Saturday, September 13, 2008

Hypocritical Concerns Over Recent Rising Inflation

posted by martin oluba

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Hypocritical apprehension by government and its monetary authorities has trailed the 14% rise in published inflation for the month of July which is according to the calculation the highest so far in two years. The change in the composite consumer price index (CPI) from which the inflation figure was calculated was said to have been a consequence of increase in the price of some staple food items, diesel, kerosene, gas and some building materials. These are however not in any way the reasons for the observed inflation. Rise in the prices of goods though can be caused by real factors but in this case are a consequence of monetary inflation which is traditionally a creation of the government and the central bank. It is because of this deliberate attempt to wrongly situate the cause of the current inflation is why I describe their apprehension and concerns as hypocritical.

To start, it is important to make it clear that we may not be wrong to assume that the published inflation rate is by far below the actual inflation rate. There are many reasons why this assumption should be right. Firstly, the government and the CBN has every incentive to report a much lower inflation rate in order to prove that the reform programmes are yielding desired results. Secondly, even the CPI itself upon which this inflation rate is based is flawed. This is because prices of different commodities cannot be averaged and any attempt to develop a best alternative is at best subjective and perhaps based on the aspirations and goals of the designers of the basket of goods and services used for the index. As a result the weights assigned to different items in the basket are at best subjective and also predicated on the intended goals of the designers. Thirdly, prices of commodities do not rise equally in response to inflation. Some rise much faster than others or considered more volatile while some rise much more slowly than others. In many instances, more of these commodities with slow pace of price change are included in the basket for measuring the core inflation rate. Fourthly, the CPI does not and cannot in any way reflect the consumption preferences of different classes of people in any objective sense. For instance while the CPI can reflect consumer preferences for say bread it however fails to reflect consumer preferences for the consumption of financial assets such as shares which are now widely held. Therefore heavy asset bubbles of up to 200% as recently experienced is never factored into the published inflation rate which could still be as low as 6%.

Inflation is not about the general rise in prices because prices of all commodities and services do not necessarily rise within the same period. On the contrary, inflation is always and everywhere the consequence of increase in money supply and credits. Prices are determined by real and monetary factors and thus as more paper money which is of no real worth are created to exchange for things of value, the prices of those things are bid up. Basically as the central bank who has the traditional responsibility of managing the quantity of money stock expands the supply of money and credit, money which is not backed with value is exchanged for things of value. The implication is obvious and therefore, the more the supply of money given the slow or less than proportionate rate of real output expansion if any, the higher the prices. This is the biggest evil of inflation because it bids resources away from the real creators of wealth to those who have access to the newly created paper money. The second level of causation will now take place based on historical experience with inflation. Oftentimes, economic agents based on their past experiences with inflation can as well expect future inflation depending on the indicators that they feel provides the lead. These expectations can actually produce real inflationary effects. But these are secondary effects which are predicated on past experience and occurrences and can easily be addressed once the primary cause is resolved. Unfortunately, these effects based on expectations are in many occasions looked up to by the statisticians and the CBN as the cause of inflation which in fact is false. That is also part of the reason given for the 14% inflation rise. Consequently the idea of inflation targeting rather than the targeting of money and credit creation is based on this notion.

Now let us examine CBN's growth of broad money supply which is considered a more relevant measure. A simple average of the percentage growth in broad money supply between January and July shows that money stock grew by 4% each month which means that by July money supply had expanded by 32%. If we assume that this trend will persist, by year end, broad money supply will have expanded by 60%. Now let us assume for want of any reasonable proxy that real output has grown by 10% by end of July which is clearly impossible given the state of the economy. Let us also assume that real out will reach 15% by year end: another impossible task necessary for our analysis. If therefore that by the beginning of this year, the stock of money available in the economy was equal to the amount of goods and services for which it will be exchanged, it does not need a diviner to see how the CBN has by expanding money stock out of thin air by itself created the current inflationary state. Similarly credit to government which produces nothing has equally been very huge on a monthly basis. Based on experience, we know that a good chunk of these funds will be laundered and never used for any meaningful productive activity.

Now that we have idea of the cause of the current state of inflation, we can go back and explain why none of the mentioned factors are behind the present level of inflation. It is very easy to see that all these mentioned commodities are essentials which people out of apprehension of possibility of future rise in their prices will spend more to acquire more of them. Additionally, the damaging consequences of many years of persistent inflationary episodes have overtime weakened the financial attraction, profitability and general appeal in food farming for majority of the fringe players which dominate the industry. The result is scarcity of food supplies and/or the fear of their future occurrence. Hence their prices go up. The same applies to the industry manufacturing building materials. The same applies in the case of petroleum, gas and diesel. Thus rather than pointing fingers at the victims of government's created inflation such as these farmers and manufacturers as the cause, the central bank and the government whose fiscal deficits it finances should own up to this recent rise therefore and go back to the drawing board.

Martin Oluba PhD, DBA is Executive Director at Forte Financial Limited. www.martinoluba.com