Key Points
- Controversies surrounding inflation
- Inflation, public borrowing, and national debt
- Inflation, wages, and employment (unemployment)
It is also known for hypothesising abstract economic theories and the underlying conceptual frameworks of the complex world. A good example is the notion of “full or near-full employment”. This theoretical scenario cannot be achieved in the real world due to internal dynamics and random shocks. In theory, full employment occurs when total expenditures in an economy are equal to total national income and when total savings are similar to total planned investments.
Such an equilibrium can be achieved locally, but it is more daunting to attain at the economy-wide level or on a global scale. Full employment also means that all scarce resources, mainly labour and capital, are fully employed when prices and wages are harmoniously stable. In such situations, the economy can be said to be in equilibrium. The assumption is that the saving-consumption ratio of households, the volume of investment and total government spending determine the equilibrium output level or the gross national product (GDP).
However, a single shock, such as a rise in general prices, can disrupt an equilibrium, even if it were to be achieved for a short period. For instance, an increase in prices of all or most consumer items can cause a gap between total expenditure and national income, known as an “inflationary gap”. The desired objective is not to achieve a zero-inflation rate permanently.
On the contrary, a manageable level of the inflationary gap can benefit the economy if there are sound policies and instruments to put adequate checks and balances in place to contain further price rises. Moderate inflation or a manageable level of the inflationary gap is more desirable to an economy as it can incentivise producers to boost supplies. This notwithstanding, the inflationary gap that potentially leads to higher prices must be reduced or eliminated.
This can be done through monetary and fiscal policy instruments such as taxation, interest rate management, and a reduction in government expenditure to maintain the economy's equilibrium. However, this is not straightforward or automatic, and policy instruments may not be able to reduce the inflationary gap or curb inflation, particularly in developing countries that face a series of structural challenges.
The main objectives of this article are two-fold:
(a) to articulate the concept of inflation and its underlying causes in a way that non-economists can understand, and
(b) to provoke an informed and evidence-based discussion on the subject while offering insights as to what can be done to curb inflation in Ethiopia and other countries of sub-Saharan Africa (SSA).
Using the Consumer Price Index (CPI) and the average growth rates in general prices, the article compares inflation in Ethiopia with the average of sub-Saharan Africa, Africa, and the developing world. It also provides a data-driven and evidence-based comparison of the devaluation of the Ethiopian Birr vis-à-vis the US Dollar about the Ethiopian Consumer Price Index.
The article proposes policy measures and institutional mechanisms to deal with inflation decisively. These include fostering economy-wide productive capacities to boost the supply of goods and services to exact higher demand while generating long-term inclusive growth.
Productive capacities are essential for economic growth and export diversification, including value addition and removing supply-side distortionary trade barriers. Additional policy proposals include fighting corruption, improving governance, and building peace and social cohesion to ensure political stability.
The article calls for establishing independent institutional arrangements, such as central banks, effective policy instruments, including inflation-targeting frameworks, transparency in monetary and fiscal policies, managing market expectations and improving market information systems.
These recommendations aim to keep moderate inflation alongside financial stability, sustainable economic growth, higher employment levels, and substantial poverty reduction.
The aim is also to explore ways and means of protecting the poor and more vulnerable sections of society who are the direct victims of price rises. Low-wage earners and populations with fixed incomes, such as pensioners, are among the casualties of high inflation who need social protection through safety nets.
What is inflation, and what are its plausible causes?
In simple, non-technical terms, inflation is a consistent and prolonged general price increase for a basket of goods and services households consume or use daily. Such an increase in consumer goods and services prices also reduces the purchasing power of households' income and the value of the local currency.
This means that a temporal or periodic roller-coaster price rise of a few goods and services with little or no impact on the purchasing power of societies does not qualify as inflation. Inflation also means consumers will pay more for the same quality and quantity of goods and services than in pre-inflationary periods. With inflation, food, school supplies for children, fuel, shelters (rentals), electricity, transportation, clothing, footwear, and medicines will become more expensive than they used to be.
Households with low and constant income will forgo some of the goods and services they used to afford in more down or inflation-free times. As discussed in detail in this article, high inflation makes an economy anemic by heightening systemic risks, uncertainties, and structural vulnerability. Not only does it affect current socioeconomic performance, but it also erodes past gains and undermines future growth and the development prospects of developing countries. If not contained, high inflation may also entrain social unrest, corruption and political instability, frustrating efforts to foster political consensus and nation-building.
Inflation is transmitted across sectors, societies, and the real economy through diverse channels and mechanisms. It weakens the purchasing power of the local currency, erodes investor confidence, undermines savings and investments, and leads to persistent budget and trade deficits and heavy indebtedness. Depending on the speed and magnitude, inflation adversely impacts the purchasing power of the local currency, diminishing the ability of households to pay for goods and services with their income, compromising their overall economic well-being.
Based on underlying causes, inflation can be grouped into three broad categories:
The first is demand-pull inflation, which is caused by excess aggregate demand for goods and services over aggregate supply in the economy. Excessive aggregate demand over aggregate supply can be caused by scarcity of production (supply shocks), increases in consumers' expendable income, increases in domestically consumable goods' exports, hoarding due to population growth or the combination of these. It can also occur because of the availability of easy credit, increase in government expenditures and indirect taxes, availability of excess money supply in an economy, continuously growing budget deficits or expansionary monetary policies, etc.
The second type of inflation is cost-push inflation, which occurs due to an increase in the cost of production of goods and services. A sudden rise in intermediate goods used in producing goods and services such as energy (an increase in oil prices or the prices of electricity), wages, and taxation can trigger inflationary pressure in an economy by pushing up the cost of production of goods and services. Similarly, uncontrollable price increases in farm inputs such as fertilisers, variety seeds or pesticides can also trigger food inflation.
The third type of inflation by causative factors is structural or bottleneck inflation. This type of inflation is caused by deep-rooted structural rigidity in an economy, such as poor infrastructure, supply chain disruption, market imperfection, institutional bottlenecks, and lousy policy formulation and implementation. In structurally weak and vulnerable economies such as Ethiopia and others in sub-Saharan Africa (SSA), the three types of inflation can coexist in parallel or in combination. Identifying and understanding the kind of inflation in an economy is critically important to formulate and implement appropriate mitigating policies and strategies. Inflation is the cause and effect of aggregate demand and supply asymmetry combined with expectations and random (unexpected) shocks.
However, monetarists and Keynesian economists argue that the sole cause of persistently high inflation is the oversupply of money in an economy. According to them, the cure is to reduce the money supply in an economy, even if this leads to “degrowth” or deceleration in economic growth.
In other words, the sole cause of inflation is the government’s monetary and fiscal policies, so the remedies should come from them. Historical and empirical evidence show that unforeseen shocks (economic, financial, climate change or health-related) can disturb the equilibrium aggregate demand and supply. For instance, since the COVID-19 pandemic, the global economy has been reeling from socioeconomic turbulence and tribulations, including temporal general price rises. Massive injections of monetary and fiscal stimulus packages, lavish incentives, and direct cash transfers in significant economies during the COVID-19 pandemic contributed to skyrocketing aggregate demand over aggregate supply, causing high inflation nationally and globally.
Adding fuel to the fire, the war in Ukraine has exacerbated high inflation and the resulting economic challenges for households, individuals, and economies. The current conflict in the Middle East may further exacerbate inflation by disrupting oil exports from the region. This may heighten global risks, uncertainties, and socioeconomic difficulties if an end is not put as urgently as possible. Overall, the cascading crises, random shocks and resulting headwinds weigh heavily on the global economy. More so on the growth and development prospects of developing countries, with devastating consequences for people with low incomes, the weak and marginalised sections of societies.
Experience shows that monetary and fiscal policies may not be the most effective for taming inflation. Despite efforts to curb inflation globally, economies worldwide are having a tough time doing so. This also compounds efforts to revitalise economic growth while at the same time maintaining macroeconomic stability. For economies of SSA, high inflation may further deepen and entrench the region's structural financial problems. Falling international commodity prices, external debt overhang, growing trade deficits, and declining agricultural production and productivity, combined with demographic trends, may further complicate the subregion's economic viability, revival, and overall socioeconomic progress.
In Ethiopia, for example, a combination of a protracted civil war, the devastating impact of climate change, particularly on its underdeveloped agriculture sector, excessive money supply in the economy, mounting external debt burden, and galloping inflation have caused severe socioeconomic imbalances, making it difficult to imagine how the country could emerge from this predicament. Under such multi-faceted socioeconomic, political, and environmental distress, it isn't easy to contemplate the Ethiopian economy's long-term growth and transformation prospects. As shown in the figures below, inflation in Ethiopia has been consistently higher than the average for sub-Saharan Africa and Africa and much higher than that of other developing economies.
As with the underlying causes, the typology of inflation can also vary depending on the speed and evolution of price rises in an economy. Creeping inflation (also called crawling, slow-moving or mild inflation) occurs in an economy for a more extended period without being perceived by consumers or households as worrying. This type of inflation (usually in lower single digits) is not dangerous to an economy. Economists regard such inflation as an incentive to producers. This is because mild inflation encourages entrepreneurs and producers to increase output to exact growing demand with sustained and long-term gains or profits.
Moderate inflation is also vital for expanding employment opportunities without increasing wages per worker or output. When the price rise reaches the upper single digits (7%-9%), crawling inflation becomes walking or trolling inflation. Walking or digging inflation, although still manageable, is a warning sign for policymakers to revisit their monetary and fiscal policies to curb further rises in general prices. If no action is taken to tame walking inflation, it leads to running inflation, usually above 10 % but lower than 20%. Still, monetary and fiscal authorities have ample room for maneuvering and curbing walking inflation without austerity measures or before it inflicts significant costs on the economy and society.
When inflation rates reach double digits (between 20% and 50%) per year, galloping inflation is considered very high. This type of inflation has reached a level that cannot be reduced or tamed without belt-tightening or austerity measures, often at a very high cost to the economy and society. The most worrying type of inflation is known as hyperinflation, which accelerates in speed (more than 50% a year) and has an extensive range and magnitude of increase, observed in a concise period. During hyperinflation, prices of consumer items can double or triple overnight or in a single day, with the value of local currency fast collapsing.
After World War II, Hungary saw one of the worst phenomena of hyperinflation, with prices doubling every 15 hours. In recent years (2007-2008), from SSA, Zimbabwe was a classic case for hyperinflation, with prices doubling daily.
In 2023, Venezuela was an exception in registering an estimated increase in consumer prices at 360 per cent, according to the latest figures from the International Monetary Fund. In all cases, hyperinflation led to acute shortages of consumer items, including food and medicine, with prices skyrocketing, the value of local currency quickly collapsing, and grim overall socioeconomic circumstances.
Ethiopia and other countries of SSA that have already registered or are approaching galloping inflation must undertake drastic, coordinated, and robust policy measures to avoid getting into hyperinflation. It is important to note that the inflation types mentioned above are not sequential occurrences or phenomena. Any inflation can be observed in an economy depending on the main drivers, accelerators, and vital causative factors. That is to say that galloping or hyperinflation can occur without an economy necessarily passing through crawling, walking, or running inflation.
Controversies surrounding inflation
The concept of inflation or inflationary gap is as old as the study of economics. It is one of the subject matters where governments, academics, and financial institutions collate and compile data regularly and systematically. Likewise, there is overwhelming historical and empirical evidence on the bad, worse and ugly face of inflation.
The causes and consequences of inflation are among the most extensively researched, debated, and widely published subject matters in economics, development economics, finance, political economy, and business decision-making processes. As it is directly linked to a business cycle or industrial fluctuation, inflation is a carefully watched and seriously followed matter in the theory and practice of business cycle and entrepreneurship.
As in the past, debates on inflation are raging again across nations, political establishments, economists, central bankers, and monetary and fiscal policy experts (and practitioners). They are within trade, finance, or development-oriented regional and global institutions. The US Senate adopted the Inflation Reduction Act 2023 at the national level. Political establishments and parties in many other countries or developing countries have also been extensively debating how to curb inflationary pressure on economies and societies (often along political lines of arguments).
Some countries use export controls or bans on domestically consumed foodstuffs to minimise the negative impact of price increases on their citizens and the purchasing power of local currencies. The July 2023 meeting of ministers of finance and central bank governors of the G-20 held in Gandhinagar, Gujarat (India), was devoted to, among other things, how to address best inflationary pressure and fragmented global demand and supply challenges while maintaining stable microeconomic and macroeconomic policy environments.
The extent and the frequency of debates show the seriousness of the matter and the determination of policymakers to get rid of inflationary pressure in their economies. High inflation puts economies and societies at severe risk and creates heightened uncertainties, with people with low incomes and the vulnerable bearing adverse consequences.
Despite all the efforts and growing consensus on its adverse socioeconomic consequences, inflation remains conceptually messy and analytically controversial. There is no common understanding about its causes, transmission mechanisms, socioeconomic impact, what it does to the economy or how to contain it. Researchers and policy experts often clash on the causes and consequences of inflation and its precise transmission mechanisms. Debates are inconclusive, and reaching agreements on how high prices should be allowed to rise and how long they should keep increasing remains elusive.
Moreover, there is no conclusive evidence on the causal relationship between inflation and economic growth, although higher inflation is believed to be anemic to economic growth. Nor is there a shared understanding of what level of inflation is good and bad for the economy and societies. Questions about why inflation is inconsistent or variable over time, particularly at double-digit levels, are still controversial.
Worst of all, inflation is the most confusing, unfathomable, and conceptually tricky subject for political elites to grasp its causes, consequences, and potential remedies fully. Yet, political elites in developed and developing nations misuse inflation to advance their political interests, often by inflating their economic scorecards.
How is inflation measured?
Measuring inflation involves complex statistical, mathematical, and econometric algorithms. It also combines the skills of economists, data scientists, statisticians, and the latest software or programming specialists. In developed economies, multiple indices such as the producer price index (PPI), the urban consumer price index (U-CPI), the wage-earners consumer price index (W-CPI), the personal consumption expenditure index (PCEI) and the Gross Domestic Product Index (GDPI) are used to measure inflation.
However, most developing countries use regionally disaggregated national consumer price index (CPI). In several other countries, urban or city-focused consumer price indexes are used to measure average changes in the prices of consumer items between two reference periods. Since most countries of SSA use CPIs, the focus here will be confined to this index.
CPIs have long been in use (since the 1870s). However, the indices have significantly changed or evolved in the methodological rigour of measurement, the objectives and purposes for which the index is used, and the extent of goods and services measured by the index. CPIs use data from household surveys to estimate the price changes for consumer items used by most households, such as food, clothing, shelter (rentals), medical services and supplies, etc., yielding a weighted price average using arithmetic or geometric mean. Therefore, CPIs measure price changes in the consumption sector of the economy, and they do not measure investment or production aspects. For instance, such indices exclude investments in stocks, bonds, real estate, and business-oriented services.
Regarding methodology, CPIs go through different computational iterations and statistical processes, ranging from sampling surveys, data collection (and organisation), normalisation, weighting, standardisation, and aggregation. It is important to emphasise that CPIs are not perfect for price movements. Still, they are the best tools to gauge consumer price trends for public and monetary policy-making. However, the CPIs are not cost-of-living indices. Nor do they measure relative living costs, as they do not show price changes in two different geographical locations or cities within the same country during measurement periods.
Moreover, in the survey samples, CPIs only offer goods and services consumed or used for day-to-day living, leaving prices of many other consumer items excluded or unmeasured. The CPIs also suffer from sampling errors, and their accuracy largely depends on the verity and honesty of responses given by consumers or households.
Besides measuring price movements, CPIs are used for different purposes, particularly in developed economies. These include indexation of wages, pension income, and social security concerning consumer price movements. It is also used to index interest rates from investments and rental payments and deflate household consumption expenditures, national accounts or purchasing power parities.
As discussed earlier in the article, in sub–Saharan Africa, an essential contributor to consumer price rises in recent years is food inflation, given that the region has historically faced shortages of production due to several factors. These include weak economy-wide productive capacities and the low productivity of agriculture, poor land policies that limit access to women and other vulnerable sections of society, climate change impacts and the combination of other supply-and-demand-side constraints.
The rising cost of energy (electricity) and fuel in several countries of SSA also contributes to the rise in consumer price indices, undermining agricultural and manufacturing value added to GDP and making transportation unaffordable, particularly to people experiencing poverty. For many countries of SSA, agriculture is the dominant sector in employment generation, ensuring food security, generating export earnings and its share in GDP.
However, the value of addition from agriculture has declined over the last several decades. For instance, in Zambia, more than 66 per cent of the population earns its livelihood from agriculture, but the GDP share of agriculture remains low at around 3 per cent.
Figure 1: Movements of Consumer Price Indices (CPIs) in selected economies: Ethiopia, SSA, Africa and Other Developing Countries (ODCs)
The global average inflation rate reached 8.7 per cent in 2022. This is short of the double-digit post-war inflation rate of 11 % experienced in the 1950s and, subsequently, in 1974. The current average rate of price increase is far higher than the 2 per cent rate generally considered acceptable in developed economies (7 per cent in developing countries) as key for maintaining a higher economic growth rate with maximum employment and price stability.
African countries, particularly those in the sub-Saharan region, are not immune to recent price increases. Instead, they are direct victims or casualties. As can be seen from Figure 2, the average growth rate of inflation in sub-Saharan Africa has declined from the peak of 37.4 per cent in 2000 to a mere 6.3 per cent in 2014 - the lowest level recorded in decades. However, since 2016, it has been running at a double-digit rate. That is, from nearly 12 per cent in 2016 to 15.8 per cent in 2022.
The corresponding levels for the African region were 11.19 per cent and 17.5 per cent in 2016 and 2022, respectively. Likewise, the average consumer price indices (CPI) for SSA increased from a score of about 32 in 2000 to 324 in 2022 (more than a 10-fold increase in two decades). The figure for the African region jumped from 40 to 388 during the same period, representing a 9.7-fold increase. In contrast, the values for other developing countries only trebled from 57 in 2000 to 192 in 2022 (see Figure 1).
The most worrying or disturbing rise in general prices is observed in Ethiopia, a country frequently touted as one of the fastest-growing economies in the world for several years. Ethiopia’s inflation growth rates exceeded, by far, the averages for developing countries, SSA and the African region. It jumped from 0.66 per cent in 2000 to 33.94 per cent in 2022, with food inflation at 40 or more per annum. The bump in Ethiopian inflation (Figure 2), with a growth rate of 40%, coincided with the global food, financial and fuel crisis of 2008-2009, which increased the country’s price rise from about 17% in 2007 to an astronomical level of 40% per annum.
Subsequent years have been very difficult for Ethiopia’s consumers and monetary authorities. This further saw a continued rise in general prices, albeit lower than in 2008, but still at more than 33 % in 2012. This is due to the combination of severe drought, oil price increases, political instability, and an increase in exports of Ethiopian staples. The country’s consumer price index (CPI) score has also skyrocketed from 35 in 2000 to 668.9 in 2022 (Figure 1), representing an increase of 19-fold in two decades, marking a much faster and more significant increase than the average for Africa, SSA, or Other Developing Countries (ODCs).
These increases keep the most influential annual changes since the global financial and economic crises of 2008 and 2009. While the steep rise in prices in Africa also coincided with the onslaughts of the COVID-19 pandemic and the war in Ukraine, the Ethiopian case is further compounded by internal conflicts, structural rigidity of the economy and decades of its expansionary monetary policies. The gravity of Ethiopian inflation is its persistence for a reasonably extended period, its impact on the efforts to reduce extreme poverty, and the purchasing power of the local currency. The value of the Ethiopian Birr vis-à- vis major international currencies (for example, the USD) has continuously deteriorated for the last two decades, losing nearly 84 % of its value over the two decades (see Figure 3).
Irrespective of the level of development of nations, high inflation, beyond economic malaise, may also cause social tensions, labour-related conflicts, industrial actions (especially in countries where trade unions are allowed to operate), and eventually political instabilities. It is important to emphasise that while there have been growing global concerns about inflationary pressure and its adverse consequences, the underlying reasons for such concerns vary between developed and developing economies. The overarching preoccupation of policymakers in developed economies is to curb inflation to a manageable level to protect the stability and integrity of monetary and financial policies, maintain healthy capital markets, secure portfolio investments with managed expectations, and maximise welfare.
The primary concern in developing countries, on the other hand, is how to contain inflation while (a) generating high levels of inclusive and sustained economic growth, minimising the debt burden and the cost of borrowing, as well as expanding access to credit facilities; and (b) reducing budget and trade deficits, as well as addressing challenges of food security, unemployment, and poverty reduction.
Regardless of the variation in primary objectives between developed and developing nations, there is recognition that persistently high inflation is bad for any economy- be it developed or developing. Economists regard high inflation as a hidden tax to the economy as it leads to macroeconomic instabilities with heightened risks and uncertainties. Inflation undercuts economic gains by inflating expenditures, the cost of living and GDP. It undermines the population's living standards, increases indebtedness, and adversely affects the purchasing powers of local currencies.
Food inflation
Improvements in farm technologies, inputs and knowledge have led to higher agricultural productivity and surplus food production since the final decades of the 20th century. Consequently, according to several studies, global food prices have declined since the 1950s. A steep decline was observed in developing countries after the 1960s, mainly due to the green revolution in India and other rural economies. However, according to the United Nations Food and Agriculture Organization (FAO), there has been a reversal since 2000 with marked hikes in global food prices.
On the positive side, there has been a significant decline in the Global Hunger Index (GHI) since the 1960s. However, by 2022, most sub-Saharan African countries, including Ethiopia, remain food deficit countries and are in “serious, alarming or extremely alarming hunger situations”. Out of 45 countries, only Haiti, North Korea, Pakistan, Papua New Guinea, Timor-Leste, Syria, and Yemen are in the categories of serious, alarming or highly alarming hunger situation, leaving the rest of the crowd concentrated in SSA.
The GHI scores of several SSA countries have deteriorated since 2015 and deepened after the COVID-19 pandemic and the Ukraine war outbreak. The decline was more pronounced in two of Africa’s most populous nations: Ethiopia and Nigeria. In 2015, Ethiopia ranked 98th in the GHI out of 125 countries for which data was available. In 2023, the country’s ranking deteriorated to 101st, suggesting a reversal in efforts to reduce hunger among Ethiopians. Likewise, Nigeria ranked 109th out of 125 countries, which marked a deterioration in the country’s ranking of 101st in 2015. In 2023, Ethiopia and Nigeria fell into the “serious hunger situation” category, with GHI scores of 26.2 and 28.3, respectively.
The deterioration in GHI scores in SSA’s two most populous nations can be attributed to several internal and external factors, including high food prices, food insecurity, conflicts, low income, the impact of climate change and disruptive weather patterns, poor infrastructure, poor participation of the private sector, continued neglect of the agriculture sector in the allocation of investments and rigid land policy, among others. A GHI score of between zero and 10 implies the prevalence of low-level hunger, whereas a score between 10 and 20 indicates moderate hunger. A score on the Index between 20 and 35 shows a severe hunger situation, and above 35 implies an alarming or highly alarming one.
According to the latest data by the International Growth Center (IGC), food Inflation in Ethiopia averaged 18.22 per cent from 2013 until 2023, reaching an all-time high of 43.90 per cent in May of 2022 in Nigeria, the National Bureau of Statistics reported that the food inflation rate in July 2022 was 22.02 % yearly, 0.99% higher than the rate recorded in July 2021 (21.03%). Ethiopia and Nigeria are not exceptions. The latest brief of the World Bank concludes that “in real terms, food price inflation exceeded overall inflation in 74% of the 167 countries where data is available”, with inflation higher than 5% experienced in 61.9% of low-income countries and 76.1% of lower-middle-income countries.
According to the latest UN data, globally, more than 800 million people, a significant proportion of which are in Africa, were going hungry in 2022. The prevalence of hunger and malnutrition amidst global luxury, income and surplus food production results from several adverse factors. These include (but are not limited to) supply chain disruptions due to the pandemic; climate change and extreme weather patterns; war in Ukraine and now in the Middle East; interethnic and religious conflicts, particularly in some countries of SSA; high cost of transportation and logistics; falling income of people with low incomes and distortions in production, harvest, and transportation as well as contortion in global trade in agriculture.
What makes food inflation acute to poor households and weaker economies is its implication for poverty reduction efforts, given that 70 % of the income of people experiencing poverty is spent on food items. Households can postpone consumption of other goods and services, but it is impossible to wait for necessities of life such as food, clothing, and shelter.
An urgent need is to address push and pull factors and structural distortionary issues behind food inflation through appropriate national, regional, and global policies. Such policies must address demand- and supply-side constraints, such as access to productive assets, notably land, to people with low incomes, including women, through flexible land policies. They should also include the provision of better farm inputs and seeds; modernising agriculture and rural infrastructure; implementing coherent trade, industrial and infrastructural policies to support better food production; and improving buffer stocks, storage facilities, logistics and distribution systems of significant staples.
There is also a need for concerted global action to mitigate the impact of climate change and disruptive weather patterns on agriculture and food production. Ensuring political stability is also crucial to minimising the potential of armed conflicts that disrupt investments and mobility of productive resources, which, in turn, diminish agricultural production and productivity.
The adverse consequences of armed conflicts and political instability manifest themselves not only in their growth-retarding effects but also in penalising investment, production, and productivity, as well as heightening economic risks and uncertainties, often causing high inflation. The enormous casualties of political instability are the poor and vulnerable sections of society, further frustrating poverty reduction efforts in structurally weak and vulnerable economies such as those in SSA.
Figure 2: Average Growth rates in Consumer Price indices in selected economies (%): Ethiopia, SSA, Africa and Other Developing Countries
Credit: UNCTADstat (2023)
One of the apparent impacts of inflationary pressure is devaluing local currency vis-à- vis the international currencies, with implications for global trade and investment. Domestic currencies lose value when inflation hits the economy hard (particularly when galloping or hyperinflation occurs). That is, local currencies depreciate often at an uncontrollable speed, while currencies with little or no inflation appreciate in a foreign exchange market. In other words, when the purchasing power of the local currency of income deteriorates domestically, the international value of the local currency will also diminish fast.
This will affect foreign direct investment (FDI) flows and international trade (exports and imports). Investors generally prefer inflation-free economies that offer investment opportunities in fixed profit-yielding bonds, securities, and green-filed investments. In times of inflationary pressure and uncertainties, investors lose confidence in the market and tend to shun such economies. They adopt “a wait and see” policy before making investment decisions or easily choose economies with low and stable inflationary trends. Even domestic owners of capital (who are profit and market-seeking) opt to invest in economies with regular currencies and monetary policies with little or no inflation. Such a situation facilitates capital flights from inflation-ridden economies towards inflation-free markets and stable currency economies.
Foreign trade is another critical area where high or above-moderate inflation adversely impacts developing countries. It makes import substitution costlier and forces nations to cut imports, fueling scarcity and adding inflationary pressure. In theory, devalued local currency makes imports grow lower than exports, improving trade balances. However, a higher inflation rate (galloping or hyperinflation) makes domestic production costs much more elevated and exports less competitive internationally, creating continuously growing trade deficits. Developing countries that usually incur trade deficits resort to financing a gap by drawing on their international reserves from ODA, FDI, or borrowing from abroad.
The Ethiopian Birr lost significant value in major global trade and investment currencies during the last two decades. In 2000, a Birr used to buy 0.1217 USD (or for every 1 USD, the equivalent in Birr was about 8.20 in an official market in the same year). In 2022, as seen in Figure 3, a Birr would buy 0.01923 USD (1 USD would buy, officially, about 55 Birr). As indicated earlier, Birr lost 84% of its value between 2000 and 2022 in an official exchange rate market. While such a deterioration in the value of the local currency is the result of deep-rooted structural economic difficulties Ethiopia has been facing, inflation has also played an essential role in depreciating the Birr.
The devaluation of local currency or the overvaluation of foreign exchange leads to a significant trade deficit, which in turn leads to the depletion of international reserves. This situation is rampant in SSA, which relies heavily on imported intermediate goods for nascent industries or manufacturing sectors. High inflation also tends to fuel illegal trade and the expansion of a parallel (black) market for foreign currency, further eroding local currency's credibility and purchasing power. Between 2000 and 2022, the unofficial (similar) market for the USD boomed in Ethiopia and many other countries of SSA.
In Addis Ababa, the unofficial exchange rate for the USD soared from 12 Birr to a dollar in 2000 to about 120 Birr to a dollar in 2022, marking an increase of 10-fold in two decades. According to the Ministry of Industry (MoI), more than 200 manufacturing firms in Ethiopia were forced to cease operations in 2023 due mainly to a lack of access to finance and foreign currency and the rising cost of intermediate inputs. This situation further intensifies the continuous decline in manufacturing value added (MVA) in GDP, accelerates premature deindustrialisation, and dampens the country's prospects for structural economic transformation.
Consequently, the government of Ethiopia has been forced to introduce several currency control measures, though unsuccessful in arresting or reversing the declining trend. For instance, all payments abroad require permits and all transactions in foreign exchange must be undertaken through authorised dealers supervised by the National Bank of Ethiopia. Similarly, exporters can retain 30% of their foreign exchange proceeds indefinitely but must sell 70% to commercial banks within four weeks. Although the impact of such regulations seems minimal when judged based on the acute forex crunches the country has been facing, consistently eroding external reserves and compromised debt repayment obligations.
Figure 3: Trends in the Ethiopian Consumer Price Index and the exchange rate between the Birr and the US Dollar during 2000-2022
Credit: UNCTADstat (2023)
According to the latest IMF Global Debt Database, the total debt remained disturbingly high at 238 % of global GDP in 2021, pushing many low-income countries of SSA to debt distress situations during the same year. The combination of the lack of financial resources in weaker economies and increased financing needs worsened the economic woes of the sub-region. This is due to the growing trade deficit and pandemic-induced financing gaps, which resulted in the decline in global official development assistance (ODA) and FDI flows.
This situation, in turn, has led to an increase in the debt-to-GDP ratio of most low-income countries, particularly in the post-pandemic environment. Moreover, the rise in inflation in significant economies of the world has triggered a sharp and sudden increase in interest rates, which in turn heightened the debt distress situation of many countries of SSA. Pre-pandemic and pre-inflation global interests have remained low for several years, which encouraged increased borrowing by developing countries both from public and private sources. However, the post-pandemic and inflationary situation forced major creditors to raise interest rates, undermining the debt servicing capacities of debtor nations that borrowed when interest rates were low.
This unholy amalgam between rising interest rates, inflation, and a challenging financial environment exacerbated the debt repayment obligations of poor economies, further compounding the growing challenges of financing their development needs. While high inflation has continued plaguing the economies of SSA, the IMF has reported that the average debt ratio in sub-Saharan Africa “has doubled in just a decade—from 30 per cent of GDP at the end of 2013 to almost 60 per cent of GDP by end-2022”. With rising interest rates, repaying this debt has also become excessively costlier to many poor nations. The inability to pay debt makes economies risky and vulnerable.
It is also a sign of deep-rooted structural problems, such as weak productive capacities, a balance of payments crises, structural budget deficit and an overall lack of investible resources. The recent opinion (article) in the Financial Times by Ms Rebecca Grynspan, Secretary-General of UNCTAD, raised an alarm bell that the “public debt of developing countries, excluding China, reached $11.5tn in 2021 with serious debt burden owed by highly vulnerable low-income countries such as Chad, Zambia or Ethiopia”.
The article further states that “in 2021, developing countries paid $400bn in debt service, more than twice the amount they received in official development aid, while their international reserves declined by over $600bn in 2022, almost three times what they received in emergency support through the IMF Special Drawing Rights allocation” Consequently, poor countries such as those in SSA paid more in debt services than their expenditures on education or health, with dampening impacts on their progress towards achieving Sustainable Development Goals (SDGs) by 2030.
Inflation, wages, and employment (unemployment)
In theory, inflation and unemployment run in opposite directions. Generally, when unemployment is low (high employment), inflation tends to rise due mainly to wage cost push. But inflation tends to fall when unemployment is high (low employment). Zero or below zero inflation is also as bad as a high inflation rate for the economy, as it signifies deflation. Deflation occurs when aggregate supply in an economy exceeds aggregate demand, leading to negative interest rates and low-price levels associated with high levels of unemployment. Research shows that societies generally prefer inflation with employment to deflation with unemployment. Inflation in an economy can also occur when economic growth slumps, causing stagflation.
Stagflation is a situation where economic growth stagnates; unemployment remains steady, but the general price rise in the economy prevails. In economics, stagflation is known as recession-inflation, and it is as dangerous as deflation or inflation in hampering the well-being of societies and frustrating efforts to achieve sustained growth and development. In theory, a low unemployment rate (or high employment) is associated with an economic boom when excess demand for labour causes money wages to rise faster than labour productivity, signifying cost-push inflation in an economy.
The objectives of policies in such situations are to minimise unemployment and inflation simultaneously while maintaining inclusive and sustainable economic growth. This is the case, particularly in democracies and countries where citizens' well-being takes priority over political interests. Such objectives may also lead to policy tradeoffs by calculating the opportunity cost of higher unemployment (lower inflation) and comparing this with the opportunity cost of higher inflation (lower unemployment).
Conclusions and the way forward
The recent rise in prices (nationally or globally) is due to structural rigidities in aggregate supply disrupted by the COVID-19 pandemic and the war in Ukraine. Massive injections of fiscal and monetary stimulus packages in developed economies that disproportionately increased aggregate demand also contributed to high inflation globally. In relative terms, if political will and determination exist, demand-pull factors could be quickly adjusted through appropriate monetary and fiscal policies, such as interest rates, taxation or prudent budgetary policies. However, supply response to match the increase in aggregate demand takes much longer to adjust.
This means that much broader and multipronged policies and strategies are necessary to deal with inflation effectively. While managing demand is essential, addressing supply-side distortions and disruptions is critical, particularly in poor and vulnerable economies. Investing in agriculture and rural infrastructure maximises the sector's employment intensity while boosting agriculture's production and productivity. Building storage facilities, buffer stocks, and distribution logistics in rural areas is vital in addressing food security challenges and hunger situations.
In short, fostering productive capacities by recalibrating abundant resources such as labour and capital and catalysing drivers of growth and transformation, particularly energy (electricity), ICTs, and the private sector, can play a prominent role in relieving key supply-side constraints.
Available evidence suggests that high inflection is growth-retarding, although the causal relationships between high price increases and economic growth are complex. There are also convincing arguments that excess aggregate demand over supply is the core of the inflationary gap and high inflation. Moreover, inflation is a hidden tax to consumers and producers, devastatingly impacting economies and societies.
As discussed in this newspaper article, inflation has much higher and broader impacts on developing countries, particularly those structurally weaker and more vulnerable than developed economies. In these economies, monetary and fiscal policies are too weak to decrease inflation. Also, the efficiency of taxation in these economies is undermined by the narrow tax bases, lack of taxable income and poor tax collection systems. Moreover, inflation is not the only economic problem in such countries; controlling it is only one of the many complex development problems they face.
Achieving inclusive growth with high employment and substantial poverty reduction remains among the most pervasive problems facing countries of SSA. Likewise, the lack of investible capital resulting from low income and low savings rates, external debt burden, and the resulting inability of capital formation (accumulation) pose serious development challenges to them.
In structurally weak and vulnerable economies that suffer from protracted conflict situations, such as Ethiopia, DRC, Somalia, South Sudan or Sudan, the confluences of higher-than-normal defence spending, poor agricultural production and low real economic growth may further intensify systemic risks and uncertainties and overall socioeconomic collapse.
The prevalence of conflicts and political instabilities can have much wider ramifications and prolonged consequences both on societies and economies. How quickly conflict-ridden or war-prone countries address the challenges and foster peace, stability, and nation-building determines their path toward inclusive growth and sustainable development. In other words, conflicts and political instabilities combined with galloping or hyperinflation may complicate economic recovery and the achievement of SDGs by these countries.
The adverse impact of inflation on weaker economies and vulnerable sections of societies is well established. However, no simple, uniform, and universal blueprint enables weak and vulnerable economies to curb or contain rising inflation while, at the same time, addressing their persistent and emerging development challenges. This means that solutions to reduce inflation should be based on specific socio-economic circumstances, resource bases, institutional capability, and overall local conditions of countries. This does not mean that there are no generally applicable policy tools.
There are two critical lessons from past operational experiences in dealing with high inflation.
First, controlling inflation should be among developed and developing countries' top economic policy priorities. Governments should opt to put in place sound and stable monetary and fiscal policy instruments.
Second, gradual approaches to curbing or containing a certain level of inflation may lead to undesirable outcomes than firms and sudden actions to stabilise high price increases. Based on these critically important policy lessons, monetary and fiscal authorities of developing countries can take the following measures, which may not be wise or famous but necessary to tame inflation:
a) Policy action and measures should have national “inflation-targeting” frameworks as a starting point. Such frameworks are vital tools to enhance monetary and fiscal policy efficiency, credibility, and performance. They include clearly articulated and defined money supply targets in the economy, threshold inflation levels or fixed ranges of consumer price indices (CPIs), and improved rentals and interest rates. Inflation-targeting frameworks also include ensuring the best central banks' independence from political influence to empower central banks in managing economic slumps during inflation. The focus should be on strategies to improve supply-side constraints, such as the production and productivity of resources and the supply of goods and services. Addressing supply-side constraints and boosting the supply of goods and services to exact growing demand play a critical role in stabilising inflation.
In short, fostering a vibrant, dynamic, modern, and independent central bank is essential for stabilising inflation. Independent central banks are free from political interference in economic decision-making regarding interest rates or exchange rate policies. They may also limit the role of governments from incurring unacceptable levels of budgetary deficits and planning and executing elephant projects through excessive borrowing or printing money for financing.
b) Improving regulations, reducing the cost of production, and maximising efficiency gains: Weak regulatory frameworks, excessive bureaucracy, and dysfunctional institutions are hidden costs to the economy, undermining production and productivity. In most developing countries of SSA, weak policy implementation capacities of institutions fuel illegal trade not only in currencies and commodities but also in urban lands and real estate. While land and real estate, as well as other fixed assets, are vital in controlling inflation by withholding liquid money that would otherwise enter markets, illegal trade in land and real estate leads to quick turnover (with high profits) and high velocity of money.
These, in turn, cause inflationary havoc in the economy. Such a situation, particularly increased turnover and velocity of money in circulation, exacerbates the flow of vast amounts of money into the market chasing few goods and services. Making regulations and policies pro-poor and pro-production transformation side by side with liberalising farm inputs, modernising land use and access policies, reducing taxation on imports of intermediate inputs, and cutting out bureaucracy can help to tame inflation in the economy by containing cost-push inflation. Stamping out corruption is equally vital in reducing the cost of business, improving production and productivity, and delivering goods and services to consumers at reasonable prices.
c) Responsible sovereign borrowing: During inflation, effective debt management and responsible borrowing should be central for structurally weaker and vulnerable economies, as debt overhang can further destabilise fiscal and monetary frameworks. Responsible sovereign borrowing is crucial for SSA economies in maintaining their creditworthiness while ensuring constant inflows of development finance, including foreign direct investment (FDI).
Responsible borrowing should not be confined to external borrowing but should include borrowing locally. More importantly, borrowed funds should be used to address problems of underdevelopment, such as weak productive capacities, unemployment and deindustrialisation centred on generating inclusive and sustainable growth with substantial poverty reduction.
d) Policy measures to protect the poor and vulnerable sections of societies: Given that a significant portion of the income of people experiencing poverty (70 %) is spent on food, governments need to put in place incentive structures, including food rationing or managed cash transfers to protect vulnerable sections of their societies from food inflation. Such measures should continue side by side with boosting food production and productivity and improving logistics, storage facilities and distribution channels. The objective should be to address food insecurity, particularly in the poor and vulnerable sections of society.
e) A mix of policies and strategies matters: A harmonised and coherent set of guidelines is more effective in controlling inflation than single or fragmented policy approaches. Risks and uncertainties caused by inflation require multipronged actions ranging from fostering productive capacities to enhance aggregate supply in the economy to introducing contractionary monetary policies and sensible fiscal policies.
f) Governments' aggressive and robust role is critical: Governments should lead in containing inflation by reforming financial, monetary and taxation policies, enforcing budgetary disciplines, stamping out systemic corruption and formulating and implementing realistic projects and programmes. Recent episodes of financial, economic and health crises brought back the role of governments in economic decision-making, even in the “free market economies”. Free market economies historically believed in and advocated for an exclusive role of demand and supply- the “invisible hand”-in economic decision-making. Realistic, problem-solving and growth-maximizing government programmes and projects are vital in reducing socioeconomic vulnerability, risks, and uncertainties and building economic resilience to random shocks. Governments of developing countries should particularly aspire to improve project planning and implementation within planned budgetary bands and by strictly enforcing the agreed time for completion.
White elephant projects that are unsustainable financially and take infinitely long to complete with little or no impact on communities, societies, and nations should be avoided at all costs. Such projects or programs are one of the primary mechanisms to entrain government budget deficits, excessive borrowing, and money printing, fueling inflationary pressure. More importantly, governments should be candid about their economic scorecards and transparent about their monetary and fiscal policy outcomes. They should also provide objective and credible information to the public about the challenges facing their economies and the policies they intend to implement to contain inflation and its impact.
g) Managing monetary liquidity in the economy is vital: Inflation tends to increase nominal money circulation while significantly reducing the actual value of money. This makes the liquidity constraint more binding, requiring prudent liquidity management. This problem can be resolved by having financial intermediaries such as modern and dynamic banking and insurance sectors, which channel the funds from entrepreneurs with excess liquidity to those lacking liquidity. Maintaining an acceptable level of monetary liquidity for commercial banks is also vital for the financial sector's viability and solvency by enabling them to meet financial stability and lending obligations.
As discussed above, when inflation increases, monetary and fiscal authorities will be forced to raise interest rates on loans, which directly or indirectly determine the liquidity position of the banks. Volatile galloping or hyperinflation negatively impacts interest rates and banks' capital holdings. Central banks have primary responsibilities in assessing the level of monetary liquidity that commercial banks should hold, particularly during a high inflation rate. Otherwise, banks with excess financial liquidity may be tempted to lend money to finance consumption (shifting away from investments in risky production sectors such as agriculture), injecting more money into the market with added inflationary momentum.
h) Addressing price information asymmetry and educating the public about inflation: Asymmetric market or price information between producers, intermediaries and consumers tends to facilitate undue pricing of goods and services, triggering inflation. Government institutions, marketing agencies, and consumer protection agencies can play a vital role in bridging the gap in price information for consumer goods and services. In situations of imperfect markets and market failures such as those evidenced in structurally weak and vulnerable economies, the existence of asymmetric information cannot be avoided and, therefore, justifies the need for practical monetary policy tools and vibrant institutions to correct imperfection and asymmetries in price information. It is also essential to educate consumers or households to manage expectations. However, not all consumers or households are responsible for inflation. People with low incomes and the most vulnerable sections of society have nothing to do with the causes of inflation. However, they are the first casualty of high inflation.
Public education on how to manage expenditures and shift them away from consumption to production (through increased savings and investments) should focus on the rich (affluent) sections of society, not on the “have nots”. The former can downsize expenditures, better manage expectations, and contribute to overall savings and investments by reducing their propensity to consume to “ordinary levels”. Cutting out or curbing lavish religious and social festivities such as marriage ceremonies and related expenditures, particularly by the well-to-do sections of society, can help fight inflation. However, the fight against inflation is the government's primary role and responsibility, as they are the custodians of monetary and fiscal policies and the leading causes of excessive budgetary deficits and sovereign indebtedness.
* Mussie Delelegn is Acting Head of Productive Capacities and Sustainable Development Branch, Division for Africa, Least Developed Countries and Special Programmes, United Nations Conference on Trade and Development (UNCTAD). This article is prepared in the author's capacity. Therefore, the opinions expressed in this article are the author’s own and do not reflect or represent the official views of UNCTAD or the United Nations. The author can be reached at (mussie.delelegn@unctad.org).
References
[1] The Global Hunger Index is a peer-reviewed tool, jointly published by Concern Worldwide and Welthungerhilfe, designed to comprehensively measure and track hunger at the global, regional, and country levels. The aim of the GHI is to trigger action to reduce hunger around the world. The Index is available at
Financial Times, 2 February 2023, “The world lacks an effective global system to deal with debt”, available at: .
*This article is re-publish with the permission of the author. The article was published in the Reporter newspaper on January 5, 2024.
