Assessment of Inflation Trends Management and Macroeconomic Effects in Ghana
Assessment of Inflation Trends Management and Macroeconomic Effects in Ghana
28 IEA MONOGRAPH
Assessment of
Inflation Trends,
Management
and Macroeconomic
Effects in Ghana
THE INSTITUTE OF ECONOMIC AFFAIRS
IEA
Ghana A Public Policy Institute
Assessment of
Inflation Trends,
Management
and Macroeconomic
Effects in Ghana
1
by DR. J. K. KWAKYE
1
Dr. Kwakye worked with the Bank of Ghana for twenty years until 2000, predominantly in the Research Department.
For the following ten years, he worked at the International Monetary Fund in Washington, D.C., as Advisor to the
Executive Director Responsible for Ghana. Dr. Kwakye is currently a Senior Fellow at the Institute of Economic Affairs.
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ISBN: 988-584-84-9
ISSN: 0855-3238
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P
rinted in Ghana. All rights reserved. No part of
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G
hana has experienced high inflation over a long
period of time. Over the past thirty years,
monetization of fiscal deficits and cyclical food
deficits have been the principal drivers of inflation. Achieving
sustained disinflation therefore depends on addressing
these factors on a durable basis.
In this paper, the author notes that, inflation management
under the previous monetary targeting (MT) framework was
ineffective because of the intractability of the underlying
causes. The move to inflation targeting (IT) in 2007 did not
help matters, mainly because of the stubborness of the
underlying causes as well as the absence of the key IT policy
and structural conditions.
The author states that, fiscal austerity has helped recent
disinflation, but could also have contributed to a slowdown
in the economy, especially in 2009. In his view, low, stable
inflation is beneficial to growth and employment in the long-
run, although there could be short-term costs to rapid
disinflation. This assertion is supported by both theoretical
and empirical literature, including Ghana’s own experience.
He concludes by noting that, oil production will be
potentially the biggest influence on future inflation, given
expected boost in government expenditure and general
aggregate demand. In his view, achieving the low single-digit
inflation envisaged over the medium-term would entail
exceedingly tight monetary policy, which could in turn put
brakes on economic activity.
Jean Mensa
Executive Director
The Institute of Economic Affairs
1
1.0 Introduction
Ghana has experienced persistently high rates of inflation for several decades.
This suggests that either the causes have been intractable, or inflation
management has been ineffective, or both. Since July 2009, however, inflation
has fallen consistently and by a significant margin, with the oft-elusive single-
2
digit level being reached since June 2010. With government efforts to reduce
the fiscal deficit that reached a record high in 2008, and a significant slowdown
of the economy in 2009—which could also have been affected by the global
economic slowdown—some people have suggested that the rate of disinflation,
which they contend to be driven by fiscal austerity or retrenchment, might be
too rapid and could have costly output and employment losses down the road.
The purpose of this paper is to throw some light on Ghana's experience with
inflation in the past and in the recent period. The paper also looks into the
question of whether there are potential output and employment costs to
achieving very fast disinflation. The paper is structured as follows: Following
this introduction, Section 2 examines inflation trends and causes during the
past three decades. This is followed in Section 3 by an assessment of inflation
management from the monetary targeting era to the current inflation targeting
framework. Section 4 examines the inflation-output link and attempts to
address the question of whether there might be permanent output and
employment costs to the current disinflation process. Section 5 looks at the
sustainability of the current progress in disinflation, especially with the coming
on-stream of oil production in the country. The last section concludes the paper.
2
This is not the first time single-digit inflation has been achieved in Ghana. Single-digit inflation was achieved in
the past, albeit for brief periods and could not be sustained.
2 The Institute of Economic Affairs
1981 100.4
1982 16.7
1983 142.4
1984 6.0
1985 19.5
1986 33.3
1987 34.2
1988 26.6
1989 30.5
1990 35.9
1991 10.3
1992 13.3
1993 27.7
1994 34.2
1995 70.8
1996 32.7
1997 20.8
1998 15.7
1999 13.8
2000 40.5
2001 21.3
2002 15.2
2003 23.6
2004 11.8
2005 14.8
2006 10.9
2007 12.8
2008 18.1
2009 16.0
AVG 31.5
Source: Ghana Statistical Service
Inflation (Year-on
Year)(%)
3
This is not to say, however, that Ghana's inflation has been entirely a monetary
phenomenon. Other “residual” factors have been recognized in the literature as
emanating from the “real” or “supply” side of the economy. Among these, food
inflation has been cited as contributing to the high aggregate inflation in
Ghana.3 In fact, the real-side effects appear to have been more prominent in the
pre-1983 period. The inflation-monetary growth plot in Chart 2 shows much
higher amplitudes for inflation than for monetary growth for that period,
indicating that inflation was influenced by other important factors beyond
monetary growth. After substantial deregulation of the economy from 1983 in
the context of the Economic Recovery Program (ERP) and the successive
Structural Adjustment Programs (SAPs), cost pressures have become an
important factor in influencing inflation. Among these are pressures emanating
from rising energy and utility prices and exchange rate depreciation. As inflation
became entrenched, expectations also became embedded in wages, exchange
rates, interest rates and the prices of goods and services, further fuelling
inflation.
3
See Kwakye, 1981, and Sowa and Kwakye, 1993, among others.
5
Inflation (Year-on
Year)(%)
6 The Institute of Economic Affairs
increase of GH¢298 million or 26 percent. (See Table 5). In 2010, the stock of
arrears is projected to fall by GH¢110 million or 7.7 percent to GH¢1,319
million, which will still be above the end-2008 level. The reduction in
government expenditure reduced the flow of money into the economy, with
(narrow) money supply growing by a mere 9.4 percent in 2009 compared with
29.7 percent in 2008. Reduced monetary growth meant reduced aggregate
demand growth that contributed to dampen inflation pressures. Given the
dominance of the public sector in the Ghanaian economy in terms of the
resources it commands and the employment it provides, reduction in
government expenditure can greatly affect spending—including spending by
government employees, road contractors, suppliers of government goods and
services, municipalities, statutory funds and subvented organizations. As we
have noted above, reduction in government expenditure reflected in both the
recurrent and capital components, which should have widespread
consequences.
In fact, non-food inflation rose in July and further in August, which could be a
turning point in its recent decline, given the potential impact of higher utility
prices and the advent of the Single-Spine Salary Structure. Pressures on
government spending, including towards clearing domestic arrears, also pose a
risk to inflation going forward.4 If the rise in non-food inflation should persist,
4
In fact, government expenditure is projected to increase by as much as 3.9 percentage points in 2010.
(See Table 4).
8 The Institute of Economic Affairs
we would not be surprised to see the MPC halt or even reverse its recent policy-
easing bias.
As Table 8 and Charts 7a and 7b show, the real PR was negative between June
and August 2009, before turning positive thereafter. The negative or low positive
real PR during June-Oct 2009 would suggest that monetary policy was not
sufficiently tight during that period. Meanwhile, recent MPC communiqués
indicate that the monetary authorities have been “easing policy” from October
2009—consistent with falling inflation—by reducing the PR. Ironically, the fact
that the real PR has been increasing seems to suggest to us rather a process of
13
“policy tightening” in the real sense. Our inference from all this is that, on the
one hand, the monetary authorities did not seem to have had in place a PR that
was sufficiently high in the earlier period when it was needed to stem inflation.
On the other hand, in the latter period, the authorities might have been
tightening policy in a real sense rather than easing it, contrary to the official
pronouncements. The two results appear to suggest some kind of instrument-
goal inconsistencies.
Meanwhile, we know that the authorities' inflation target has been consistently
exceeded, sometimes by wide margins. Because of these shortcomings, some,
including the IMF, would prefer to describe Ghana's IT as “IT-lite” rather than a
“full-fledged IT.” It has indeed been suggested that the authorities intensify their
efforts to improve the critical policy and structural conditions to enhance the
effectiveness of the framework. As the IMF and others have also suggested, it
would probably be best, in the interest of monetary policy credibility, for the
authorities to channel their efforts, in the mean time, towards providing their
best “estimate” of inflation rather than trying to achieve what appears to be an
ever-elusive target. When conditions permit, the inflation estimates could be
transformed into concrete targets. There is some comfort in that the official
inflation target for 2010 might be achieved. But whether this year's success
could be replicated in the succeeding years is the key question, which we
examine in Section 5.
5
See CEPA's Report on the State of the Ghanaian Economy in 2009
15
Whether continued disinflation could have permanent output and employment
costs, however, is uncertain, especially because we seem to have entered a
territory that has not been charted before in our history, i.e. bringing inflation
down so quickly to such low levels. The historical evidence from Ghana's past
would seem to suggest that periods of higher and more unstable inflation, such
as 1979-1990, were associated with lower and more volatile growth than
periods of lower and more stable inflation, such as 1991-2009. As Table 10
shows, the 1979-1990 period experienced average inflation of 46.0 percent with
a standard deviation of 41.5 and average real GDP growth of 1.7 percent with
standard deviation of 4.8 percent. Comparatively, the 1991-2009 period
experienced average inflation of 22.3 percent with a standard deviation of 14.6
percent and average real GDP growth of 4.8 percent with a standard of deviation
of 1.0 percent. Clearly, the more macroeconomically-stable period, 1991-2009,
achieved better growth performance.
The greatest impact on future inflation is likely to emanate from oil production.
In theory, oil production puts upward pressure on prices through the extra
demand generated from the revenue that may not likely be matched by supply of
goods and services because of production and supply constraints. The greatest
source of demand pressure will be spending by government as the principal
beneficiary of the revenue. The conduct of fiscal policy in the oil era will therefore
be critical for the future course of inflation. A more aggressive fiscal policy
geared to delivering an “oil dividend” to the population could put enormous
pressure on prices. Oil revenue would certainly allow domestic output and the
supply of imported goods to be increased, which would help dampen inflation
pressure. Oil production is also likely to result in exchange rate appreciation as
more foreign exchange becomes available to the economy. This would dampen
the impact of import prices on domestic inflation. On the other hand, as
recovery of the world economy takes hold, there is bound to be an uptick in
global inflation, which would affect domestic prices through imports.
Inflation would also be affected by some cost pressures. Utility tariffs are likely
to be increased periodically given the persisting gaps between providers' costs
and tariffs. This would put pressure on inflation.6 Another potential source of
6
Of course, there is considerable room for the utility companies to improve their efficiency and reduce their costs
and thereby ease the perennial pressure on tariffs.
19
6.0 Conclusion
Ghana has been exceptionally prone to high rates of inflation, which could be
attributed to the intractability of the causes, or ineffectiveness of inflation
management, or both. Demand, driven by monetization of fiscal deficits has
been a major cause of inflation in Ghana. Real or supply side factors have also
contributed to Ghana's high rates of inflation, dominated by cyclical food
inflation. Following the extensive deregulation of the economy since 1983, cost
pressures emanating from rising petroleum and utility prices and exchange rate
depreciation have played an increasing role in the inflationary process. As
inflation became entrenched, expectations became embedded in wages,
exchange rates, interest rates, and general prices, further fuelling inflation. We
believe that the two critical requirements for sustaining low inflation in Ghana
are to purge the economy of “fiscal dominance” and increase production of food
and ensure its availability all year round.
Prior to 2007, monetary policy was conducted under a monetary targeting
framework, whereby money supply was used as an intermediate path to
targeting inflation. In the face of large-scale deficit financing, monetary policy
was ineffective in achieving the inflation targets. Monetary policy was further
20 The Institute of Economic Affairs
rendered more ineffective by the weakening of the link between money supply
and inflation with financial and other structural changes in the economy. In
2007, the Bank of Ghana (BoG) adopted an IT framework that involves targeting
inflation directly without using a monetary aggregate as an intermediate
variable. To be effective however, it requires certain structural and policy
conditions, including a sufficiently developed financial system, central bank
autonomy, fiscal discipline and a flexible exchange rate regime. Further, there
should be adequate and reliable data and a robust and comprehensive
forecasting model. Ghana would appear to fall short in all these critical
requirements. It is no wonder therefore that the BoG has continually missed its
inflation targets, often by very wide margins. In that case, it is probably right to
describe Ghana's IT as “IT-lite” rather than a full-fledged IT. In the meantime,
the BoG's efforts could be channeled into providing its best forecast of inflation
rather than aiming to achieve an ever-elusive point- or range-target, until
conditions permit migration to a full-fledged IT.
In the past year, inflation has fallen consistently, reaching the oft-elusive single
digit level since June 2010. In 2009, government expenditure declined in the
effort to reduce the fiscal deficit that reached a record high in 2008. At the same
time, the economy significantly slowed down and, while this occurred amid a
slowdown of the global economy, some people have attributed it to the apparent
fiscal austerity and too rapid disinflation. This school of thought has argued
that there have been costly output and employment losses as a result of the
economic retrenchment policies. The authorities have, however, rejected this
assertion, arguing that government expenditure has been on course and that
there has not been any attempt to “orchestrate” disinflation through fiscal
retrenchment. Higher and more unstable inflation led to lower and more
unstable growth in Ghana during 1979-90, whereas lower and more stable
inflation led to higher and more stable growth during 1991-2009. This evidence
seems to support the view that low and stable inflation is more beneficial to
economic growth at least in the long run. Low single-digit inflation is being
targeted over the medium-term horizon. The expected boost in government
expenditure and in private demand from oil revenue and the Single Spine Salary
Structure respectively—will put pressure on inflation. If the low single-digit
inflation targets are to be achieved, monetary policy will have to be extremely
tight—including through high interest rate and currency appreciation—which
could dampen the projected higher growth.
The course of future inflation will be influenced by several factors, but the
greatest impact will come from oil production. Oil revenue will generate strong
demand for goods and services that is unlikely to be matched by supply because
of production and supply constraints and lags, which will fuel inflation. On the
other hand, oil revenue is likely to strengthen the exchange rate, which will
dampen the impact of import prices on domestic prices. The Single Spine Salary
Structure will exert both demand and cost pressures on inflation by
respectively boosting employees' incomes and increasing employers' costs.
Utility tariffs are likely to go up periodically, given persisting gaps between
21
providers' costs and tariffs, and this will exert pressure on inflation. Food prices
will continue to be an important factor in the course of future inflation, given
prevailing bottlenecks in production, storage, and marketing that are unlikely to
be overcome anytime soon.7
7
Recent food supply trends have been very encouraging and have been a key driver of declining inflation. Should
this trend be sustained, and should food prices decline substantially, the impact on inflation could be phenomenal.
22 The Institute of Economic Affairs
References
Ahmad, N., 1970, Deficit Financing, Inflation, and Capital Formation: The
Ghanaian Experience, 1960-65, Munic Welferun Verlag.
Argy, V., 1970, “Structural Inflation in Developing Countries,” Oxford
Economic Papers, Vol. 22, No.1.
Cagan, P., “The Monetary Dynamics of Hyperinflations,” Studies in the
Quantity Theory of Money, (ed.) M. Friedman, University of Chicago Press.
Ewusi, K., 1977 (Dec.), The Determinants of Price Fluctuations in Ghana,
ISSER Discussion Paper, University of Ghana, Legon.
Heberger, A.C., 1963, “The Dynamics of Inflation in Chile,” Measurements in
Economics, (ed.) C.F. Christ, Stanford University Press.
Kwakye, J. K., 1999, “The Macroeconomics of Rapid and Sustainable Growth,”
ISSER Millennium Seminar Series.
Kwakye, J. K., 1999, “Some Perspectives on Macroeconomic Developments in
Ghana in the Nineties,” mimeo, Research Department, Bank of Ghana.
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MSc Thesis, University of Ghana.
Lewis, W.A., 1955, The Theory of Economic Growth, Allen and Unwin, London.
Sowa, N. K., and J. K. Kwakye, 1993, Inflationary Trends and Control in Ghana,
African Economic Research Consortium (AERC) Research Paper 22, Nairobi,
Kenya.
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