Inflation in Ghana: Causes and Impacts

1. Econ 216 – Economy of Ghana II LECTURE 1 - INFLATION IN GHANA

2. Meaning of Inflation • Persistent • Average/ general level of prices • Goods captured by the ‘market basket’ • The Consumer price index, the change in which reflects inflation

3. Impact of inflation • “… both inflation and robbery deprive their victims of some property, with the difference that the robber is visible whilst the inflation is invisible; the robber’s victim may be one or few at a time, the victims of inflation are the whole nation; the robber may be dragged to court, inflation is legal” – Gockel (1996) • Severity & whether or not it is anticipated.

4. Impact of Inflation • Redistributive effects – debtors/lenders; government; fixed income earners • Business planning & Investment – capital investment/ budgeting • Distortion of price mechanism & inefficient resource allocation • Real value of savings • International competitiveness • Wage demands

5. Impact of Inflation • Currency substitution • Menu cost

6. Theories of Inflation We shall consider the different theories on the causes/ sources of inflation; • Demand-pull inflation • Cost-push inflation • Monetarist view • Structuralist view

7. Demand-Pull Inflation • Too much money chasing too few goods. • Assumes full employment of inputs. • AD rises beyond the economy’s productive potential (a relatively stable AS), pulling up prices till equilibrium is re-established through the interaction of market forces. • Thus inflation according to theorists arises from the demand-side of the aggregate goods market.

8. Cost-push Inflation • Increases in cost of production arising from wage and interest rate rises. • Caused by shifts of the aggregate supply schedule following surges in one or more element of production cost. Some include; • Labour union negotiations; real wages, fringe benefits • High import duties • Exchange rate depreciation • Activities of middlemen, esp. agriculture • Oligopolistic markets for raw materials and intermediate goods.

9. The Monetarist View • Inflation is always and everywhere a monetary phenomenon. • Increases in money supply increases desire to spend and thus, increases aggregate demand. • Inflation is a monetary phenomenon and can be dealt with using monetary and fiscal policy.

10. Structuralist View • Fundamentally from the social and economic structure of the economy • Differences in market structures in an economy (no full employment); • Rigidities in the agricultural sector • Inefficient fiscal system • Imperfect markets for goods, labor and capital • Volatile international commodity markets

11. Structuralist View • They identify proximate (direct) cause and fundamental (precipitating) causes which trigger the proximate. • For e.g. an increase in money ss is the proximate cause of inflation, however the fundamental cause are the factors that leading to the increase. • Therein therefore lies the solution for Structuralist.

12. Deciding what is the cause of inflation • Inflation, once set in, fuels it self as all other factors interact and in varying degrees induce it.

13. Inflationary Trends in Ghana (1960 – 2012) Ghana’s inflationary experience can be characterized into four episodes; • Episode 1; 1960 – 1972 • Episode 2; 1973 – 1982 • Episode 3; 1983 – 2000 • Episode 4; 2001 - 2007

14. Immediate post-independence period; 1960 - 1972 • Inefficiency of State Owned import-substitution industries led to declines in output and hence shortages. • Government expenditure significantly exceeded income, esp. tax income (budget deficit). • Deficit was largely financed with accumulated reserves and windfall from good performance of cocoa in the world market.

16. The deteriorating phase; 1973 - 1982 • Characterized by military takeovers, which resorted to expansionary fiscal policies. • Financing of deficit was through inflationary measures i.e. printing of money by BoG(loose monetary policy/ quantitative easing). • In ’71, budget deficit grew from ¢17m to ¢781m in ’77 with total money supply increasing by 500% as inflation hit almost 117%. • Whilst producer prices for cocoa doubled, public sector wages tripled, without any corresponding increase in output.

17. The deteriorating phase; 1973 - 1982 • On non-monetary causes, price controls in the form of maximum prices to protect consumers were legislated in ’79. Producers and suppliers refused to offer goods for sale and this worsened the shortages and led to black market pricing. • Again, continuous devaluation (lowering value of cedi relative to other currencies) affected the prices of imported finished goods and production cost of industries dependent on imported raw materials. Together, these led to a rise in the general price level.

18. hyper Inflation galloping Inflation

19. The ERP period; 1983 - 2000 • Inflation rose to significantly high level of 123% in ’83. • Some plausible causes included external shocks such as drought and bush fires which hit the agricultural sector, withdrawal of crude oil supply from Nigeria, and in some ways the deportation of some 1 million Ghanaians from Nigeria - SS side shocks. Growth was negative. • Implementation of various reforms under the ERP in ’84 not only helped the agricultural sector recover, but also brought a lot of change to the economy. • Following the restoration of democratic rule, elections and unplanned expenditures fueled inflation; in the run-up to ’92 elections, civil servants pushed for an 80% increase in salary that pushed the wage bill to 8% of GDP; the budget deficit which stood at 5.27% in the months leading up to the elections deteriorated to 8.5% after the elections.

20. The ERP period; 1983 - 2000 • Taxation tends to be politically expensive hence government has often tended to inflationary finance. • Falling world prices for cocoa and gold, increase in crude oil price, rapid depreciation of the cedi (fall in value of currency relative to other major currencies) contributed to the 40.5% inflation in 1999/2000.

21. hyperinflation galloping inflation

22. The recent period; 2001 - 2010 • Q: What has been the recent trend of inflation and what are the factors that have accounted for this trend?

23. Major Causes of Inflation in Ghana Studies have shown that inflation in Ghana has can be attributed to DP, CP and Structural factors; • Liquidity injection • Wage/ salary increases unrelated with productivity • Balance of payment crises • Low level of productivity in agricultural sector

24. Combating inflation • Demand management policies • Measures aimed at increasing aggregate supply • Income policies

25. Anti-Inflationary measures by successive governments; 1960 - 2000 • Control of Prices (Act 113) in 1962 • Amended in 1965 by Control of Price Amendment Act (Act 298) • Control of Prices Amendment Decree, NCLD 95 (’66 – ’68) with drastic import and exchange rate restrictions, devaluation of cedi by 30% in ’67, significant reduction in government expenditure, rescheduling of debt, retrenchment programs. All together aimed at curbing inflation and restoring internal and external balance.

26. Anti-Inflationary measures by successive governments; 1960 - 2000 • In ’73, Act 113 and its subsequent amendments were repealed by the Price Control Decree, NCRD 17 under the NRC. • The Operation Feed Yourself (OFY) programs was launched aimed at making the economy self sufficient in food production. • These policies seemed to help curb inflation albeit for a short period. • Despite the extensive use of PCs [tend to distort relative prices and worsen the problem of structural constraints in an economy] and exchange rate controls to combat inflation, the problem was only suppressed as the underlying causes were not eliminated.

27. Anti-Inflationary measures by successive governments; 1960 - 2000 • In the period 1986 – 1989, following the good progress made at removing bottle necks in revenue collection, the narrow coverage of the budget recorded surpluses. • In 1990, there was a deliberate effort by the government to link wage/salary increases to productivity increases. This was outlined in the budget for that fiscal year.

28. Recent Developments in Fighting Inflation (2002 – present) • In sum, inflation in Ghana has had more to do with fiscal dominance coupled with monetary accommodation to finance the fiscal deficits. • This is aside the inertial inflationary expectations within the economy due to past volatilities. • Challenges; • Commodity shocks of ’99, ’00 • Rise in import bill for crude oil (increased production and Asian crises) • Huge spending and domestic borrowing , donor budget support was not forthcoming, exacerbating inflation, rise in interest rate and inflation.

29. Monetary Policy Environment • MP – use of interest rate, money ssto influence output, employment and the general price level. • Bank of Ghana Act 612 was passed in 2002 to grant the Central bank operational Independence; • Maintain price stability independent of instructions from government or any other authority • Monitory Policy Committee (MPC) to formulate monetary policy (transparency & communication with public to ‘anchor’ inflation expectations) • Gov’t borrowing from CB in any year shall be limited to 10% of its revenue (eliminate fiscal dominance)

30. New monetary policy process - Inflation Targeting • The Central Bank commits primarily to controlling inflation, with an explicit target rate/ range. • The CB uses all monetary policy tools at its disposal to achieve this. • This frees the CB to pursue other important goals such as output, exchange rate and interest rate stabilization and employment creation. • These are implemented through the monetary policy committee (MPC) which meets every other month to set the key policy rate – prime rate. • The key principles underlying their work is transparency and credibility, which are crucial to inflation expectations and inflationary pressures.

31. Inflation Performance