Inflation

1. Inflation Isdefined as a persistent increase in the general level of prices as reflected in the consumer price index (CPI). The most common measure of inflation is the rate of change in the CPI. The CPI measures the cost of buying a fixed basket of goods and services representative of the purchases of urban consumers.

2. Point Worth Noting • For inflation to occur the overall price level (as reflected in the CPI) must rise. • The increase in the general level must be persistent for the situation to fit the inflation label. A day increase in the general level can hardly be described as constituting inflation.

3. Misconceptions about Inflation • Do high prices mean inflation? • Does a fall in the rate of inflation means there is a reduction in prices? The table below shows Inflationary trend in Ghana

5. Effects of Inflation Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways: • Reduction in the real value of saving: the rate of interest does not compensate for the increase in the general price level. • Reduction in the real value of money: As inflation rises, every cedi you own buys a smaller amount/percentage of a good or service.

6. Effects Cont. • Disruption of business planning: uncertainty abt the future makes planning difficult and this may have a negative effect on the level of planned capital investment. Also, Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.

7. Effects Cont. • Fall in international competitiveness: If the inflation rate is greater than that of other countries, domestic products become less competitive. • Redistributive effects- debtors gain whiles creditors lose. For those who borrow, this is similar to getting an interest-free loan.People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living whiles those on variable income (e.g. businessmen etc) gain.

8. Effects Cont. • Currency substitution: high and uncontrolled inflation erode the confidence that people have in the local currency as it become worthless. E.g. the high rate of inflation in the 2000, led the currency substitution or dollarization of the cedi. • Menu cost: The entire economy must absorb re-pricing costs ("menu costs") as price lists, labels, menus and more have to be updated. • Higher wage demand which can further fuel inflation

9. Effects Cont. • Finally, inflation is a sign that an economy is growing. In some situations, little inflation (or even deflation) can be just as bad as high inflation. The lack of inflation may be an indication that the economy is weakening. As you can see, it's not so easy to label inflation as either good or bad - it depends on the overall economy as well as your personal situation. 

10. Theories of Inflation • Demand-Pull Inflation: it occurs when AD rises more rapidly than the economy’s productive potential, pulling up prices to equilibrate the aggregate quantities demanded and supplied. The general consensus was that the persistent upward shift of the AD schedule against the relatively stable AS curve is the main cause of inflation. This result in an inflationary gap of AD over AS which pulled up prices. It is also seen as a situation where too much money chases few goods.

11. Theories Cont. 2. Cost-Push Inflation: It occurs when increase in cost of prodn is passed on to consumers in the form of higher prices. When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, exchange rate depreciation or increased costs of imports.

12. Theories Cont. 3. The Monetarist Position: They argue that an increase in money supply increases the demand for a variety of assets. This increased desire to spend increases AD. To the monetarist, inflation is mainly a monetary phenomenon and must be corrected via monetary and fiscal means.

13. Theories Cont. 4. The Structuralist View: They view the fundamental causes and the socially acceptable remedies of inflation in the economic and social structure. They see differences in mkt structures which suppresses the assumption of full empt as a major source of inflation. The structural factors making for inflation include: • Rigidities in the agric sector • Imperfect mkt for goods, labour and capital • An unstable and stagnating foreign mkt for exports

14. Causes of Inflation in Ghana • Liquidity injection • Increase in wages/salary unrelated to increases in productivity • BOP crises • Low level of productivity espthe agricsector • Depreciation and devaluation of the cedi • Increases in petroleum products

15. Solutions to Inflation • The use of monetary policies (e.g. open market operation, bank rate etc.) • Increase in wages/salary should related to increase in productivity • BOP crises could be address through import substitution, export promotion etc. • Increase in productivity esp. the agricultural sector through construction of dams, irrigational facilities, mechanization etc. • Increase in foreign exchange earnings and reduction in imports

16. Anti-inflationary Measures By Successive Govt:1961-2000 From 1961-1966 • Act 113 in 1962. It was to facilitate an effective control of prices of certain items deemed crucial. • In 1965, this Act was amended by the Control of Price Amendment Act, Act 298. • These price controls failed. This failure was due partly to the absence of deflationary policy backing.

17. Anti-inflationary Measures By Successive Govt. Cont. From 1966-1968 • From 1966 to middle 1968, the National Liberation Council further amended Act 113 by the Control of Price Amendment Decree, NCLD 95. • There were drastic import and exchange restrictions. Govt. reduced its expenditure by cancelling projects deemed uneconomic, rescheduling debts and retrenching labour. • These measures yielded positive results.

18. Measures By Successive Govt. Cont. From 1972-82 • The NRC govt pursued an incomes policy with the aim of reducing inflation. In 1972, Act 113 and it subsequent amendments were repealed by the Price Control Decree, NCRD 17. • Also, the Prices and Incomes Board was set up to enhance incomes policy administration. Again, govt launched the operation feed yourself program. • These measures were however short lived in abating inflation.

19. During this period extensive use was made of fixed exchange rate and price controls. • But, these policies failed to check the rising trend in prices; they merely suppressed it. • These measures distorted relative prices, and further aggravated the problem of structural constraints within the economy.

20. Measures By Successive Govt. Cont. From 1981-2000 • Decline in inflation rate was one of the main objectives of the PNDC govt. • Attempt was made to eliminate budget deficits. To achieve this effort were made to remove bottlenecks in revenue collection machinery. This resulted in significant increases in tax revenue. Hence govt registered surpluses for the period 1986-1989. • Also, PNDC govt linked wage and salary increases to increases in productivity.

21. It is obvious from the foregoing, that the various anti-inflationary measures adopted by successive govts in Ghana at best had been marginally successful.

22. Inflation Targeting Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.

23. Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. Examples: • If inflation appears to be above the target, the bank is likely to raise interest rates. This usually (but not always) has the effect over time of cooling the economy and bringing down inflation. • If inflation appears to be below the target, the bank is likely to lower interest rates. This usually (again, not always) has the effect over time of accelerating the economy and raising inflation.