? How low should it be desireable Inflation is more likely to conflict with unemployment if there was a supply side shock such as lower productivity or an increase in the prices of commodities. In this case, to keep inflation low would need a very tight monetary policy and a recession may be quite likely. However, in some circumstance, keeping inflation low may be unsuitable for the economy. If there was a supply side shock to the economy, keeping to the inflation target may cause increased unemployment and lower growth which is very undesirable. Therefore, the govt should perhaps aim for low inflation but have a degree of flexibility if this appears unsuitable to the current economic climate. In conclusion low inflation has many benefits which help improve the economic performance of the economy such as increased investment which will enhance the economic prospect of this country.. Also it is possible to have low inflation and low unemployment which suggests the Phillips curve trade off is limited. Long live ICEG Long live Ghana. God Bless US All Resources: ISSER, State of the Ghanaian Economy, yearly editions (2000 to 2008), Iddisah Sulemana, Inflation; Some Misconceptions Graduate Assistant, Department of Economics, The University of Akron, Ohio, USA. And Ghana statistical service website Abdul Aziz CE, Bsc Economics & Mathematics-Statistics, Page 7