The subject of economics is known for controversies and conflicts of ideas. It is known also for hypothesizing abstract economic theories and the underlying conceptual frameworks of the complex world. One of these concerns the notion of “full or near-full employment” which cannot be achieved in the real world, due to internal dynamics and random shocks. In theory, full employment occurs when total expenditures in an economy are equal to total national income, and when total savings are equal to total planned investments. Such an equilibrium can be achieved at local level, but it is more daunting to attain at the economy-wide level or on a global scale. Full employment also means that all scarce resources, including labour and capital, are fully employed with stable prices and wages. In such situations, the economy can be said to be in equilibrium. The assumption is that the saving-consumption ratio of households, the volume of investment and total government spending determine the equilibrium level of output or the gross national product (GDP).
However, a single shock such as a rise in general prices can disrupt an equilibrium, even if it were to be achieved for a short period of time. For instance, an increase in prices of all or most consumer items can cause a gap between total expenditure and national income-usually known as an “inflationary gap”. A manageable level of inflationary gap can be good for the economy if there are sound polices and instruments to put effective checks and balances to contain further price rises. In fact, moderate inflation or a manageable level of inflationary gap is more desirable to an economy as it can act as an incentive to producers to boost supplies. This notwithstanding, the inflationary gap that potentially leads to higher prices needs to be reduced or eliminated. This can be done through a mix of monetary and fiscal policy instruments such as taxation, interest rate management and a reduction in government expenditure for maintaining the economy at equilibrium level. However, this is not straightforward or automatic and policy instruments may not be able to reduce the inflationary gap or curb inflation, particularly in developing countries that face a series of structural challenges.
The main objectives of this newspaper article are to: (a) articulate inflation in an understandable way for readers and explore its underlying causes; and(b) elicit an informed and evidence-based discussion on the subject and offer insights as to what can be done to curb inflation in Ethiopia and other countries of sub-Saharan Africa (SSA). In this regard, by using the Consumer Price Index (CPI) and the average growth rates in general prices, the article compares inflation in Ethiopia with the average of sub-Saharan Africa, Africa, and the developing world. It also provides a data-driven and evidence-based comparison of the devaluation of the Ethiopian Birr vis-à-vis the US Dollar in relation to the Ethiopian Consumer Price Index. The article proposes a series of policy and institutional mechanisms to decisively deal with inflation. These include fostering economy-wide productive capacities to boost the supply of goods and services to exact higher demand, while generating long-term inclusive growth.
Productive capacities are key for economic growth and export diversification, including value addition as well as removing supply-side distortionary trade barriers. Further policy suggestions include the need to fight corruption and improve governance; and build peace and social cohesion to ensure political stability. The article calls for putting in place independent institutional arrangements, such as central banks, effective policy instruments, including inflation-targeting frameworks, transparency in monetary and fiscal policies, managing market expectations and improving market information systems. The ultimate objective of these recommendations is to keep moderate inflation side-by-side with monetary stability and sustainable economic growth with higher levels of employment and substantial poverty reduction. The aim is also to explore ways and means of assisting how to best protect the poor and more vulnerable sections of society who are the direct victims of price rises. Low wage earners and populations with fixed incomes such as pensioners are among the casualties of high inflation who need social protection in the form of safety nets.
What is inflation and what are its plausible causes?
In simple non-technical terms, inflation is a consistent and prolonged general increase in prices for a basket of goods and services consumed or used on a day-to-day basis by households. Such an increase in the prices of consumer goods and services also reduces the purchasing power of the income of households and the value of the local currency. This means that a temporal or periodic roller-coaster price rise of a few goods and services with little or no impact on the purchasing power of societies does not qualify as inflation. Inflation also means that consumers will pay more for the same quality and quantity of goods and services when compared with a pre-inflationary period. With inflation, food, school supplies for children, fuel, shelters (rentals), electricity, transportation, clothing, and footwear, as well as medicines will become more expensive than they used to be. Households with low and constant income will forgo some of the goods and services they used to afford in lower or inflation- free times. As shall be discussed in detail in this article, high inflation makes an economy anemic by heightening systemic risks, uncertainties, and structural vulnerability. Not only does it affect current socioeconomic performance, but it also erodes past gains and undermines future growth and the development prospects of developing countries. If not contained, high inflation may also entrain social unrest, corruption and political instability, frustrating efforts to foster political consensus and nation-building.
Mechanisms through which inflation is transmitted to societies and the real economy are diverse. It weakens the purchasing power of the local currency, erodes investor confidence, undermines savings and investments, leads to persistent budget and trade deficits, as well as to heavy indebtedness. Depending on the speed and magnitude, inflation adversely impacts purchasing power of the local currency, diminishing the ability of households to afford paying with their income for the acquisition of goods and services (compromising their overall economic wellbeing).
Based on underlying causes, inflation can be grouped into three broad categories: The first is demand-pull inflation which is the type of inflation caused by an excess in aggregate demand for goods and services over aggregate supply in the economy. Excessive aggregate demand over aggregate supply can be caused by scarcity of production (supply shocks), increases in expendable income of consumers, increase in exports of domestically consumable goods, hoarding and due to population growth or the combination of these. It can also occur because of the availability of easy credit, increase in government expenditures and indirect taxes, availability of excess money supply in an economy, continuously growing budget deficits or expansionary monetary policies, etc.
The second type of inflation is cost-push inflation, which occurs due to an increase in the cost of production of goods and services. A sudden rise in intermediate goods used in the production of goods and services such as energy (an increase in oil prices or the prices of electricity), wages, and taxation can trigger inflationary pressure in an economy by pushing up the cost of production of goods and services. Similarly, uncontrollable price increases in farm inputs such as fertilizers, variety seeds or pesticides can also trigger food inflation.
The third type of inflation by causative factors is structural inflation or bottleneck inflation. This type of inflation is caused by deep-rooted structural rigidity in an economy such as poor infrastructure, supply chain disruption, market imperfection, institutional bottlenecks and due to bad policy formulation and implementation. In structurally weak and vulnerable economies such as Ethiopia and others in sub-Saharan Africa (SSA), the three types of inflation can coexist in parallel or in combination. Identifying and understanding the type of inflation in an economy is critically important to formulate and implement appropriate mitigating policies and strategies. In sum, inflation is the cause and effect of asymmetry in aggregate demand and aggregate supply, combined with expectations and random (unexpected) shocks.
However, monetarists and Keynesian economists argue that the sole cause of persistently high inflation is the oversupply of money in an economy. According to them, the cure is to reduce money supply in an economy even if this leads to “degrowth” or deceleration in economic growth. In other words, the sole cause of inflation is governments’ monetary and fiscal policies, and as such the remedies should come from them. Historical and empirical evidence show that unforeseen shocks (be they economic, financial, climate change or health related) can disturb the equilibrium aggregate demand and aggregate supply. For instance, since the COVID-19 pandemic, the global economy has been reeling from socioeconomic turbulence and tribulations including temporal general price rises. Massive injections of monetary and fiscal stimulus packages, lavish incentives, and direct cash transfers in major economies during the COVID-19 pandemic contributed to skyrocketing aggregate demand in excess of aggregate supply, causing high inflation nationally and globally. Adding fuel to the fire, the war in Ukraine has exacerbated high inflation and the resulting economic challenges for households, individuals, and economies at large. The current conflict in the Middle East may further exacerbate inflation by disrupting oil exports from the region which may heighten global risks, uncertainties, and socioeconomic difficulties, if an end is not put in place as urgently as possible. Overall, the cascading crises, random shocks and resulting headwinds are weighing heavily on the global economy. More so on the growth and development prospects of developing countries, with devastating consequences for the poor, the weak and marginalized sections of societies.
The worst news of all is the ineffectiveness of monetary and fiscal policies to tame inflation. To date, despite efforts to curb inflation globally, economies across the world are having tough times to do so. This also compounds efforts to resuscitate economic growth, while at the same time, maintaining macroeconomic stability. For economies of SSA, high inflation may further deepen and entrench structural economic problems of the region. Falling international commodity prices, external debt overhang, growing trade deficits, declining agricultural production and productivity, combined with demographic trends may further complicate economic viability, revival, and overall socioeconomic progress of the sub-region. In Ethiopia, the combination of internal protracted wars, devastating impacts of climate change particularly on its underdeveloped agriculture sector, excessive money supply in the economy, mounting external debt burden and galloping inflation can cause socioeconomic havoc that can be too ghastly to imagine. Under such multi-faceted socioeconomic, political, and environmental distress, it is difficult to contemplate the long-term growth and transformation prospects of the Ethiopian economy. As can be seen in the figures further below, inflation in Ethiopia has been consistently higher than the average for sub-Saharan Africa, Africa and much higher than that of other developing economies.
As with the underlying causes, the typology of inflation can also vary depending on the speed and evolution of price rises in an economy. Creeping inflation (also called crawling, slow-moving or mild inflation) is an inflation that occurs in an economy for a longer period without being perceived by consumers or households. This type of inflation (usually in lower single digits) is not dangerous to an economy. In fact, economists regard such an inflation as an incentive to producers. This is because mild inflation encourages entrepreneurs and producers to increase output to exact growing demand with sustained and long-term gains or profits. Such an inflation is also key for expanding employment opportunities without necessarily increasing wages per worker or per output. When the price rise reaches upper single digits (7%-9%), crawling inflation becomes walking or trolling inflation. Walking or trolling inflation, although still manageable, is a warning sign for policymakers to revisit their monetary and fiscal policies to curb further rises in general prices. If no action is taken to tame walking inflation, it leads to running inflation-usually at the rate of above 10 % but lower than 20%. Still monetary and fiscal authorities have ample room for maneuvering and for curbing walking inflation without austerity measures or before it inflicts significant costs to the economy and society.
When inflation rates reach double digits (between 20% and 50%)per year, it is called galloping inflation, which is regarded as very high inflation. This type of inflation has reached a level where it cannot be reduced or tamed without belt-tightening or austerity measures, often at a very high cost to the economy and society. The last type of inflation is known as hyperinflation, which is not only accelerating in speed (more than 50% a year), but the range and magnitude of increase is very large, observed in a very short span of time. During hyperinflation, prices of consumer items can double or triple overnight or in a single day, with the value of local currency fast collapsing.
After World War II, Hungary has seen one of the worst phenomena of hyperinflation with prices doubling every 15 hours. In recent years (2007-2008), from SSA, Zimbabwe was a classical case for hyperinflation with prices doubling every day. In 2023, Venezuela is an exception in registering an estimated increase in consumer prices at 360 percent, according to the latest figures from the International Monetary Fund. In all cases, hyperinflation led to acute shortage of consumer items including food and medicine, with prices skyrocketing, the value of local currency fast collapsing, and with grim overall socioeconomic circumstances. Ethiopia and other countries of SSA that have already registered or approaching galloping inflation, must undertake drastic, coordinated, and robust policy measures to avoid getting into hyperinflation. It is important to note that the above-mentioned types of inflation are not sequential occurrences or phenomena. Any type of inflation can be observed in an economy depending on the main drivers, accelerators, and key causative factors. That is to say that galloping or hyperinflation can occur without an economy necessarily passing through crawling, walking, or running inflation.
Controversies surrounding inflation
The concept of inflation or inflationary gap is as old as the study of economics. It is one of the subject matters where there exists improved and systematically collected data. Likewise, there is overwhelming historical and empirical evidence on the bad, worse and the ugly face of inflation. Causes and consequences of inflation are also among the exhaustively researched, most debated, and widely published subject matters in economics, development economics, finance, political economy, and business decision-making processes. As it is directly linked to a business cycle or industrial fluctuation, the phenomenon of inflation is one of the carefully watched and seriously followed matters both in the theory and practice of business cycle as well as entrepreneurship.
As in the past, currently, debates on inflation are raging once again across nations, political establishments, economists, central bankers, monetary and fiscal policy experts (and practitioners). As they are within trade, finance, or development-oriented regional and global institutions. At the national level, the US Senate adopted the Inflation Reduction Act 2023. Political establishments and parties in many other countries-developed or developing-have also been extensively debating as to what to do to curb inflationary pressure on economies and societies (often along political lines of arguments). Some countries are using export controls or bans on domestically consumed foodstuffs to minimize the negative impact of price increases on their citizens and on the purchasing power of local currencies. The July 2023 meeting of ministers of finance and central bank governors of the G-20 held in Gandhinagar, Gujarat (India), was devoted to, among other things, how to best address inflationary pressure and fragmented global demand and supply challenges while maintaining stable microeconomic and macroeconomic policy environments. The extent and the frequency of debates show the seriousness of the matter and the determination of policymakers to get rid of inflationary pressure in their economies. This is because that the phenomenon of high inflation brings serious risks, and heightened uncertainties to economies and societies, with the poor and the vulnerable bearing the brunt of its adverse consequences.
Despite all the efforts and growing consensus on its adverse socioeconomic consequences, inflation remains conceptually messy and analytically controversial. There is no common understanding about its causes, transmission mechanisms, socioeconomic impact, what it does to the economy or how to contain it. Researchers and policy experts often clash on the causes and consequences of inflation, as well as its precise transmission mechanisms. Debates are inconclusive and reaching agreements on how high prices should be allowed to rise and how long they should keep increasing remains elusive. Moreover, there is no conclusive evidence on the causal relationship between inflation and economic growth, although higher inflation is believed to be anemic to economic growth. Nor is there a common understanding of what level of inflation is good and what level is bad for the economy and societies. Questions as to why inflation is inconsistent or variable over time particularly at double-digit level is still the subject of debates and controversy. Worst of all, inflation is the most confusing, unfathomable, and conceptually difficult subject for political elites to fully grasp its causes, consequences, and potential remedies. Yet, political elites both in developed and developing nations attempt to use and misuse inflation to advance their political interests often by inflating their economic scorecards.
How is inflation measured?
Measuring inflation involves complex statistical, mathematical, and econometric algorithms. It also involves the combination of skills of economists, data scientists, statisticians, and the latest software or more recently, programming specialists. In developed economies, multiple indices such as the producer price index (PPI), the urban consumer price index (U-CPI), the wage-earners consumer price index (W-CPI), the personal consumption expenditure index (PCEI) and the Gross Domestic Product Index (GDPI) are used to measure inflation. However, most developing countries use regionally disaggregated national consumer price index (CPI). In several other countries, urban or cities focused consumer price index is used to measure average changes in prices of consumer items between two reference time periods. Since most countries of SSA use CPIs, the focus here will be confined to this index.
CPIs have long been in use (since the 1870s), although the indices have significantly changed or evolved over time both in the methodological rigor of measurement, the objectives, and purposes for which the index is used, and the extent of goods and services measured by the index. CPIs use data from household surveys and provide an estimate of the price changes for consumer items used by most households such as food, clothing, shelter (rentals), medical services and supplies, etc. which yield weighted average of prices by using arithmetic or geometric mean. Therefore, CPIs measure price changes in the consumption sector of the economy and they do not measure investments or production aspects. For instance, such indices exclude investments in stocks, bonds, real estate, and business-oriented services.
In terms of methodology, CPIs go through different computational iterations and statistical processes, ranging from sampling surveys, data collection (and organization), normalization, weighting, standardization, and aggregation, among others. It is important to emphasize that CPIs are not a perfect measure of price movements, but they are the best available tools to gauge the trends in consumer prices for use in public and monetary policy making processes. However, the CPIs are not costs-of-living indices. Nor do they measure relative living costs, as they do not show price changes in two different geographical locations or cities within the same country during measurement periods. Moreover, CPIs only show goods and services that are in the survey samples that are consumed or used for day-to-day living, leaving prices of many other consumer items excluded or unmeasured. The CPIs also suffer from sampling errors and their accuracy largely depends on the verity and honesty of responses given by consumers or households. Besides measuring price movements, CPIs are used for different purposes particularly in developed economies. These include indexation of wages, pension income, and social security with respect to consumer price movements. It is also used for indexing interest rates from investments, rental payments and to deflate household consumption expenditures, national accounts or purchasing power parities.
As discussed further below in the article, in sub–Saharan Africa, an important contributor to consumer price rises in recent years is food inflation, given that the region historically faces shortages of production due to several factors. These include weak economy-wide productive capacities and the low productivity of agriculture, poor land policies that limit access to women and other vulnerable sections of society, climate change impacts and the combination of other supply-and demand-side constraints. Rising cost of energy (electricity) and fuel in several countries of SSA also contributes to the rise in consumer price indices, undermining agricultural and manufacturing value added to GDP and making transportation unaffordable particularly to the poor. For many countries of SSA, agriculture is the dominant sector in terms of employment generation, ensuring food security, generating export earnings and in its share in GDP. However, the value of addition from agriculture has been precipitously declining over the last several decades. For instance, in Zambia, more than 66 percent of the population earns its livelihood from agriculture, but the GDP share of agriculture remains low at around 3 percent.
Figure 1: Movements of Consumer Price Indices (CPIs) in selected economies: Ethiopia, SSA, Africa and Other Developing Countries (ODCs)
Recent trends in inflation
The global average inflation rate reached 8.7 percent in 2022. This is short of the double-digit post-War inflation rate of 11 % experienced in the 1950s and, subsequently, in 1974. The current average rate of price increase is by far higher than the 2 percent rate generally considered as acceptable in developed economies (7 percent in developing countries) as key for maintaining higher rate of economic growth with maximum employment and price stability. African countries, particularly those in the sub-Saharan region are not immune from recent price increases. Rather they are direct victims or casualties. As can be seen from Figure 2, the average growth rate of inflation in sub-Saharan Africa has declined from the peak of 37.4 percent in 2000 to a mere 6.3 percent in 2014- the lowest level recorded in decades. However, since 2016, it has been running at double-digits. That is, from nearly 12 percent in 2016 to 15.8 percent in 2022. The corresponding levels for the African region were11.19 per cent and 17.5 percent, respectively, in 2016 and 2022.Likewise,the average consumer price indices (CPI) for SSA increased from a score of about 32 in 2000 to324 in 2022(more than 10-foldincrease in two decades). The figure for the African region jumped from 40 to 388 during the same period, representing a 9.7-fold increase, whereas the values for other developing countries only trebled from 57 in2000 to 192 in 2022 (see Figure 1).
The most worrying or even disturbing rise in general prices is observed in Ethiopia, the country which has been frequently touted as one of the fastest growing economies in the world for several years. Ethiopia’s inflation growth rates exceeded, by far, the averages for developing countries, SSA and the African region. It jumped from 0.66 percent in 2000 to 33.94 percent in 2022, with food inflation running at the rate of 40 percent or more per annum. The bump in the Ethiopian inflation (Figure 2) with the growth rate of 40% coincided with the global food, financial and fuel crisis of 2008-2009, which increased the country’s price rise from about 17% in 2007 to an astronomical level of 40% per annum. Subsequent years have been very difficult for Ethiopia’s consumers and monetary authorities, which further saw a continued rise in general prices, albeit at lower level than in 2008, but still at more than 33 % in 2012. This is due to the combination of severe drought, oil price increases, political instability, and an increase in exports of the Ethiopian staples. The country’s consumer price index (CPI) score has also skyrocketed from 35 in 2000 to 668.9 in 2022 (Figure 1), representing an increase of 19-fold in two decades, marking a much faster and larger increase than the average for Africa, SSA, or Other Developing Countries (ODCs).These increases mark the largest annual changes since the global financial and economic crises of 2008-2009.While the steep rise in prices in Africa also coincided with the onslaughts of the COVID-19 pandemic and the war in Ukraine, the Ethiopian case is further compounded by internal conflicts, structural rigidity of the economy and decades of its expansionary monetary policies. The gravity of the Ethiopian inflation is its persistence for a reasonably longer period, the impact it had on the country’s poverty situation and on the purchasing power of the local currency. The value of the Ethiopian Birr vis-à- vis major international currencies (usually the USD) has continuously deteriorated for the last two decades, losing nearly 84 % of its value over the two decades (see Figure 3).
Irrespective of the level of development of nations, high inflation beyond economic malaise, may also cause social tensions, employer-trade union conflicts, industrial actions, and eventually political instabilities. It is important to emphasize that, while there have been growing concerns across the world about inflationary pressure and its adverse consequences, the underlying reasons for such concerns vary between developed and developing economies. The overarching preoccupation of policymakers in developed economies is to curb inflation to a manageable level to protect the stability and integrity of monetary and financial policies, maintain healthy capital markets and secure portfolio investments with managed expectations, as well as to maximize welfare.
The primary concern in developing countries, on the other hand, is how to contain inflation while:(a) generating high levels of inclusive and sustained economic growth, minimizing the debt burden and the cost of borrowing, as well as expanding access to credit facilities; and (b)reducing budget and trade deficits, as well as addressing challenges of food-security, unemployment, and poverty reduction. Regardless of the variation in primary objectives between developed and developing nations, there is recognition that persistently high inflation is bad for any economy-developed or developing. Economists regard high inflation as a hidden tax to the economy as it leads to macroeconomic instabilities with heightened risks and uncertainties. Inflation undercuts economic gains by inflating expenditures, the cost of living and GDP. It undermines the standards of living of the population, increases indebtedness and adversely affects purchasing powers of local currencies.
Improvements in farm technologies, inputs and knowledge have led to higher agricultural productivity and surplus food production since the final decades of the 20th century. Consequently, according to several studies, global food prices have been precipitously declining since the 1950s. In developing countries, the steep decline was observed after the 1960s due largely to the green revolution in India and other agrarian economies. However, according to the United Nations Food and Agriculture Organization (FAO), there has been a reversal since 2000 with marked hikes in global food prices. Although there has been a marked decline in the Global Hunger Index (GHI) since the 1960s, still most sub-Saharan African countries including Ethiopia are in serious, alarming or extremely alarming hunger situations in 2022.Out of 45 countries, only Haiti, North Korea, Pakistan, Papua New Guinea, Timor-Leste, Syria, and Yemen are in the categories of serious, alarming or extremely alarming hunger situation, leaving the rest of the crowd concentrated in SSA. The score on GHI of several countries of SSA has deteriorated since 2015 and further deepened after the COVID-19 pandemic and the outbreak of the war in Ukraine. The decline was more pronounced in two of Africa’s most populous nations: Ethiopia and Nigeria. In 2015, Ethiopia ranked 98th in the GHI out of 125 countries for which data was available. In 2023, the country’s ranking deteriorated to 101st, suggesting a reversal in efforts to reduce hunger among Ethiopians. Likewise, Nigeria ranked 109th out of 125 countries, which marked a deterioration in the country’s ranking of 101st in 2015. In 2023, with the respective scores of 26.2 and 28.3 on GHI, Ethiopia and Nigeria fall into the “serious hunger situation” category.
The deterioration in GHI scores in SSA’s two most populous nations can be attributed to several internal and external factors, including high food prices, food insecurity, conflicts, low income, impact of climate change and disruptive weather patterns, poor infrastructure, poor participation of the private sector, continued neglect of the agriculture sector in the allocation of investments and rigid land policy, among others. A GHI score of between zero and 10 implies the prevalence of a low-level hunger, whereas a score between 10 and 20 indicates a moderate hunger situation. A score on the Index between 20 and 35 shows a serious hunger situation, and above 35 implies an alarming or extremely alarming hunger situation. According to the latest data by the International Growth Center (IGC), food Inflation in Ethiopia averaged 18.22 percent from 2013 until 2023, reaching an all-time high of 43.90 percent in May of 2022. In Nigeria, the National Bureau of Statistics reported that food inflation rate in July 2022 was 22.02 % on a year-on-year basis, which was 0.99% higher compared to the rate recorded in July 2021 (21.03%). Ethiopia and Nigeria are not exceptions. The latest brief of the World Bank concludes that “in real terms, food price inflation exceeded overall inflation in 74% of the 167 countries where data is available”, with inflation higher than 5% is experienced in 61.9% of low-income countries and 76.1% of lower-middle-income countries.
Overall, according to the latest UN data, globally, more than 800 million people, the significant proportion of which are in Africa, were going hungry in 2022. The prevalence of hunger and malnutrition amidst global opulence, income and surplus food production results from the combination of several adverse factors. These include (but are not limited to) supply chain disruptions due to the pandemic; climate change and extreme weather patterns; war in Ukraine and now in the Middle East; interethnic and religious conflicts particularly in some countries of SSA; high cost of transportation and logistics; falling income of the poor and distortions in production, harvest, and transportation as well as contortion in global trade in agriculture. What makes food inflation acute to poor households and weaker economies is its implication to poverty reduction efforts given that 70 % of income of the poor is spent on food items. Household can postpone consumption of other goods and services, but it is impossible to postpone necessities of life such as food, clothing, and shelter.
There is an urgent need to effectively address push and pull factors, as well as structural distortionary issues behind food inflation through appropriate policies at the national, regional, and global levels. Such policies must address both the demand- and supply-side constraints such as access to productive assets notably land to the poor including women through flexible land policies. They should also include the provision of better farm inputs and seeds; modernizing agriculture and rural infrastructure; implementing coherent trade, industrial and infrastructural policies to support better food production; and improving buffer stocks, storage facilities, logistics and distribution systems of major staples. There is also a need for concerted global action to mitigate the impact of climate change and disruptive weather patterns on agriculture and food production. Ensuring political stability is also key to minimizing the potential of armed conflicts which disrupt investments, mobility of productive resources which, in turn, diminish agricultural production and productivity. The adverse consequences of armed conflicts and political instability manifest themselves not only in their growth-retarding effects, but also in penalizing investment, production, and productivity, as well as heightening economic risks and uncertainties often causing high inflation. The large casualties of political instability are the poor and vulnerable sections of society, further frustrating poverty reduction efforts in structurally weak and vulnerable economies such as those in SSA.
Figure 2: Average Growth rates in Consumer Price indices in selected economies (%): Ethiopia, SSA, Africa and Other Developing Countries
Inflation, exchange rate and foreign trade
One of the obvious impacts of inflationary pressure is in devaluing local currency vis-à- vis the international currencies of global trade and investment. When inflation hits the economy hard (particularly when galloping or hyperinflation occurs), domestic currencies lose value. That is, local currencies depreciate often at an uncontrollable speed, while currencies with little or no inflation appreciate in a foreign exchange market. In other words, when the purchasing power of the local currency of income deteriorates domestically, the international value of the local currency will also fast diminish. This will have implications for foreign direct investment (FDI) flows and international trade (exports and imports).Investors generally prefer inflation-free economies that offer opportunities to invest in fixed profit yielding bonds, securities, and green-filed investments. In times of inflationary pressure and uncertainties, investors lose confidence in the market and have the tendency to shun such economies. They adopt “a wait and see” policy before making investment decisions or easily choose economies that are not inflationary. Even domestic owners of capital (who are profit and market seeking), opt to invest in economies that have stable currencies and monetary policies with little or no inflation. Such a situation facilitates capital flights from inflation-ridden economies towards inflation-free markets and stable currency economies.
Another important area where high or above-moderate inflation adversely impacts developing countries is foreign trade. It makes import substitution costlier and forces nations to cut imports, further fueling scarcity and adding inflationary pressure. In theory, devalued local currency makes imports grow lower than exports, improving trade balances. However, in practice, higher rate of inflation (galloping or hyperinflation) makes domestic costs of production much higher and exports less competitive internationally, creating continuously growing trade deficits. Developing countries that usually incur trade deficits resort to financing a gap by drawing on their international reserves, from ODA, FDI or through borrowing from abroad. During the last two decades, the Ethiopian Birr lost significant value in major global trade and investment currencies. In 2000, a Birr used to buy 0.1217 USD(or for every 1 USD, the equivalent in Birr was about 8.20in an official market in the same year). In 2022, as can be seen from Figure 3, a Birr would buy 0.01923 USD(1USD would buy, officially, about 55 Birr). As indicated earlier, the Birr has lost 84% of its value between 2000 and 2022 in an official exchange rate market. While such a deterioration in value of the local currency is the result of deep-rooted structural economic difficulties Ethiopia has been facing, inflation has also played an important role in depreciating the Birr.
The devaluation of local currency or the overvaluation of foreign exchange leads to a significant trade deficit, which in turn leads to the depletion of international reserves. This situation is rampant in SSA which relies heavily on imported intermediate goods for nascent industries or manufacturing sectors. High inflation also tends to fuel illegal trade and the expansion of a parallel (black) market for foreign currency, further eroding the credibility and purchasing power of local currency. Between 2000 and 2022, the unofficial (parallel) market for the USD boomed in Ethiopia and many other countries of SSA. In Addis Ababa, the unofficial exchange rate for the USD soared from 12 Birr to a dollar in 2000 to about 120 Birr to a dollar in 2022, marking an increase of10-fold in two decades. According to the Ministry of Industry (MoI) more than 200 manufacturing firms in Ethiopia were forced to cease operations in 2023, due largely to a lack of access to finance and foreign currency, as well as the rising cost of intermediate inputs. This situation further intensifies the continuous decline in Manufacturing Value Add (MVA) in GDP, accelerates premature deindustrialization, and dampens prospects for structural economic transformation in the country. Consequently, the Government of Ethiopia is forced to introduce several currency control measures, though unsuccessful to arrest or reverse the declining trend. For instance, all payments abroad require permits and all transactions in foreign exchange must be undertaken through authorized dealers supervised by the National Bank of Ethiopia. Like with exporters can retain indefinitely 30 per cent of their foreign exchange proceeds but must sell 70% to commercial banks within four weeks. Although the impact of such regulations seems to be very minimum when judged based on the acute forex crunches that the country has been facing, consistently eroding external reserves and compromised debt repayment obligations.
Figure 3: Trends in the Ethiopian Consumer Price Index and exchange rate between the Birr and the US Dollar during 2000-2022
Inflation public borrowing and national debt
According to the latest IMF Global Debt Database, the total debt remained disturbingly high at 238 % of global GDP in 2021, pushing many low-income countries of SSA to debt distress situations during the same year. The combination of the paucity of financial resources in weaker economies and increased financing needs worsened the economic woes of the sub-region. This is due to the growing trade deficit, pandemic-induced financing gaps, which resulted in the decline in global official development assistance (ODA) and FDI flows. This situation, in turn, has led to an increase in debt to GDP ratio of most low-income countries particularly in the post-pandemic environment. Moreover, the increase in inflation in major economies of the world has triggered a sharp and sudden increase in interest rates, which in turn heightened the debt distress situation of many countries of SSA. Pre-pandemic and pre-inflation global interests have remained low for several years, which encouraged increased borrowing by developing countries both from public and private sources. However, the post-pandemic and inflationary situation forced major creditors to raise interest rates which undermined debt servicing capacities of debtor nations which borrowed when interest rates were low. This unholy amalgam between rising interest rates, inflation, and challenging financial environment exacerbated debt repayment obligations of poor economies, further compounding the growing challenges of financing their development needs. While high inflation has continued plaguing the economies of SSA, the IMF has reported that the average debt ratio in sub-Saharan Africa “has doubled in just a decade—from 30 percent of GDP at the end of 2013 to almost 60 percent of GDP by end-2022”. With rising interest rates, repaying this debt has also become excessively costlier to many poor nations. Inability to pay debt makes economies risky and vulnerable. It is also a sign of deep-rooted structural problems, such as weak productive capacities, a balance of payments crises, structural budget deficit and an overall paucity of investible resources. The recent opinion (article)in the Financial Times by Rebecca Grynspan, Secretary-General of UNCTAD, raised an alarm bell that the “public debt of developing countries, excluding China, reached $11.5tn in 2021 with serious debt burden owed by highly vulnerable low-income countries such as Chad, Zambia or Ethiopia”. The article further states that “in 2021, developing countries paid $400bn in debt service, more than twice the amount they received in official development aid, while their international reserves declined by over $600bn in 2022, almost three times what they received in emergency support through the IMF Special Drawing Rights allocation”. Consequently, poor countries such as those in SSA paid more in debt services than their expenditures on education or health with dampening impacts on their progress towards achieving Sustainable Development Goals (SDGs) by 2030.
Inflation, wages, and employment (unemployment)
In theory, inflation and unemployment run in opposite directions. Generally, when unemployment is low (high employment), inflation tends to rise due largely to wage cost- push. But when unemployment is high (low employment), inflation tends to fall. Zero or below zero inflation is also as bad as a high rate of inflation for the economy, as it signifies deflation. Deflation occurs when aggregate supply in an economy exceeds aggregate demand, leading to negative interest rates and low-price levels associated with high levels of unemployment. Research shows that societies generally prefer inflation
with employment to deflation with unemployment. Inflation in an economy can also occur when economic growth slumps, causing stagflation.
Stagflation is a situation where economic growth stagnates; unemployment remains steadily high but the general price rise in the economy prevails. In economics, stagflation is known as recession-inflation, and it is as dangerous as deflation or inflation in hampering the wellbeing of societies and frustrating efforts to achieve sustained growth and development. In theory, a low rate of unemployment (or high employment) is associated with an economic boom when excess demand for labour causes money wages to rise faster than labour productivity, signifying cost-push inflation in an economy. The objectives of policies in such situations, is to minimize both unemployment and inflation simultaneously, while maintaining inclusive and sustainable economic growth. This is the case particularly in democracies and in countries where the wellbeing of citizens takes priority over political interests. Such objectives may also lead to tradeoffs in policies by calculating the opportunity cost of higher unemployment (lower inflation) and comparing this with the opportunity cost of higher inflation (lower unemployment).
Conclusions and the way forward
The recent rise in prices is due to structural rigidities in aggregate supply disrupted by theCOVID-19 pandemic and the war in Ukraine. Massive injections of fiscal and monetary stimulus packages in developed economies that disproportionately increased aggregate demand also contributed to high inflation globally. In relative terms, demand pull factors could be quickly adjusted through appropriate policies, if there is political will and determination. However, supply response to match the increase in aggregate demand takes much longer time to adjust. This means that much broader and multipronged policies and strategies are necessary to effectively deal with inflation. That is, while managing demand is important, addressing supply side distortions and disruptions is critically important particularly in poor and vulnerable economies. Investing in agriculture and rural infrastructure is key in maximizing employment intensity of the sector while boosting the production and productivity of agriculture. Building storage facilities, buffer stocks, and distribution logistics in rural areas is also vital in addressing food-security challenges and hunger situations. In short, recalibrating productive resources such as labour and capital and catalyzing drivers of growth and transformation particularly energy (electricity), ICTs and the private sector can play a prominent role in relieving key supply side constraints.
Available evidence suggests that high inflection is growth-retarding, although the causal relationships between high price increases and economic growth are difficult to clearly establish. There are also convincing arguments that excess aggregate demand over supply is the core of inflationary gap and high inflation. Moreover, inflation is a hidden tax to consumers and producers alike, with devastating impact on economies and societies. As discussed in this newspaper article, inflation has much higher and wider impacts on developing countries particularly those that are structurally weak and vulnerable than developed economies. In these economies monetary and fiscal policies are too weak to bring inflation down. Also, the efficiency of taxation in these economies is undermined by the narrow tax bases, lack of taxable income and poor tax collection systems. Moreover, inflation is not the only economic problem in such countries and controlling it is only one of the many complex development problems that they face. Achieving inclusive growth with high employment and substantial poverty reduction remains among the most pervasive problems facing countries of SSA. Likewise, the paucity of investible capital resulting from low income and low savings rates, external debt burden, as well as the resulting inability of capital formation (accumulation)pose serious development challenges to them. In structurally weak and vulnerable economies that suffer from protracted conflict situations such as Ethiopia, DRC, Somalia, South Sudan or Sudan, the confluences of higher-than-normal defense spending, poor agricultural production and low real economic growth may further intensify systemic risks and uncertainties and overall socioeconomic collapse. Prevalence of conflicts and political instabilities can have much wider ramifications and prolonged consequences both on societies and economies. How quickly conflict ridden, or war-prone countries address the challenges and foster peace, stability and nation building determine their path toward inclusive growth and sustainable development. In other words, conflicts and political instabilities combined with galloping or hyperinflation may complicate economic recovery and the achievement of SDGs by these countries.
The adverse impact of inflation on weaker economies and vulnerable sections of societies is well established. However, there is no simple, uniform, and universal blueprint that enables weak and vulnerable economies to curb or contain rising inflation while, at the same time, addressing their persistent and emerging development challenges. This means that solutions to reduce inflation should be based on specific socio-economic circumstances, resources base, institutional capability, and overall local conditions of countries. This does not mean that there are no generally applicable policy tools. Two critical lessons from past operational experiences in dealing with high inflation are that: first, the control of inflation should be among the top priorities of economic policy in both developed and developing countries. Governments should opt for putting in place sound and stable monetary and fiscal policy instruments. And second, gradual approaches to curbing or containing a certain level of inflation may lead to undesirable outcomes than firm and sudden actions to stabilize high price increases. Based on these critically important policy lessons, monetary and fiscal authorities of developing countries can take the following measures, which may not be wise or popular but necessary to tame inflation:
- Policy action and measures should have national “inflation-targeting” frameworks. Such frameworks are vital tools intended to enhance the efficiency, credibility, and performance of monetary and fiscal policies. They include clearly articulated and defined targets of money supply in the economy, threshold inflation levels or fixed ranges of consumer price indices (CPIs), as well as fixed levels of rentals and interest rates. Inflation-targeting frameworks also include how to best ensure the independence of central banks from political influence with the view to empowering central banks in the management of economic slumps during inflation. The focus should be on strategies to improve supply side constraints such as production and productivity of resources as well as the supply of goods and services. Addressing supply side constraints and boosting supply of goods and services to exact growing demand play a critical role in stabilizing inflation. In short, fostering a vibrant, dynamic, modern, and independent central bank is key for stabilizing inflation. This is because independent central banks are free from political interference in economic decision-making regarding interest rates or exchange rate policies. They may also limit the role of governments from incurring unacceptable levels of budgetary deficits, planning and executing elephant projects through excessive borrowing or printing money for financing.
- Improving regulations, reducing the cost of production, and maximizing efficiency gains: Weak regulatory frameworks, excessive bureaucracy and dysfunctional institutions are hidden costs to the economy, undermining production and productivity. In most developing countries of SSA, weak policy implementation capacities of institutions fuel illegal trade not only in currencies and commodities but also in urban lands and real estates. While land and real estate, as well as other fixed assets are key in controlling inflation by with holding liquid money which would otherwise enters markets, illegal trade in land and real estate leads to quick turnover (with high profits), and high velocity of money. These, in turn, cause inflationary havoc in the economy. Such a situation particularly increased turnover and velocity of money in circulation, exacerbates the flow of huge amounts of money into the market chasing few goods and services. Making regulations and policies pro-poor and pro-production transformation side by side with liberalizing farm inputs, modernizing land use and access policies, reducing taxation on imports of intermediate inputs, and cutting out bureaucracy can help to tame inflation in the economy by containing cost-push inflation. Stamping out corruption is equally important in reducing the cost of business and improving production and productivity as well as the delivery of goods and services to consumers at reasonable prices.
- Responsible sovereign borrowing: During inflation, effective debt-management and responsible borrowing should be central for structurally weaker and vulnerable economies as debt overhang can further destabilize fiscal and monetary frameworks. Responsible sovereign borrowing is key particularly for economies of SSA in maintaining their credit worthiness while ensuring constant inflows of development finance including foreign direct investment (FDI).Responsible borrowing should not be confined to external borrowing but should include borrowing locally. More importantly borrowed funds should be used to address problems of underdevelopment such as weak productive capacities, unemployment and deindustrialization centered on generating inclusive and sustainable growth with substantial poverty reduction.
- Policy measures to protect the poor and vulnerable sections of societies: Given that significant portion of income of the poor (70 %) is spent on food, governments need to put in place incentive structure including food rationing or managed cash transfers to protect vulnerable sections of their societies from food inflation. Such measures should continue side by side with boosting food production and productivity, as well as improving logistics, storage facilities and distribution channels. The objective should be to address food insecurity, particularly the poor and vulnerable sections of society.
- A mix of policies and strategies matter: Harmonized and coherent set of policies are more effective in controlling inflation than single or fragmented policy approaches. Risks and uncertainties caused by inflation require multipronged actions ranging from fostering productive capacities with the objective of enhancing aggregate supply in the economy to introducing contractionary monetary policies and sagacious fiscal policies.
- Aggressive and robust role of governments is key: Governments should play a leading role in containing inflation by reforming financial, monetary and taxation policies, enforcing budgetary disciplines, stamping out systemic corruption and formulating and implementing realistic projects and programmes. Recent episodes of financial, economic and health crises brought back the role of governments in economic decision making even in the “free market economies”. Free market economies are those which historically believed in and advocated for an exclusive role of demand and supply-the “invisible hand”-in economic decision making. Realistic, problem-solving and growth maximizing government programmes and projects are key in reducing socio economic vulnerability, risks, and uncertainties, as well as in building economic resilience to random shocks. Governments of developing countries should particularly aspire to improve project planning and implementation within planned budgetary bands and by strictly enforcing the agreed time for completion. White elephant projects which are unsustainable financially and take infinitely long time to complete with little or no impact on communities, societies, and nations at large should be avoided at all costs. Such projects or programmes are one of the main mechanisms to entrain government budget deficits, excessive borrowing, and/or money printing, fueling inflationary pressure. More importantly, governments should be candid about their economic scorecards, transparent about their monetary and fiscal policy outcomes. They should also provide objective and credible information to the public about the challenges facing their economies and the policies that they intend to implement to contain inflation and its impact.
- Managing monetary liquidity in the economy is vital: Inflation has the tendency to increase nominal money circulation while significantly reducing the real value of money. This makes the liquidity constraint more binding, requiring prudent liquidity management. This problem can be resolved by having financial intermediaries such as modern and dynamic banking and insurance sectors, which channel the funds from entrepreneurs with excess liquidity to those lacking liquidity. Maintaining an acceptable level of monetary liquidity for commercial banks is also extremely vital for the viability and solvency of the financial sector by enabling them to meet financial stability and lending obligations. As discussed above, when inflation increases, monetary and fiscal authorities will be forced to increase interest rates on loans which directly or indirectly determine the liquidity position of the banks. Volatile galloping or hyperinflation negatively impacts interest rates and the capital holding of the banks. Central banks have primary responsibilities in determining the level of monetary liquidity that commercial banks should hold, particularly during a high rate of inflation. Otherwise, banks with excess monetary liquidity may be tempted to lend money to finance consumption (shifting away from investments in risky sectors of production such as agriculture), injecting more money into the market with added inflationary momentum.
- Addressing price information asymmetry and educating the public about inflation: Asymmetric market or price information between producers, middlemen and consumers has the tendency to facilitate undue pricing of goods and services, hence trigger inflation. Government institutions and marketing agencies, as well as consumer protection agencies can play vital role in bridging the gap in price information for consumer goods and services. In situations of imperfect markets and market failures such as those evidenced in structurally weak and vulnerable economies, the existence of asymmetric information cannot be avoided and, therefore, justifies the need for effective monetary policy tools and vibrant institutions to correct imperfection and asymmetries in price information. It is also important to educate consumers or households to manage expectations. However, not all consumers or households are responsible for inflation. The poor and the most vulnerable sections of society have nothing to do with causes of inflation. However, they are the first casualty of high inflation. Public education on how to manage expenditures and shift it away from consumption to production (through increased savings and investments) should focus on the rich (affluent) sections of society; not on the “have nots”. The former can downsize expenditures, better manage expectations, and contribute to overall savings and investments by reducing their propensity to consume to “ordinary levels”. Cutting out or curbing lavish religious and social festivities such as marriage ceremonies, as well as related expenditures particularly by the well-to-do sections of society can help fight inflation. However, the gut to fight inflation is the primary role and responsibility of governments, as they are the custodians of monetary and fiscal policies and main causes of excessive budgetary deficits and sovereign indebtedness.
This article is prepared in full consideration of ST/AI/2000/13 section 2, and it is in the personal capacity of the author. Therefore, the opinions expressed in this article are the author’s own and do not reflect or represent the official views of UNCTAD or the United Nations. The author can be reached at ([email protected]).