Imani Alert: Inflation Is Bad For Ghana, Period

Friday, February 25, 2011

A casual overview of the world economy should ordinarily dispel the viewpoint that inflation must of necessity accompany sustained economic growth. Runaway inflation in Zimbabwe has depressed growth rates, while decades of fast-paced growth in China has generated anything but runaway inflation.

On Thursday, the 17th of February 2010, one of our researchers participated in a discussion on TV3 (“Agenda”) about the President’s State of the Nation’s address.

During a segment of the discussion focussed on the economy he entered into a minor argument with another participant, who had been introduced as speaking for a major political party in this country.

The party spokesperson expressed some scepticism about the official inflation rate provided by the Ghana Statistical Service. He cited as one piece of evidence for his scepticism what he believed to be an “unusual” correlation between the reported real GDP growth rate and the inflation rate.

In his view, over the same period that the economy was reported to have grown from “4.1% to 5.9%” (Sic) inflation was also reported to have fallen considerably. This he considered implausible. His understanding of the matter was that: “the general trend is for higher economic growth rates to be associated with higher inflation”.

We have over the years observed how widespread this notion, in different guises and variants, is held. Some of our most revered economists and economic commentators, usually suffering from a selective reading of John Keynes, hold positions and recommend policies that question the importance of restraining inflation as a cardinal goal of monetary policy. They make it appear that standard economic analysis bear them out.

It is not so.

Notions that inflation can be systematically used “to stimulate economic growth” are, in fact, unorthodox as far as the empirical data are concerned.

We are therefore grateful to the party spokesperson for giving us the occasion to launch a national debate that MAY hopefully help settle the matter, at least in the domain of policymaking.

Perhaps the point is moot since both the monetary and fiscal managers at the helm of our economic affairs at present are anti-inflation hawks. We believe however that the same cannot be said about many influential persons in both major parties. It will be good if the outcome of such a debate was that those on the right side of the data and the facts prevail across partisan lines.

A casual overview of the world economy should ordinarily dispel the viewpoint that inflation must of necessity accompany sustained economic growth. Runaway inflation in Zimbabwe has depressed growth rates, while decades of fast-paced growth in China has generated anything but runaway inflation.

The problem of course is that such casual insights are usually tainted by anomalies and outliers, because the latter tend to be the most striking features on the landscape. To systematically critique the notion of “managed inflation” amounting to a respectable tool of economic policymaking, it is to dynamical analysis we must turn.

As Friedman sagely said inflation everywhere is a monetary phenomenon. By commonsense extrapolation, this means that inflation, properly speaking, arises from government misdeed in the matter of controlling the supply of money. Inflation is an implied tax on investment that governments cynically use to default on their debts. By debasing the worth of the currency, the relative values of its debt repayments change to the detriment of investors.

This is particularly true of weaker economies where government’s role is disproportionately heavy. The general effect of the debasement of the currency is the increase in the money supply whether due to loose interest rate policy or the minting of new coin (the cynically termed “quantitative easing”). The consequence is obvious: “too much money chasing too few goods”.

Investors, savers and consumers treat the currency levels as signals pointing to productive levels, and they are likely, each group in its own unique way, to misjudge the true state of output in the economy if government’s monetary policy leads to an oversupply of money.

In a certain sense, this, instead of the arcane theories gaining ground nowadays, offers the most relevant context for treating the “output gap”, or what some economists believe refer to the differential between actual and potential GDP levels (the relationship between “levels” and “growth” of GDP is not unproblematic, but that needs not detain us here).

The truth is that employment has a hard correlation with output levels while productivity is similarly strongly correlated with GDP growth. Wrong signals from the government’s monetary managers with respect to output levels and the output gap necessarily throw the balance of forces in the economy out of gear.

The sum effect is that the production of goods therefore fails to keep pace with the availability of currency. As production lags, and money continues to flood the market, inflation rises AND the growth rate DECLINES.

Under very few scenarios should inflation rise because output levels are rising UNLESS government’s monetary policy fails to ensure a corresponding supply of money, a situation which in practice can only be temporary in any decently managed economy. In the same vein, it is reckless to assume that the supply of money itself would enhance productivity, which alone can boost output.

We acknowledge that the argument is sometimes cast as one of government reining in inflation “too aggressively”. This is hard to believe when the figure is still closer to 10% than 1%. And at any rate, the above arguments still apply.

The notion of “direct government expenditure” also provides no escape route, unfortunately, for those beholden to the “let’s (moderately) inflate our way to growth philosophy” since if government makes genuinely productive investments, then sound monetary and welfare policy should ensure that private beneficiaries have the corresponding means to access the fruits of those investments (recall that even government employees are in the end “private consumers”).

“Observable” strong and sustained correlations between growth spurts and inflationary pressures may nevertheless be plausible in a situation where certain “undesirable” government policies are intermingled with some other factors that may be boosting output (foreign direct investment, for instance). In those circumstances the “high growth” becomes a convenient proxy for bad government behaviour, which in fact is the TRUE correlate of the nasty inflation.

Such “bad behaviour” includes poor budget implementation and monitoring, distortionary taxes and trade policies (which lead to an “importation” of foreign inflation, for instance, or to biases against productivity-enhancing investments) and disincentives to Banks through rigid reserve policies or perverse incentives to these same institutions through mispricing of government debt or the lowering of credit quality indicators.

In connection with the last point, it must be clarified that falling inflation DOES appear to penalise borrowers, many of whom are investors and to reward savers (since inflation appear to the latter as the cost of holding money) but here again the proxy is mistaken for the actual. It is deteriorating credit conditions which, by failing to synch the borrowing rate with the inflation rate,are really to blame.

And here, we must admit that insofar as human perception is involved in the delicate balancing act between money supply and productive output, the outcomes should best be arrayed in ranges. In that sense, growth may temporarily induce inflationary pressures, but never to such an extent as cannot be reined in by skilled calibration.

The aforementioned party spokesperson’s concern about the quality of inflation measurement data in this country is of course perfectly justified. What is suspect is his method for disputing the data.

By all means, we should all treat official economic statistics in this country with some caution.

Successive governments have failed to adequately resource and reform the key institutions in charge of that aspect of our national life.

The Consumer Price Index, which is the technical measurement of inflation, uses weights for the different categories of household expenditure deduced from the 1998/99 household survey, while employing a base year of 2002. Some have suggested using more recent referent points. Our view is that this misses the point.

The critical issue is the inadequacy of ethnographic research in the establishment of sufficiently representative weights for the different categories of items. It is laughable to believe that the “average household” in modern Ghana spends just 0.3% of household income on communications or 1.60% on education (in these days of “extra classes” and “professional qualifications”). So long as the computation of the CPI fails to sufficiently take into account income group differentiation, its sensitivity will remain suspect.

More items (than the current 242) need to be collected for the CPI, from more varied sources, and with greater analytical sensitivity. Furthermore the escalating divergence between the Producers Price Index (inflation as perceived by businesses – PPI) and the CPI (inflation as perceived by consumers) is becoming worrying. PPI is currently believed to hover above 18%.

It is noteworthy that when the International Comparative Program (ICP – an exercise to synch Ghanaian measurement with international practice on a pilot basis) was active in Ghana, strong divergence was noted for many months between ICP and CPI figures, with ICP measurements of inflation exceeding CPI measurements by 20% on certain occasions.

But the fact that we are failing to measure inflation more rigorously does not detract from the significance of the indicator, even if only as a comparative rather than absolute tool in the tracking of trends in the economy from year to year, which is to say the same tools, and presumably their flaws, have been used for guiding policy in this country during successive administrations.  

Most importantly of all, it takes nothing away from government’s prime duty to reduce the rate of inflation. That reality is commonsensical.

Of course, a day may come when we may no longer have to rely so critically on governments to manage this crucial aspect of our economic lives, but that is another discussion entirely.

Courtesy of IMANI-Ghana ( and