Pent up inflation pressures are now letting loose

THE ORACLE

“We all know that inflation is an evil thing, but when it runs its course unplanned it brings certain natural correctives. Today, these correctives have not been allowed to come into play, and the result is most unhealthy. The making of large paper profits, which is a natural concomitant of inflation, enabled industry to maintain its real capital intact; the restriction of money profit at a time of rising prices is denuding industry, not of real profits, but of real capital.”

The above quote is credited to Paul Chambers, formerly a senior official of the British Inland Revenue and at the time a leading member of the Conservative Party which was at the time, in opposition in the British Parliament. When he stated the above wisdom, the context at the time, was that the British Government, which then was a Labour Party Government, had placed a heavy reliance on price controls, which were being instituted to tame the rising tide of inflation and against a background policy of very low interest rates, which were being directed downwards in an effort to stimulate the expansion of credit to industry. This scenario, which is all too familiar in the Zimbabwean economy today, has dire consequences for both industry as well as the general health of the economy.

In recent months, we have seen very nuanced efforts by the Government to control prices of essential goods as well as the price of credit (interest rates). We have also see efforts to influence prices of various services. None of these efforts can be effectively as allocative tools in the normal process of resource allocation. Eventually, all strategies only serve to build up pressures in the economy that will eventually be unleashed as a resurgence of inflation.

This is exactly what is happening in the Zimbabwean economy today. The effects of price caps, especially on money (credit and exchange rates) are beginning to slowly bring the economy to a boil. These pent up pressures are beginning to push through and immediate policy action will be required to bring the train back on the rails.

Zimstat has just released inflation statistics for the month of July 2018. The year on year inflation rate (annual percentage change) for the month of July 2018 as measured by the all items Consumer Price Index (CPI) stood at 4.29 percent, having gained 1.38 percentage points over the June 2018 rate of 2.91 percent. Simply put, consumer prices as measured by the all items CPI, increased by 4.29 percent, on average, during the twelve-month period from July 2017 to July 2018. A 1.38 percent jump in inflation is not a small one, and serves to confirm that indeed, the coiled spring is about to loosen. We must in fact brace for more inflation in the coming months.

Food and Non-Alcoholic beverages inflation, which is usually prone to transitory shocks, drove the figures up. Food inflation was recorded at 6.35 percent, whilst the Non-food inflation rate, normally referred to as “core inflation”, was measured 3.33 percent for July 2018.

Concomitantly, the month on month inflation rate in July 2018 was 0.98 percent gaining 1.03 percentage points on the June 2018 rate of -0.05 percent.

This means that prices as measured by the all items CPI increased by an average rate of 0.98 percent from June 2018 to July 2018.

The month on month Food and Non-Alcoholic Beverages inflation rate stood at 0.74 percent in July 2018, gaining 0.97 percentage points on the June 2018 rate of -0.23 percent. The month on month non-food inflation rate stood at 1.09 percent, gaining 1.05 percentage points on the June 2018 rate of 0.04 percent.

This is all happening in an environment of very low interest rates. The concerns for Economists like me, should be that, whilst cheap money may in the short term, reduce the cost of debts service for firms and households, the current environment where interest rates are capped and there is a very high marginal income tax rate, two things usually happen. Currently there is no incentive to save money at all by both corporates and households.

Like Chambers, I am therefore inclined to argue that oftentimes interventions by the Government in the financial markets can be occasionally more harmful than they are useful. Understandably, it is the Government’s place to worry about the welfare of the people and from that angle, the authorities have always had a legitimate interest in seeing that basic goods and services not only remain available in the market, but also remain affordable. It is however time to reflect and perhaps adopt a more aggressive policy stance that will reign in inflation.

The pent-up inflation pressures in the economy are a direct result of the rapid expansion of the money supply which all of us agree can be traced back to the beginning of 2014. Since that time Money supply growth measured on a monthly basis or annual basis has consistently outpaced growth in GDP.

In simple terms if we assume that GDP growth is a proxy for productivity growth in each year, when one compares annual money supply growth to GDP growth there must be a relationship. However, when money supply begins to expand much faster than GDP growth we are bound to have inflation in the economy.

There is now too much money chasing too few goods. The question then is, should government panic over recent price increases. My honest gut feel answer in NO. There is absolutely no need for government to fret over the recent price increases for a number of reasons.

One of the main reasons is that the Zimbabwe economy has now come out of a three year deflation spiral which was borne out of cautious spending by consumers which resulted in depressed demand and low capacity utilization. Local producers were squeezed for margin and many companies were not profitable. The expansion in nominal money balances in the economy has triggered the demand for both local products and imported substitutes. This in turn has resulted in increased demand for foreign exchange which unfortunately is mostly available on the unofficial market at hefty premiums. It is the foreign exchange premiums that are fuelling price hikes as resellers of goods try to price their stocks at anticipated future replacement values rather than current replacement value. In other words, retailers are charging prices of the goods that are on the shelf based on the cost patterns that they anticipate will be prevailing when they have to replace the stocks in future, and not on historical costs. So the economy is pricing in inflation expectations and this is what has caused the recent rapid rises in prices.

The reason government needs not panic is therefore very simple, such pricing models are hardly sustainable for a long time. Sooner than later, consumer resistance on its own will force a correction of the prices. This is exactly what happened in 2009 after adoption of the multi-currency basket. There was a short-term spike in prices but competition and consumer resistance kicked in and what followed was a very long period of sustained price stability. In fact, for the better part of three years, some prices were falling and consumers were singing Ebenezer.

Secondly when government allows panic to set in, as is now happening, the authorities are normally tempted to react in an unstructured and haphazard manner. These haphazard reactions can cause further market distortions, hindering normal self-correction mechanism in the market. The result is that the market will over react to government intrusion, supply chains are disrupted and shortages result, leading to even higher prices. Whilst there is no singular answer, my recommendation would be for Government to allow markets to establish their own equilibrium, and only step in when serious welfare issues or market failures are to be addressed.

Thirdly, any Government interventions in the commercial space fly directly in the face of its stated objective of creating a liberalized environment, which is conducive for commerce. The Open for Business mantra seems to suggest that the economy will increasingly be market driven.

I am not at all advocating for Government to allow the blatant abuse of consumers by the business sector, but I am saying, there is no investor locally and abroad, who will want to pour in money into an environment where there is micromanagement of the business sector by the state. If the new economic order is sincerely intended, then Government’s role must be restricted to managing the macroeconomic policy space. In this regard, I posit that Government does not need to be setting up committees to investigate the micro dynamics in the various value chains. What the state should instead be doing now is to address the macro-economic disturbances that have caused upsets at the micro level.

 

The writer is an economist and can be reached on oraclefiles@ gmail.com.

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