In the last few weeks, academics, policy-makers, law-makers and the media have commented on the inability of the Bank of Ghana to hold down to single digit inflation. Some have also continued to prescribefunctions and have recommended the persona of an ideal central banker.
Meanwhile, as the rains set in, farmers and consumers from as far away as the Afram Plains continue to haggle over the clearing price for a basket of tomatoes and a tuber of yam. ‘This is my last money, quivered Adwoa’, the market woman; ‘well go to Burkina Faso, you will get them cheaper’, replied Kotoku, the farmer. Adwoa snarled back, ‘if you reduce the price, you would sell more.’ No! replied Kotoku : ‘I would carry my goods home.’
As I listened to this fascinating conversation, my intuition in economics reminded me that the amount of money in circulation multiplied by its velocity of circulation equals the general level of prices multiplied by the volume of trade. It follows therefore that the general level of prices must always be inversely related to the number of transactions. But Kotoku insisted that prices are generally increasing and it pays to take all his unsold stocks home; maybe he would get a better price next time.This sounds a familiar phenomenon; markets do not clear fully in the presence of price stickiness.
As the general rise in the price of goods and services continues, the Bank of Ghana in a conscious effort to reduce the cost of goods and services applies a policy tool called inflation targeting.
Inflation targeting is a monetary policy framework based on the announcement of a numerical target for inflation and an institutional commitment to reach the announced target. Under this strategy, the anchor for inflation is the publicly announced inflation target itself. Critics argue that this strategy is not working, but fall short of recommending an alternative policy.
Basically, there are two types of inflation targeting, namely strict and flexible. In the former it is only inflation that enters the Central Bank’s objective function whereas in the latter there is also a positive weight placed on other variables. While strict inflation targeting entails a rapid push towards the target under all circumstances, under flexible inflation targeting actual inflation converges to the target rate gradually. This has been the wisdom of the Central Bank of Ghana’s policy stance.
However, with globalization, necessitating open economy settings, most small developing economies including Ghana have become integrated into the world market. With openness,an economy becomes exposed to foreign shocks and financial market disturbances to both commodity and financial markets. This necessitates additional channels for policy. For instance, the policy instrument; rates (interest or exchange) will now affect output through its impact on the exchange rate. The exchange rate is the foreign price of domestic currency. This indirect channel will reduce net export demand by appreciating the exchange rate. Net export demand is reduced further and the impact can be severe especially in the case of small open economies who fail to add value to their exports. Given that the policy instrument, operating through the exchange rate, has a more powerful first- period effect on inflation, policy must be used more moderately in response to deviations from the target.
A further third major impact on the Ghanaian economy arises through changes in price. For instance, in small open import dependent economies the changes in import prices due to movements in the exchange rate are passed throughinto domestic prices more rapidly than in industrial countries. With this high pass through, a change in the exchange rate has a large short-run impact on inflation and a small short-run impact on output. Hence a small developing open economy is vulnerable to shocks stemming from international commodity and financial markets. Hence, for an economy such as ours, which is heavily import dependent, inflation is not a beast that can be haunted down and then slain once and for all. It is a process which reflects the stance of monetary policy.
While critics of inflation targeting do not assign any reason, it must be noted that even Keynes, the grandfather of economics, rejected any initial assumption about full level of employment. For Keynes, full employment is a myth and no economy adjusts to clear all goods and services.
For policy recommendation, the appropriate policy response by an inflation targeting central bank will depend on the source of shock; in the case of Ghana a combination of policies centered on credibility, consistency and the application of exchange/interest rates may be appropriate, as inflation is primarily a monetary phenomenon. Besides, co-ordination between the central bank and the finance ministry is a necessary requirement in driving down inflation. Central Banking is predominantly an art(of which inflation targeting is a part) rather than an exact science.
Author: Dr Godwin Kwame Adjei :Economist : Institute of Directors : Ghana
Kwame201290@yahoo.co.uk 0240238384
