1. Introduction: In discussing economic issues it is a prerequisite to have common understanding of economic jargons. So, we begin with definitions. Inflation is a general rise of prices of goods and factors of production. Factors of production are land, labor, capital and management used in the production of goods and services. Deflation is a fall in most prices and costs. Deflation has also a secondary meaning of a drop in real output and an increase in unemployment regardless of price behavior.
In both cases, all prices do not move in the same direction or in exactly the same proportion. As a result of changes in prices and in total spending, both inflation and deflation cause changes in the distribution of income and total output. Unforeseen inflation has a tendency to favor debtors and profit makers at the expense of creditors and fixed income earners. In other words, lenders and wage earners are the losers. Those who invest in real estate or in common stocks make profit during unforeseen inflation. Prices rise between the time a businessman buys and sells his goods. Fixed or overhead costs remain the same, other cost rise, but not as rapidly as prices.
As a result of all these profit increases. In time of deflation these situations change. Creditors and fixed income earners gain at the expense of debtors and profit makers. Between the time that a businessman buys and sells goods, he is condemned to take a loss. A wage earner who keeps his job and whose pay is not reduced will find that his real wage has increased. At the same time the government finds that the burden of its public debt goes up relative to tax collection and national income. A hoarder finds the real value of his wealth increasing every time as prices fall. An employer who gives someone a job finds that he cannot cover his expenses leave alone making profit. All these imply redistribution of income from one economic actor to another. Redistribution of income due to inflation is observed through time.
Money put aside during young age results in low purchasing power at old age. Thus, income is affected with time. Apart from redistribution of income, inflation affects the total real income and production of a country. Historically, “an increase in price is usually associated with high employment. During inflation industrial output is near capacity. Private investment is hurried, and job is plentiful.” Do not forget this is taking place in the private sector. When comparing little deflation and little inflation, both employers and workers talk of the latter as a lesser of the two evils. The losses to the fixed income groups or investors are less than the gain to the whole community.
Even fixed-wage earners are better off because of improved employment opportunities and greater wage bill. A rise in interest rates on new securities makes up for the losses to creditors. Increases in social security benefits partly make up for the losses to the retired persons. In the case of deflation, on the other hand, the growing unemployment of labor and capital reduces the benefits to the community. In deep deflation almost everyone suffers. The creditor is left with uncollectible debts. From the above discussions, we understand that investment spending is useful in times of unemployment even if there is inflation.
When the economy suffers from depression, private and public spending might be helpful as it increases production and create jobs. But, once full employment and full capacity have reached, any increase in spending is wasteful in high prices. 2. Types and Experiences with Inflation: There are various types of inflation that are caused by different economic situations. We will try to see some of them as follows: • Galloping inflation: when each increase in price becomes the signal for an increase in wages and costs, which sends prices still further, we say we are in the middle of galloping inflation or hyperinflation. Nothing good comes out of it. Production and even the social order are then disorganized.
The total wealth of the population is wiped out as money becomes worthless. Debtors chase creditors to pay off their debts in worthless money. Speculators take advantage of the situation. Consumers rush to spend their paychecks before prices rise still further. In the process price rises further. Everything is scarce, but money is in large supply. Production is disorganized and prices are erratic. Business is in a halt because they don’t know how much to charge. Consequently, everybody tends to hoard goods and avoid money. There could be a partial return to barter, exchanging goods for goods, wheat for barley. The primary fear today is of a steady rise in prices. Such a development could be unavoidable. The rise in price could be fast and steady. • Cost-push Inflation: This is known as sellers’ inflation. Generally, wholesale prices, farm prices and cost-of-living prices are rising. Prices rise due to wage-push or demandpull.
Normally, money wages are raised almost every year, usually by more than labor productivity. Trade unions enforce the rise in wages by means of “threat of strikes.” Wage-push also takes place where labor is un-unionized. As employers grant the wage increases, it sends up the cost of production. This sends up the prices firms charge for their goods and services. This causes new inflation. Apart from wage-push, rise in input price, steel price or fertilizer price, is also responsible for the increase in wholesale price index. Profit margins contribute to increase in price. Thus, both labor and non-labor factors inputs become responsible for a rise in price.
• D e m a n d – p u l l inflation: This is caused by a rise in total spending. With spending more money comes into the market. When spending is in excess of goods supplied then price goes up. Spending originates from consumption, investment and government. Consumers spend their money to meet their needs for goods and services. Investors buy inputs they need for production. Government spends its budget to meet the needs of the public. In all cases, demand pulls up prices. When spending is not off-set by tight budget, it leads to price inflation, causing demand for wage increase.
Both aggravate the rise in the “general price” level. This situation throws macromanagers into a complex situation that stretches in-between demand-pull and cost-push. This situation does not enable them to do anything about the rate of inflation. We realize that wage is down-ward rigid, potentially difficult to decrease On the other hand, the excess in purchasing power results in price increases. The impression that government expenditure is irreducible fans inflation. Tax and government expenditure policy, known as fiscal policy, has impact on income. Government expenditures act like consumption and investment thereby determining income.
This policy may have an impact on inflationary levels. Change in tax affects taxpayers’ income; a rise in tax, for example, reduces their income. As income reduces, demand for goods and services declines, lowering demand-pull inflation. Monetary policy has also inflationary impacts. This policy can help to choke of investment spending and capital formation by making credit tight and very dear. Alternately, expansive monetary policy can stimulate capital formation by making credit easy and available with low interest rates. Both fiscal and monetary policies, therefore, have effect on inflation either through increasing or depressing demand.
• Deflationary gap: When investment opportunities rise, then national income increases. The reverse is also true. If net investment drops to zero, it leads to unemployment. Income will fall to a point where the community finds it hard to make a saving. Unless saving is used for investment, a country cannot create the required employment. If faces a “deflationary gap” which is measured by the deficiency of investment.
3. The Inflationary Situation in Ethiopia: 3.1 The situation: No country is immune from inflation. The alternative to it is deflation, which is worse. The question is how to manage inflation within limits that do not affect investors, consumers and government. Normally, the National Bank, which should be accountable to the Parliament, is responsible for handling the monetary situations of a country. It uses interest rate as instrument of promoting investment that creates output and employment. The bank is also a lender to the government by just printing only the amount required by the borrower. The rate of growth of money supply should be closely related to the growth of gross domestic production (GDP) in order to avoid hyperinflation.
In other words, money supplied should be somehow related to growth of output. Where there is a shortage of output, money supplied by the National Bank causes excess demand over supply. This leads to inflation. This becomes the economics not of efficiency but of attrition. The losers are the defenseless fixed income earners and pensioners. The annual inflation rate is reported to have risen to 12.9 percent in April, 2019 from the 11.2 percent in the previous month (source: https://tradingeconomics. com). Prices increased faster for food (14.5 percent) and for non-alcoholic beverages (11.4 percent).
It is reported that the rise in these prices is attributable to the Easter holiday season. Consumer price index (CPI) for housing utilities rose to 135.9 percent from 134.2 percent; for transportation it rose to 131.5 percent from 129.8 percent the previous month. 3.2 Measures to take: First, take measures to bring inflation within a reasonable limit. This requires an investigation into the imbalance between supply of and demand for goods in each sector of the economy, particularly, in the productive sectors of agriculture and manufacturing. Both agriculture and manufacturing firms should be stimulated with government policies.
But, these policies should be preceded by relevant and deep studies of problems of supply in these sectors, including problems of inputs. Second, the Ethiopian people suffer mostly from shortages of basic goods. These shortages indicate supply-side problems. Supply is generally affected by deficiencies in the management of inputs. These inputs include: land, labor, capital and management skills. If these inputs are managed properly, supply of goods to the market would help satisfy the needs of people.
Efficient utilization of these factors is a precondition if supply is to meet demand. Land should be available to and owned by the tiller for efficient production of agricultural output. Land-use plan is of the utmost importance that contributes to the productivity of farmers. Labor mobility in any part of the country should be ensured for availing skilled labor for the economic sectors that require it most. However, labor has two sides: supply side and demand side. Labor supply is determined by population growth rate, which, in turn, is influenced by birth rate and death rate.
Its skill is determined by the quality of education. Demand for labor, in short, is related to the right type of skill required by the economy. Free mobility of capital, like labor, is also important for economic development. Investors have to move freely to identify and invest in sectors that meet their interests better. Credit should be available to these investors by the development bank, provided that they deliver well-studied projects, for follow-up and monitoring of project implementation by the creditor.
The free application of these factors of production contributes greatly to raising output both for domestic market and for external market. Third, the other measure to take is demand management. On the demand side we have consumers, investors and the government (C+I+G). Consumers need goods for consumption; investors need producers’ goods (such as machineries) and the government requires goods and services for meeting its responsibilities (such as maintaining peace, provision of basic services, etc.).
Consumers, investors and government would be forced to curb their demand if it is an exaggerated one, beyond the country’s potential to meet it. Consumers, for example, should be forced to curb conspicuous or noticeable consumption that is not necessary for a living. Similarly, investors and government should control unnecessary expenditures. Such measures could adjust demand to a realistic level. From the above explanation, both realistic demand for and supply of goods could help control inflation. However, we should be careful that excessive control of inflation may not lead to the other extreme, deflation, which depresses the economy.
The effective design and implementation of fiscal and monetary policies are of the essence for managing inflation and deflation. On the fiscal side, the Ministry of Finance and the Planning Commission should join their heads together to design a fiscal policy and a program for its implementation. The National Bank should play its role, designing proper and relevant monetary policy and program for its implementation. Are they ready to do that?
The Ethiopian Herald Sunday Edition May 26/2019
By Getachew Minas
