General price level is one of the major macroeconomic variables. It has a multiplier effect in the overall economic activity of an economy through its price transition mechanism to the domestic economy as well as the external sector. Besides, it determines the state of equilibrium by affecting demand, supply and price of goods and services.
It also measures the cost of living within and indicates the health of the economy. And when there is a persistent rise in the general price level of an economy, it is called inflation, and deflation if the trend is reversed.
When there is a persistent and sustained rise in the average price of goods and services within an economy, it is expressed in what is inflationary pressure. It is a significant macroeconomic ill that has negative consequences, deteriorating the living standard and raising the cost of living.
An inflationary rate of three to five percent is normal, while if it reaches above seven percent, it is negative. Unfortunately, economic theory states that there is no single policy measure for curing inflation. The remedy varies depending on the factors that are causing it, be it demand pull, cost-push or supply-side inflation.
Demand-pull inflation is a result of an increase in aggregate demand. It is a situation where the price level rises when the total monetary demand for domestic output exceeds the values of full employment output at the current price level. It can also occur when consumers save too much, incomes have risen, and credit and interest rates are low.
Cost-push inflation, on the other hand, is a result of an increase in the cost of production that results in a fall in aggregate supply. It has less to do with excessive consumer demand and more with costs that are ultimately passed to consumers. Last but not least is supply side inflation where a reduction in aggregate supply through fiscal and monetary policies factor in.
For Ethiopia, inflation is a recurring problem, where deadlock seems to have been reached. In spite of the fact that Ethiopia is well known for its lowest rate of price hikes in sub-Saharan Africa, the trend has reversed to mean a double-digit inflation.
Paradoxical to what macroeconomists and economists argue, Ethiopia’s economy has been experiencing an economic phenomenon that has meant growth but not one free from inflation. On the one hand, there has been a relatively sustained double-digit economic growth for the past decade, which I believe is merely quantitative. On the other side, the living standard of the people is getting worse, even as incomes have risen, where people are finding it harder to live by what they earn.
What is evident about the double-digit growth is that it is not in keeping with the economic well-being of the people. And this is not a hidden fact. The largest proportion of the country’s population is grouped under the low-income group. In the rural parts of Ethiopia, many are living at a subsistence level, where they hope to satisfy the basic needs of life. Inflation has become the most significant economic ill with various negative economic consequences, mainly the deterioration of living standards and the retardation of the masses’ ability to maintain their minimum living standards.
As a result, people have become pessimists about tomorrow with a negative mental attitude. They become convinced that change will not come as a result of their effort alone, which will significantly affect their aspirations, productivity and sense of national interest. It exacerbates the socio-economic and political problems of the country.
Amongst the contributing factors for the recent double-digit inflation is the dominance of the exploitative capitalist system which the Marxist school of thought states is the act of “capital sabotage” by businesses. Even though in principle the country follows a market-oriented economic system based on free competition, where price is determined by the interaction of demand and supply, the system is dominated by those few that earn abnormal profits.
The normal function of the market is being distorted through unfair competition, driving smaller firms out of competition, and ultimately leading to the rise of monopolies. This has meant they could at will set the price higher, adding to the country’s inflationary problem.
Wholesalers, retailers, distributors, small and medium-sized businesses and small traders have likewise been noted hoarding goods and services, reducing supply, which is yet another cause. It has created an artificial shortage of supplies in the market, lending itself to the rise in prices.
Therefore, there is a need for the government to make an appropriate intervention within the market to correct this flaw and allow the market to be free, fair and competitive. It also has to work harder with communities, starting from the grassroots level. It can coordinate stronger consumer unions, regularly revising and setting the floor and ceiling prices for goods and services. Another would be implementing strict and prohibitive laws that impose discouraging penalties on the actors.
Of course, the inflationary pressure is being abetted by another more adverse factor: the nature and structure of the economy and the related mitigating policy measures.
The economy is characterised by the existence of underdeveloped dual sectors and ineffective supply in which both domestic production and consumption heavily depend on imported raw materials, fuels, consumer and capital goods and services. Thus, the heavy reliance of the local economy on the external sector exposes the economy to transmit shocks from external to the domestic economy.
Devaluation has likewise been another cause for inflation. The government has persistently devalued the Birr with the objective of boosting export earnings and discouraging imports. But the policy failed to meet its target due to a number of factors related to the nature and structure of the economy. Reversely, the devaluations have directly increased the domestic price of imported goods and services as well as the cost of inputs for production by its price transition channel to the local economy.
The government, thus, should be conscious of monetary measures such as these, as the devaluation has proved ineffective. The priority should not be improving the performance of the external sector. It should instead be the structural transformation of the economy, with appropriate complementary policies and strategies. They should be taken in such a way to allow the horizontal and vertical diversification of export as well as specialisation on import substitution industrialisation.
The government has to divert its attention towards alternative policies instead of the devaluation, since playing that is a negative sum game that has constantly led to inflation.
The fourth cause of inflation has been the existence of a distorted macroeconomic policy. Inconsistent fiscal policies when it comes to both revenues and expenditure have aggravated the problem. An expansionary fiscal policy has meant a sharp rise in public spending, directly increasing demand for imported and locally sourced goods and services. Add to this the existence of ineffective supply, and aggregate supply has been made to lag far behind the total demand.
There is a huge gap between government revenues and expenditure because income has increased slowly while public spending has grown at great speed. It has meant a budget deficit is a feature of the economy. The action taken by the government as a mitigating factor to fill the gap, such as the crowding out of private investment, has resulted in a contractionary output, negatively contributing to the recent inflation of the country. An increase in the broad supply of money thus is an additional cause for the recent inflation.
Finally, another critical factor for the current inflationary trend is an inflationary expectation. People are pessimistic when it comes to these things, believing that the best time to purchase anything is today and expecting price increases every time. This is currently serving as an effective inertia for inflation, fuelling continuous spirals in prices.
For this, the government has no other option but to intervene to change the public opinion about inflation. The success of such efforts, however, raises the issue of credibility on the part of the government. It is essential, therefore, for it to announce prudent macroeconomic policies and adhere to it for a considerable period.
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