የኢትዮዽያውያን ዴሞክራቶች ድረ-ገፅEthiopian Democrats' Website

The years after the great depression of the 1930s were dominated by Keynesian economic thinking, which suggests that there must be a continuous increase in the level of inflation in order to achieve economic growth and, hence, to reduce unemployment. In other words, there exists a positive long-term relationship between inflation and economic growth.

However, this thinking was questioned by monetarists in the early 1970s when inflation could not reduce the level of unemployment. Inflation has a negative effect on the growth of the economy, the episode of high inflation and high unemployment during this period suggested. The leading economist at the time, Milton Friedman, reckoned that “inflation is always a monetary phenomenon.”

Is this saying true in the case of Ethiopia?

At least two pieces of evidence could help to reject this. National Bank of Ethiopia (NBE) has the power to craft the monetary policy of the country. The mission of the Bank is to assist the economic growth of the country and also reduce the level of inflation.

However, the bank faces a problem in reconciling these two conflicting targets due to the lack of governmental commitment to keep it independent. Some developing countries have shown great success in reducing inflation and enhancing economic growth by making their central banks independent from the hands of government. Good examples include Ghana and South Africa.

If the central bank is independent, the government will be restricted from borrowing money from local sources.

The Ethiopian government finances its expenditures mainly through borrowing. This borrowing is both from local and international lenders. The central bank stands as the main source of the government’s local borrowing.

Such financing, in return, is causing inflation in the economy since it is only by printing money that the bank finances the governments’ ambitious expenditures. If the central bank was independent, this problem would be solved, since government borrowing would be restricted beyond a certain limit.

Obviously, the measure could push government expenditures down, with inflation reduced even further, so as to assist the economy to grow at a faster rate. The lack of independence at the central bank, as it stands, is tempting the government to finance its expenditures by printing money. This is one of the reasons that inflation is not a monetary phenomenon in Ethiopia.

However, it is very difficult to make NBE independent unless it has professional staff. Lack of professional manpower in the country might be one reason not to extend independence to the Bank at this particular moment.

But, the government should display a strong commitment to reducing its direct and indirect borrowings from the bank, in order to reduce inflation. Expansionary fiscal policy must be abandoned by the government.

The Ethiopian government has taken several measures to reduce the level of inflation in past years. Most of the measures are monetary in nature, including raising the interest rate from three per cent to four per cent to boost savings in the economy. However, this has not curbed inflation.

The reserve requirement was the other monetary policy of the central bank meant to reduce the credit availability in the economy. However, this, too, failed, by forcing the government to put a credit cap on bank lending.

Dismayingly, it was also not able to reduce the inflation rate. In fact, inflation reached 64pc during the time of the credit cap on commercial banks, the data reveals. It was evident that monetary measures failed to control inflation.

The treasury bill market is the other monetary policy instrument. Yet, it is not expected to reduce inflation. Instead, it is expected to pour fuel on the fire of inflation.

The market that restarted with the financial liberalisation of 1991 is being used to finance the government budget deficit.

Unlike any other developing country, the Ethiopian government issues treasury bills in order to finance its deficit. They are deployed to inject money into the economy and liquidate it. Yet, the practice is in complete contradiction with the theory.

If inflation in Ethiopia has always been a monetary phenomenon, the policies taken should have curbed it. But, these policies have not served this purpose.

“What should be done in order to reduce inflation?” one may ask. “Where does the large amount of money in the economy come from? Does it exist because of the large amount of credit available to the private sector? Is it because of a reduced supply of goods? Is it due to high government expenditures?”

Inflation is mostly caused by fiscal balance deficits, much research undertaken in this area indicates. It is almost impossible to find research evidencing that Ethiopian inflation is a monetary phenomenon or an imported one, except from interviews of some government officials in the media.

Inflation in Ethiopia is, thus, largely a fiscal phenomenon. If there is a real commitment by the government to reduce it, monetary policy must not be used but, rather, fiscal policy.

Fiscal conservatism is the only choice that the government has to reduce the level of inflation. One thing must be noted in reducing the level of inflation, though, and that is the sacrifice ratio.

Any economic policy might impose a negative impact on one variable to achieve another targeted variable. Similarly, if inflation is reduced through fiscal conservatism, it is expected that economic growth will decline, as well.

The question is which one is better. Even developed and industrialised countries face this choice. But, the way they resolve it is far different from what has been done in Ethiopia. It is all about the costs and benefits of the policy for each individual.

It is not the government that decides for the people that economic growth is better than inflation or vice versa.

In democratic systems, all choices, including economic ones, are made based on the needs of the people. As it appears, the basic objective of all Ethiopian political parties is to have low and stable inflation, together, with rapid economic growth.

But, one cannot have their cake and eat it, too. The choice is important.

In light if this, the EPRDF has a strong commitment to economic growth, while the Ethiopian Democratic Party (EDP) stands as the lone opposition party in combating inflation. This was observed in the previous Parliament, when Lidetu Ayalew, the then-president of the EDP, compared inflation to blood pressure, while Prime Minister Meles Zenawi compared it to a simple seasonal flu.

The essential choice between economic growth and reducing inflation can only be correctly made by the people. Choosing on behalf of the people a complete preference for economic growth will only make all stakeholders lose in this game.

By Abis Getachew Makuria

abisgetachew@yahoo.com