In the past week, we had the rude awakening to the news that April inflation rate was 23.6%, a significant rise from March’s 19.4%. Ghana’s rate of inflation has continued a precipitous trend since May 2021 when it was 7.5%. That this is a very discomforting trend goes without saying.
The managers of the economy have stated that this may not be too surprising, judging from similar trends across the globe. Whether a reversal- a slide in inflation rate- is imminent is doubtful, as contributing factors still exist.
Inflation is defined as a general increase in the prices of goods and services in an economy. When the price levels rise on the average, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. What we could buy with, for instance one hundred Ghana Cedis last month becomes more than what we can buy now.
The opposite of inflation is deflation. Deflation means a sustained decrease in the general price level of goods and services. Deflation, therefore, potentially increases purchasing power. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index. As prices do not all increase at the same rate, the consumer price index (CPI) is often used for this purpose in many countries, and Ghana is no different. Other countries may use other metrics to gauge or express general inflation or a specific aspect of the economy. For instance, the employment cost index is used for wages in the United States. India uses the wholesale price index as well as the CPI.
Economists believe that very high inflation and hyperinflation – which have severely disruptive effects on the real economy – are caused by persistent excessive growth in the money supply. A typical example is Argentina which has gone through periods of hyperinflation followed each time by attempts at stabilization.
Hyperinflation distorts the economy and it usually requires external intervention from the International Monetary Fund (IMF) or major industrialized donor nations. Hyperinflation requires drastic remedies to end, such as imposing the shock therapy of slashing government expenditures.
Why US Dollars?
The IMF has been a popular proponent of shock therapies in many distressed economies. Through its programmes which lend to failing economies because of hyperinflation, freezes on spending like cutting government wage bills and drastic reduction or cancellation of many social interventions. Many times, these are tough and unpopular decisions governments resort to as last options.
Another measure to correct hyperinflation is to alter the currency basis to restore confidence in the economy’s monetary system. One form this may take is dollarization, the use of a strong and stable foreign currency as a national unit of currency. In recent times, the rationale for the continued use of the American dollar for dollarization has been questioned owing to high inflation rates in the United States of America.
Views on low-to-moderate rates of inflation are more varied. Low or moderate inflation may be due to changes in real demand for goods and services, or changes in available supplies such as during periods of scarcities. Moderate inflation is not totally bad and affects economies in both positive and negative ways. On the negative side, the opportunity cost of holding money increases. There is uncertainty over future inflation and this may discourage investment and savings.
Also, if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. For instance, in Ghana, many motorists were used to seeing fuel pump stations declare that they had run out of stock, in anticipation of imminent upward price reviews.
Positive effects, on the other hand, include reducing unemployment due to nominal wage rigidity, allowing the central bank greater freedom in carrying out its monetary policy role of stabilizing the monetary system, encouraging loans and investment instead of money under mattresses and in large receptacles in homes, and avoiding the inefficiencies associated with deflation.
What’s the Cause?
Several causes of inflation have been espoused by different economic theories. The quantity theory of money is more widely accepted as an accurate cause of inflation in the long run, than the quality theory of inflation.
Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of the money in circulation compared to how fast the whole economy is growing.
However, in the short and medium term, inflation may be affected mainly by supply and demand pressures in the economy, and influenced by how wages, general prices of goods and services, and interest rates change.
Most countries, since the 1980s, have practiced inflation-targeting monetary policy. This is a measure the central bank adopts to control inflation. When inflation is very low, the central bank would maintain low rates of interest on lending to commercial banks. This would influence the rates at which it borrows through treasuries. The general low rates would dissuade households and the investing public from investing in treasuries and similar investments.
Rather, they would assume a bit more risk and invest in businesses to earn more. This would release more money for businesses to expand and employ more people. Conversely, when inflation rises, the central bank would seek to control the rise by increasing interest rates through their various mechanisms. More money would be invested in treasuries, therefore, than in businesses and this would help exert a downward pressure on inflation.
The central bank or government may peg the local currency’s value to that of a more stable economy (and therefore, usually, a stronger, more stable and convertible currency, like the US dollar. Also, instead of a single currency, a basket of currencies may be used. Gold or a fixed exchange rate may be assumed by a country to also try to control inflationary pressures that are acute.
Yet another measure that countries adopt is the control of prices. In Ghana, we have had ‘control price’ regimes. Sometimes these measures are drastic. It would be recalled that the Makola market in Accra was razed to the ground in a bid to rid the country of ‘kalabule’, a phenomenon that spurred inflation, particularly.
Since purchasing power is eroded by inflation, it is usual for economies experiencing elevated levels of inflation to adopt measures to mitigate the effects of inflation. Even with normal rates of inflation, employment contracts, pension benefits, and social security entitlements are tied to a cost-of-living index, typically to the consumer price index. Salaries, contract remunerations and social security benefits would be adjusted periodically, typically annually.
A cost-of-living adjustment (COLA) adjusts remunerations based on changes in a cost-of-living index. Though it does not control inflation, it seeks to mitigate the consequences of inflation for those on fixed incomes and other vulnerable people. During periods when inflation is higher than normal, remunerations are usually adjusted quarterly or even more frequently.
It is hoped that the Bank of Ghana, with recent increases in its Monetary Policy Committee (MPC) rate, would be able to harness inflation. The rate of inflation has risen precariously high and there is no telling if an end to the rise is in sight. The citizenry expects to see a slowdown of inflation and subsequently the stability of prices.
ABOUT THE AUTHOR
Kwadwo Acheampong is Head Research at OctaneDC. Over the years, Kwadwo garnered experience in fund management and administration, portfolio management, management consulting, operations management and process improvement.
Through his writings Kwadwo has discovered his love and knack to simplify complex theories spicing them with everyday life experiences to enrich and educate his readers. Feel free to send him your feedback on this article: [email protected] /+233 244 563 530