Ghana’s Inflation - The tale of two governments

After experiencing inflation of 40.5% plus in 1999-2000, inflation in Ghana is currently 9.08%. The current government is boasting that it has consistently brought inflation down from the highest of 22% from mid 2009. The NPP administration naturally credited itself for bringing inflation down from 40.5% to the 18% in 2008 when they left power. In this paper I intend to look at the policies both administration worked on to bring down the figures.

In the developed economies, sound monetary and fiscal policies are the most important tools for maintaining low inflation. The central bank's monetary policy committees are given an inflation target by the government. The first step is for the central bank to try and predict future inflation. They look at various economic statistics and try to decide whether the economy is overheating. If inflation is forecast to increase above the target, the central bank will increase interest rates. Most central banks have used interest rates to try and achieve inflationary target.

Increasing interest rates help reduce the growth of Aggregate Demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending because they increase the cost of borrowing, reducing spending, make it more attractive to save money and reduce the disposable income of those with mortgages and long term loans

However changes in fiscal and monetary policies such as bank rate changes can take up to two years to have their full impact on inflation. It is therefore important for central banks to look ahead when they are deciding on the appropriate monetary policies in order for them to begin to bear fruits two years down the line.

In Ghana today the NDC began enjoying interest rate drop three months into its administration. Could that be attributed to monetary and fiscal policies that the nation had invested in from 2007? The whole world experienced an economic meltdown in the last quarter of 2007 and continued through 2008. The shocks naturally upset our inflation figures causing it to rise from 12% in 2007 to 18% at the end of 2008.

If one notices under the NDC, even though inflation is dropping, GDP growth has slumped from 8.4% in 2008 to 5.9% in 2010. With this statistics the NDC administration is trumpeting sound economic policies. The government however, to this day, apart from the blanket “sound economic policies” phrase has not been able to point to the reasons for this downward trend. The truth is that they have not got a clue because they are not responsible for it neither is any of their policies. In Ghana food prices account for the biggest factor in inflation figures. It accounts for 45% of the CPI basket. If food prices drop, which thankfully is the case due to bumper harvest, then nature is looking kindly on our inflationary figures. According to the Statistical Services since January food inflation has been in single digits, dropping from 9.08% to 5.62% in October. Over the same period, non-food inflation – including alcoholic beverages – stayed above single-digit level despite recording a decline from 18.79% to 11.82%. That is why a Senior Economist at the Institute of Economic Affairs (IEA), Dr. John K. Kwakye, argued that the continuous decline in inflation, which touched single-digit in June and further dropped to 9.38% in October, is explained more by stable food prices than Central Bank policy. However instead of riding on this providence the NDC is actively trying to tinker with the economy to be appearing to manage it with some outmoded monetarist ideas which would have a devastating effect two years down the line.

The reason why the NDC have allowed the GDP growth to slump is because of simple politics- to keep inflation down. With growth of 8.4% under NPP they realised that demand in the economy could be growing faster than the NDC capacity to manage it. High GDP growth naturally leads to inflationary pressures known as demand pull inflation. Therefore by shrinking the economy they are deliberately reducing the growth of Aggregate demand, which comes with a temporary side effect of reducing inflationary pressures. For the government to be genuine in its effort it should be able to tackle inflation drop with both investment growth and focusing attention on enhancing the productive capacity of the economy to achieve strong GDP growth.

The government is also using increment in taxes such as was witnessed in the 2011 budget and spending cuts. In the short term this looks like improving the budget situation and helping to reduce demand in the economy with low inflationary pressures without causing a recession but this could lead to deflation. Deflation is a result of a slow economy, and causes its own problems — since prices are falling; there is no urgency for consumers and businesses to buy or invest, which leads to lower production and employment. It's also more difficult to repay debts when business revenues or household incomes are falling.

As Ghana's has a relatively high inflation and negative growth, then the policy of reducing aggregate demand as the NDC is pursuing would be more unpalatable as reducing inflation would lead to lower output and higher unemployment. They could still reduce inflation, but, it would be much more damaging to the economy.

The NDC have been an ardent believers in monetary as against fiscal policies, hence the appointment of two monetarists like Dr. Duffuor and Mr. Ammissah-Arthur

Monetarism seeks to control inflation through controlling the money supply. Monetarists believe there is a strong link between the money supply and inflation. If you can control the growth of the money supply, then you should be able to bring inflation under control. Monetarists therefore stress policies such as higher interest rates to tighten monetary policy, reducing budget deficit which means deflationary fiscal policy and control of money being created by government. However, in practise, the link between money supply and inflation is weak. In the 1990s these duo, with the help of the NDC Economic Monitoring Team adopted the same macroeconomic policy mix which caused persistent uncompetitiveness and rising costs, hence when the inflation got out of hand, it shot to nearly 50% and put the economy between the devil and the deep blue sea.

The outlook is looking bleak already in the coming years as the Monetary Policy Committee of the BoG have decided to peg the Monetary Policy Rate at 13 per cent in 2011. The decision, according to them “follows considerations such as the inflation outcome for the end of year, inflation outlook for 2011, recovery in economic activity and the counterbalancing effects of the risks in the outlook”. The sources of risk are the management and settlement of wage arrears and the flexibility of the expenditure programme, especially the continued earmarking of revenues, debt servicing from the Collaterization of our oil revenue and the STX tax burden we are going to pick up as a country. The others are the impact on crude oil prices and the significant build-up in foreign exchange reserves arising out of inflows of private capital in the money market and in foreign direct investment from the oil trade.

The NPP on assuming power in 2001 introduced a major ground breaking policy of the reserve ratio and other supply side policies which almost immediately started to make the economy to become more competitive and help to moderate inflationary pressures. For example there were more flexible labour markets to help reduce inflationary pressure.

The government instead of “creating money” allowed the private sector to generate it and rather gave the powers to the bank of Ghana to control the country's reserve ratio which is the amount of money that banks are allowed to hold by the central bank. This portion is expressed as a percent of depositors' balances retail banks must have on hand as cash. This is a requirement determined by the country's central bank, which in Ghana is the Bank of Ghana. The reserve ratio affected the money supply in the country and hence its inflation rate. Bank of Ghana also used the discount rate system which is the interest rate that an eligible bank is charged to borrow short-term funds directly from a central bank.

The general feel good factor and the flexible investment climate under NPP also created open market operations which is the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Purchases injected money into the banking system and stimulated growth while sales of securities did the opposite.

Open market operations were the principal tools of monetary policy even though the discount rate and reserve requirements were also used effectively by the NPP administration. The aim of Dr Acquah the then Governor of the Bank of Ghana in using this technique was to adjust the central funds rate--the rate at which banks borrowed reserves from each other. This strategy was used consistently from 2001 until the recession at the tail end of 2007 and in 2008 upset the strategy temporary. The government at that point threw a lot of money into the system when the price of crude shot to $147 a barrel.

Reducing inflation from 18% to 9% is not as long a journey as reducing it from 40.5% to 18%. The journey in the case of the NPP was visited by the vagaries of the world's worst recession while the NDC journey is petted with roses of recovery as well as following the path of already laid down fiscal policies. I have created an open goal here for the NDC to score but will they be able manage it? I doubt it, certainly not with Dr. Duffuor and Mr. Ammissah Arthur.

Kwesi Atta-Krufi Hayford
Read more from The Thoughts of the Native Son at hayfordatta-krufi@blogspot