Big Goals and Big Upheavals: Addressing Inflation in Ethiopia
Assistant Professor Atnafu Gebremeskel delves into the impact of inflation on various societal segments, explores macroeconomic and microeconomic factors driving inflation, and examines growth consequences if inflation is left unchecked. The assignment also discusses optimal inflation levels for developing countries like Ethiopia and suggests measures to combat inflation. Utilizing data sources from national institutions, the analysis focuses on key variables influencing inflation dynamics.
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Transforming Ethiopia: Big Goals and Big Upheavals ( ) INFLATION Atnafu Gebremeskel (PhD) Assistant Professor of Economics, AAU CoBE, AAU, Department of Economics Eshetu Chole Building, Office Number 429 E-mail: atnafu.gebremeskel@aau.edu.et Tel:(+251) 911 48 19 63
THE ASSIGNMENT 1. What is the relative importance of macroeconomic and microeconomic factors in driving inflation? 2. What has been the effect of inflation on the different sections of the society the low and fixed income earners? 3. What are the growth and development consequences of inflation if not addressed successfully? 4. What is the optimal level of inflation for a developing country such as Ethiopia? 5. What are the possible measures that can be taken to address inflation? 2/20/2025 2
APPROACH Economics starts from 1. Theory and ends with numbers and/or a new theory or 2. Numbers and ends with numbers or new theories Owning to the nature of the assignment, the second approach is adopted with focus on Macro variables Data sources: NBE and MoFEC Methodology: Graphical diagnostics to learn drivers of inflation 2/20/2025 3
1. What is the relative importance of macroeconomic and microeconomic factors in driving inflation? What does the data Say? Inflation Components and Ecnomic Growth Rate 150.00 100.00 Grwoth Rates 50.00 0.00 1970.00 1980.00 1990.00 2000.00 2010.00 2020.00 Periode Food General Non-food Growth Rate 2/20/2025 4
1. What is the relative importance of macroeconomic and microeconomic factors in driving inflation? Monetary Aggregates, Base money, Resource Gap and Inflation 100.00150.00 GRowth Rates 50.00 0.00 -50.00 1970.00 1980.00 1990.00 2000.00 2010.00 2020.00 year General GRBM GRRG GRM2 GRM1 the relationship beween Monetary growth and Inflation Source: Computed from National Data 2/20/2025 5
1. What is the relative importance of macroeconomic and microeconomic factors in driving inflation? Inflationa nd Currency Fluctuation for Birr per USD,EURO AND POUND 150 100 EXR 50 0 1970 1980 1990 2000 2010 2020 yYear General EURO Byuing USDByuing POUND Byuing Figurgure 2/20/2025 6
2. What has been the effect of inflation on the different sections of the society especially- the low and fixed income earners? Increases cost of holding money leading to welfare cost (Public holds insufficient Real Cash Balances) INFLATION TAX IN MILLIONS OF ETHIOPIAN BIRR FOR ETHIOPIA 200000 400000 600000 800000 0 1970.00 1980.00 1990.00 2000.00 2010.00 2020.00 Periode SEIGNORAGEFINAL AVINLTAX SEIGNORAGE1 Figure 2: Welafare cost of Inflation Computed from Ethiopian Data 2/20/2025 7
3. What are the growth and development consequences of inflation if not addressed successfully? I. Inflation can affect growth negatively because it can be considered to be a tax on Investment and therefore could increase the profitability required to undertake an investment projects and would reduce the real interest rate relevant for saving Fisher s effect Real Interest rate = Nominal interest rate -Inflation 2/20/2025 8
3. What are the growth and development consequences of inflation if not addressed successfully? III. High inflation may lead to excessive resources being devoted to transaction and cash management instead of the production of goods and innovation, i.e., overall inflation provides an incentive households to devote MORE RESOURCES TO ACTIVITIES' THAT ARE NOT THE ENGINES OF SUSTAINED GROWTH for firms and 2/20/2025 9
3. What are the growth and development consequences of inflation if not addressed successfully? IV. Inflation causes distortion that affects the search intensity of individual and monopoly power of firms V. Inflation increases uncertainty, which affects adversely public s ability to make their best decision Uncertainty about macroeconomic policy increases with inflation. 2/20/2025 10
3. What are the growth and development consequences of inflation if not addressed successfully? Fisher(1991) supports this view by arguing that inflation is an indicator of the overall ability of the government s to mange the economy. Since there are no good arguments for high inflation a government that is producing high inflation is a government that lost control. Therefore, in a high inflation economies the government will be more prone to introduce price controls, CHANGES TAX and trade regimes, all of which increases uncertainty about the future, thereby affecting investment and growth. 2/20/2025 11
3. What are the growth and development consequences of inflation if not addressed successfully? VI. High anticipated inflation is associated with high variability inflation, i.e., the inflation rises with the level of inflation: Subsequently: Forecast of future conditions will be more problematic in a high inflationary environment of unexpected about uncertainty macroeconomic 2/20/2025 12
3. What are the growth and development consequences of inflation if not addressed successfully? Relative price variability also increases with inflation, as a result informational content of prices declines with inflation since current prices are poor indicators of future prices VI. Inflation reduces Individuals have to choose between consumption and leisure, and to purchase consumption goods, they face cash- in-advance constraint. Therefore, the effective price of consumption goods will include the rate of inflation, like a tax , since the individual will have to hold money in order to buy consumption goods. 2/20/2025 labor supply. How? 13
3. What are the growth and development consequences of inflation if not addressed successfully? Therefore, an increase in inflation rate will increase the price of consumption with respect to leisure inducing substitution from consumption to leisure, thereby reducing the labor supply. 2/20/2025 14
3. What are the growth and development consequences of inflation if not addressed successfully? VII. Inflation also reduces the ability of the financial markets to perform efficient financial intermeadtions as it inhibits long-term contracts. In the world of imperfect information, the informational problems may be exacerbated at high inflation rates affecting the efficiency with which credit is allocated and the total volume of intermediation 2/20/2025 15
3. What are the growth and development consequences of inflation if not addressed successfully? VIII. budget. Inflation also distorts government's 2/20/2025 16
4. What is the optimal level of inflation for a growing country like Ethiopia? Professor Paul Samuelson 2 to 3 per cent 150.00 Inflation and economic growth rate 100.00 Per cent 50.00 0.00 1970.00 1980.00 1990.00 2000.00 2010.00 2020.00 Periode General Growth Rate Figure 3: Infaltation and Ecnomic Groiwth rate computed from Ethiopian data 2/20/2025 17
4. What is the optimal level of inflation for a growing country like Ethiopia? Inflation and Economic Growth This is used to obtain threshold level of inflation by reading from the plot 15 Economic Growth rate 10 5 0 0 20 40 60 80 100 General inflation in per cent Fitted values Based on the general inflation wich is the weigted average of food and non-food inflation Figure 4: Infaltation and Ecnomic Growth rate computed from Ethiopian data 2/20/2025 18
Summary 1. On the components of inflation: Food inflation is more pronouncing in fact the general inflation is driven by food inflation 2. Drivers: monetary factors are the dominant macroeconomic drivers 3. Currency fluctuation and fiscal deficit Fiscal deficit is 4. Inflation has negatively affected welfare and growth during the previous 1 decade. 2/20/2025 19
5. What are the possible measures that can be taken to address inflation This analysis suggests 1. Fiscal and Monetary policies to synchronize in order to influence(cannot control because of endogieniety of money supply ) factors affecting monetary aggregates particularly the factors affecting the Remember MB= FD + TDC + BoB 2. From money supply framework there are two key suggestions M = TDC + NFA monetary base. under accounting 2/20/2025 20
5. What are the possible measures that can be taken to address inflation 2. From money supply under accounting framework there are two key suggestions M = TDC + NFA Two possibilities a. NFA = 0 implying M = TDC b. M = 0 implying TDC =- NFA The second possibility is full sterilization of the foreign exchange flows. The data exhibits case a instead of case b because: ? =m- g >0 and the gap has been widening 2/20/2025 21
5. What are the possible measures that can be taken to address inflation How and by whom? The authorities 1. Independent central bank 2. Key targets and the corresponding instruments Academics, EEA and statistical offices 1. Statistical capacity is very important for a nation. In 2018, Ethiopia is ranked 60th of out of 143 countries with average score of 72.22, while Mexico and Libya ranked the 1st and the 143th with scores of 96.67 and 29.44 respectively (Min = 0, Max =100 scores) 2. Rigorous research and continuous engagement with policy makers 2/20/2025 22
5. What are the possible measures that can be taken to address inflation 3. The media 3.1 Dialoged with suppliers 3.2 Dialogue towards consumers behaviors 2/20/2025 23
Thank you for your attention! 2/20/2025 24
