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01.05.2000 Feature Article

INFLATION, DOLLARIZATION AND THE AVERAGE WORKER IN GHANA

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In recent days, there have been a slew of feel-good stories and saccharine oeuvre about declining inflation rate in Ghana spinning out from official circles. A recent Ghana Statistical Services newsletter reportedly estimates that inflation rate dropped from 15.7% in December last year to 15.3%, 15.0% and 13.7% in January, February and March respectively this year. But while officialdom is painting a near-rosy picture and high-fiving about the drop, the average Ghanaian winces or at best feels very ambivalent about it because he/she can hardly see the impact on their everyday cost of living.

Economists have debated the seriousness of inflation since time immemorial, yet its economic cost remains ambiguous. No matter what the real economic cost of inflation, however, it seems clear that we don't like it - for the uneasiness and unhappiness it rubs on our national and personal psyche. It can have a devastating impact on the political landscape. In countries where there is a great deal of transparency and governments don't have a monopoly over information, and thus the citizens can make informed decisions, presidents or elected officials can lose elections because of inflation. Such is the impact of inflation!

A great deal of the ambiguity surrounding inflation has to do with measurement problems. There are about 3 ways of measuring inflation - by the Consumer Price Index (CPI), Producer Price Index (PPI) and the GNP Deflator. The most commonly used index (as in Ghana)is the CPI. But as Mark Twain, arguably the greatest American novelist of the Century, once remarked there are three lies: lies, damned lies and statistics. Thus despite their importance, published statistics are sometimes inaccurate. And coming from our part of the world where, in addition to all the institutional weaknesses, the government can easily "cook" the books for political expediency, we have every reason to treat official news about inflation with a grain of salt. Thus we have to be very careful about our interpretation of statistics. More importantly , one must be extremely cautious to distinguish between WHAT A STATISTIC MEASURES AND WHAT IT DOES NOT MEASURE. For instance, the Consumer Price Index (CPI) does not factor in the fact that consumers tend to substitute one good for another when relative prices change. Changes in the quality of goods and services are not measured by the CPI.

Several factors affect inflation in Ghana. Among them are food prices, petroleum prices, other imports (through exchange rate pass-through), and money supply. In Ghana, food prices and oil prices are the two most statistically important factors. In this light, assuming that official statistics are accurate, then one can think of two likely principal factors responsible for the declining inflation in Ghana: (1) falling oil prices in the last few years and (2)the recent appointment of, and half-hearted independence given to, a conservative governor of the Bank of Ghana who isn't money-supply-happy.

But the two-billion-cedi question is that if inflation is falling why are average Ghanaians not feeling it in their cost of living index? There seems to be so much confusion about the difference between inflation and SUSTAINED inflation, and also about the difference between inflation and CHANGES IN RELATIVE PRICES. Inflation measures an increase in the overall price level while sustained inflation is an increase in the overall price level that continues over a significant period of time. So in order for the drop in inflation to have any impact on average Ghanaians, it must be sustained. Besides, one point normally missed out in our consideration of inflation is that not all prices change at the same time. While prices of some goods and services may be declining, others may be increasing steadily or may remain constant. The price level describes the terms by which a representative bundle of goods is exchanged for money, but relative prices describe the terms by which individual goods and services are exchanged for one another.

It is worth bearing in mind that the CPI which is used to measure inflation is based essentially on "basket of goods" consumed by a typical family, but few families may fit the prototype exactly. If your "market basket of goods" contains items whose prices haven't been falling relatively, but not contained in the prototype "basket of goods" you are highly unlikely to appropriate any positive effects that falling inflation might bring. But probably the most important reason why people do not feel the impact of declining inflation in Ghana is that in recent years wage rate (which measures changes in wages) especially for the average Ghanaian (farmers, teachers, lower-tiered workers, unemployed, pensioners, etc) has not increased sufficiently to match the rate of inflation. Thus so long as the wage rate lags behind the inflation rate, the average Ghanaian would not be impressed by any glib stories.

Inflation may be good or bad depending on which side of the economics aisle you belong. For the government it's a good source of revenue - seigniorage. Debtors may benefit from it. However, inflation can disrupt business and consumption decisions. Money, largely, can be considered as the bridge between the present and the future. So during sustained periods of price instability, it is difficult for people to predict future prices and therefore plan accordingly. Generally creditors and those on fixed incomes/wages may suffer, especially if unanticipated inflation is higher than anticipated inflation. In periods of high inflation, real interest rate (nominal rate minus rate of inflation) is likely to be negative. That's why creditors suffer. Thus people have no or little incentive to save. To entice savers, interest rate has to be astronomically high, and this can have dire consequences on investment and ultimately economic growth. That's why inflation encourages commercialization or buy-and sell(trading for quick profits), a phenomenon that has characterized our economy in recent years. It may allocate resources to unproductive activities.

Inflation is also tied to the value of the cedi and the "dollarisation of the Ghanaian economy". (I must caution that a weak currency per se is not bad. It can be used as a strategic export policy to spur economic growth.) Uncertainty about inflation undermines the ability of money to perform its functions and serve as the bridge between the present and the future. In simple economic terms, money performs basically 3 functions - a medium of exchange, a store of value and a unit of account. In times of high inflations, as has characterized Ghana in the last few years, a national currency loses it's role as store of value even though officially by fiat it's still the medium of exchange. The reason? Very simple: consumers being rational hedge against inflation by dealing (saving) in a more stable currency (in this case the US dollar). So it is not enough to resort to emotive appeals or threat of punishment to discourage people from "dollarizing the Ghanaian economy. We should blame the poor suffering-from-kwashiorkor economy (invariably the government) for this frustrating but purely Economics-rational phenomenon in Ghana now. A short-term solution would have been for the government, if it had enough foreign reserves, to intervene in the foreign exchange market to prop up the cedi. But unfortunately, the government has virtually no reserves to be able to "run out" and impact on the foreign exchange market. And even if the government had the reserves to intervene, it's very skeptical it would solve the problem. Part of my skepticism comes from the fact that because Ghana imports almost everything (we produce nothing of our own), an appreciated cedi (cheaper dollar) would continue to exert pressure on the exchange rate, thereby gyrating a vicious cycle of exchange rate problems. Even in an advanced country like Japan, series of co-ordinated interventions by both the governments of US and Japan haven't prevented the fall of the Japanese yen. A very long-term way of reducing inflation and thus restoring some confidence in our national currency is to produce, produce and produce and export, export and export. Countries earn dollars (foreign reserves) by producing and exporting a la Asian countries. And to earn more from our exports, we can't rely on primary products like cocoa for a lifetime. If we don't change our export orientation, then the light at the end of the tunnel will continue to elude us. Inflation is a very complex issue. But the next time they give you any "filla" about inflation ask them about your "basket of goods" and what they have done for you lately by way of wage rate!

Maxwell Oteng
Maxwell Oteng, © 2000

The author has 28 publications published on Modern Ghana.Column: MaxwellOteng

Disclaimer: "The views/contents expressed in this article are the sole responsibility of the author(s) and do not neccessarily reflect those of Modern Ghana. Modern Ghana will not be responsible or liable for any inaccurate or incorrect statements contained in this article."

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