27.06.2022 Press Release

Rethinking Inflation Management In Ghana In The Wake Of Covid-19 And Russia-Ukraine War

...A Summary Of A Paper To Be Presented At A Roundtable On Tuesday, 12th July, 2022
Rethinking Inflation Management In Ghana In The Wake Of Covid-19 And Russia-Ukraine War
27.06.2022 LISTEN

Ghana is experiencing its share of the inflation crisis that has engulfed the whole world as a result of Covid-19 and the Russia-Ukraine. Inflation has risen consistently every month in the past year to reach an 18-year high of 27.6% in May. Almost every consumer item has been affected and, with wages and most incomes being almost stagnant, Ghanaians are experiencing untold economic hardship. So far, the Bank of Ghana (BoG) has responded quite aggressively by raising the Policy Rate (PR) cumulatively by 550 basis points in the past year to 19.0% in May. The strong policy tightening, however, has not been able to contain the inflation.

  1. Ghana's Inflation Dynamics and Causes

Ghana has a history of high inflation compared to our peers in Africa and elsewhere. In the eighties and nineties, inflation was in the high double digits. Over the last twenty years, however, inflation has declined significantly along with improvement in general macroeconomic performance. But we have not resolved the problem completely. Indeed, all this time, the BoG has been struggling to keep inflation at single digits at a time when inflation had been tamed globally. Empirical evidence identifies over-expansionary fiscal policies, food supply deficits and exchange rate volatilities as some of the key drivers of

Ghana's inflation. Also, occasional oil price shocks, coupled with the multiple taxes and levies in the domestic price build-up, fuel inflation from time to time.

Analysis of the current inflation shows the strong influence of food, fuel, transport and the exchange rate. In May, 4 out of the 13 major divisions of the Consumer Price Index (CPI) recorded much higher rates of inflation than the headline rate 27.6% and those items related to transport, energy and food. In terms of contributions to headline inflation in May, 3 of these very 4 items were dominant, accounting for 75.6%. Indeed, over the 3-year period, May 2020-May 2022, these very items dominated inflation, contributing an average of 76.7% per year. These figures clearly confirm food, fuel and transport as key drivers of Ghana's recent inflation. While the role of food, fuel and transport is directly discernible from the data, the role of the exchange rate is not. We know, however, that in May, inflation for imported goods was 28.2% as against 27.3% for local goods, with the exchange rate contributing to the difference. Indeed, imported goods inflation has increased almost consistently since May 2020.

  • Inflation Management

The BoG adopted the Inflation Targeting (IT) framework in 2007, which uses the Policy Rate (PR) that it charges on loans to banks to influence interest rates banks charge on various loans to consumers so as to induce them to purchase less goods and services generally and thereby bring down prices in the economy. The snag with the IT, however, is that because Ghana's

financial system is less developed, financial products are limited and financial inclusion is low, the transmission of the PR is constrained, as is its potential to influence consumer behaviour and inflation. IT is further limited in the Ghanaian context by the fact that, as we noted above, our inflation has strong supply and cost undercurrents that are less amenable to the PR, which is essentially a demand-management tool. In view of these limitations, using IT solely to control inflation can be counterproductive as it can inflict harm on the real sector. Also, in Ghana where wages, incomes, and aggregate demand are low, and most people live from hand to mouth, to attempt to squeeze demand further through the IT framework can exacerbate economic hardship.

  • A New Approach for Managing Inflation

A new approach is required for managing inflation in Ghana because of the strong supply and cost undercurrents. More importantly, the new approach requires the BoG and Governments working together rather than in separate silos or pigeon holes. For this purpose, we wish to

separate the management of the current inflation, which is like a fire-fighting exercise, from finding a lasting solution to inflation persistence in Ghana.

Mitigating the current inflation calls for interventions in respect of food and fuel, especially. For food, it is necessary to augment supply, including from accessing the ECOWAS strategic stock, importing some food items and banning exportation of essential items. Further, the Government should consider providing a temporary subsidy on staples like maize, rice and bread to ease the burden on low-income consumers. Even the IMF, which is known not to be a fan of subsidies, has called on Governments to provide food subsidies to their citizens. For fuel, the Government should try to cushion pump prices, including from its own windfall earnings from higher oil prices, the Energy Sector Stabilisation Levy Act (ESLA) fund, or reduction of some of the taxes and levies. Meanwhile, the BoG may still have to keep monetary policy tight, as necessary, to dampen potential demand pressures from fiscal policy impulses as well as counter second-round effects that could emanate from the supply shocks.

To deal with inflation over the long-term, we suggest a mixed or hybrid approach. This is a combination of the IT approach-which, for want of a better name, we call the "macro­

approach" to the extent that it targets the entire headline inflation-with an approach that directly targets the persistent supply or cost components of the CPI, which we refer to as the "micro-approach." The following specific policies are recommended in support of the IT framework:

  • Ensure adequate food access and affordability, including by: i) promoting production; ii) increasing storage and processing facilities; and iii) ensuring availability of food in all markets all-year round.
  • Ensure sustainable supply of fuel and avoid extreme price volatilities, including by: i) resourcing BOST to maintain strategic reserves for cushioning shocks; ii) resuscitating TOR to refine Ghana's share of crude oil; and iii) mitigating price shocks from Government's windfall earnings and ESLA fund and reducing taxes and levies, as necessary.
  • Improve access and availability of public transport, including by: i) expanding and subsidising intra-city and inter-city transport; and ii) resuscitating the railway system to serve as an alternative means of public transport.
  • Reduce exchange rate volatilities, including by: i) increasing foreign exchange earnings from expanded and diversified exports, remittances and natural resources, ii) aggressively producing import substitutes through industrialisation; and iii) building confidence in the economy through credible policies to attract investors.
  • Reduce the destabilising effect of fiscal policy by: i) entrenching fiscal discipline through revenue-enhancing and expenditure-rationalisation measures; and ii) reducing borrowing and debt accumulation.

Finally, we wish to emphasise that what we are proposing is a pragmatic rather than an ideological approach to resolving what has become a perennial national problem. What we all want is what works for Ghana. Further, it is important that we refrain from operating in silos or pigeon holes, as that would not work for us. The BoG and Governments should work together to achieve the common national goal of finding a durable solution to Ghana's inflation persistence. Indeed, with many other central banks equally struggling to contain the current type of inflation-and many considering targeted interventions, including subsidies­ Covid-19 and the Russia-Ukraine war may have already triggered a rethinking of monetary policy and inflation management not only in Ghana but globally.

For further information or details, please contact Dr. J. K. Kwakye, Director of Research, IEA, via these emails: j;

ModernGhana Links