Another relevant aspect of inflation worth highlighting here is what is referred to as “inflation expectations”. James Lee, Tyler Powell and David Wessel, in their seminal paper entitled “What are inflation expectations? Why do they matter?” (2020), aptly note that “Inflation expectations are simply the rate at which people – consumers, businesses, investors – expect prices to rise in the future. They matter because actual inflation depends, in part, on what we expect it to be. If everyone expects prices to rise, say, 3 per cent over the next year, businesses will want to raise prices by (at least) 3 per cent, and workers and their unions will want similar – sized raises. All else equal, if inflation expectations rise by one percentage point, actual inflation will tend to rise by one percentage point as well.” Readers in the Gambia should be able to easily relate to the importance of inflation expectations, given that the continuous hikes in the prices of a wide range of basic commodities that have been taking place and at short intervals since the onset of recent inflationary pressures could be partly attributed to expectations on the part of consumers, businesses and investors that inflation rates will persist. It is for this reason that one of the intermediate objectives of the Central Bank of the Gambia’s fight against inflationary pressures is the anchoring of inflation expectations.
What are the different types and causes of inflation and how are they normally addressed by governments?
As noted above, it is essential to delineate and differentiate between the different types of inflation and their respective underling causes. Just as in the case of diseases, making accurate diagnosis is imperative for administering the correct cures. In this regard, three types of inflation are normally discussed in the literature. The first one is called “Demand Pull Inflation”, and it is mostly triggered by disequilibrium between demand and supply, i.e. when demand for goods and services in this case considerably exceeds their supplies. As explained by one of the basic principles of economics, i.e. demand and supply, when that occurs, prices go up. Thus, one of the key drivers of inflation is shortage of commodities and services. For instance, if there is shortage of onions, cooking oil and rice, their prices will shoot up as they are consumed by the mass of people on a daily basis, and this will be reflected in increases in the Consumer Price Index.
The second type of inflation is referred to as “Cost – Push Inflation”. This occurs when the prices of production inputs, such as raw materials, fuel, labour, energy or technology, go up. Increases in wages, either as a result of labour shortage, industrial action by workers that aim for higher wages or sizeable wage increases by the public authorities, have been an important factor in cost push inflation in many countries over the past decades. The recurring hikes in energy prices have also been a notable factor in cost – push inflation in many parts of the world. In small open economies like the Gambia’s, that depend on external markets for both their consumer and key production inputs, the pass-through effects of the depreciation of their currencies also constitute important factors in cost-push inflation, when the primary importers hike up the selling prices of these goods in the domestic market to recover the additional costs they incur from the payments for more expensive foreign currencies.
The third type of inflation could be termed as “Structural Inflation”. Even though the manifestation of this type of inflation is also increases in the Consumer Price Index or rise in input costs, which in turn trigger general price increases, the main underlying factors of structural inflation arise principally from supply bottlenecks as has been the case since the outbreak of COVID 19, aggravated by the geopolitical conflicts, notably the Russia/Ukraine war. The ensuing disruptions in supply chains across the globe and their adverse impacts on shipping and distributional costs have by now been extensively analysed. The impact of such supply side disruptions on price levels of small open economies like the Gambia’s are felt almost directly. It is useful to point out that the structural causes of inflation are not solely driven externally, but could also be triggered by adverse developments in the domestic scene. These could include natural occurrences such as earthquakes, floods and prolonged droughts as well as the negative effects of climate change, all of which could impact adversely on domestic food production, availability and affordability, for instance.
What are normally the major causes of inflation?
In the preceding paragraphs, we have discussed the main types of inflation and briefly highlighted some of their triggering factors. But for the purpose of this article, and given their clearer bearing on policy making for tackling inflation, we will tease out in greater detail drivers that normally trigger inflationary pressures, especially in developing economies like the Gambia’s.
In this regard, the first driver is increased money supply in the economy. This happens when a government prints more currency of a given country that significantly exceeds the amount that is commensurate with the prevailing economic growth. This will be manifested in the proverbial “too much money chasing too few goods and services”, thereby triggering demand pull inflationary pressures. A typical example of this that is cited in the literature is the massive printing by the post-World War II German Government in order to pay the reparations imposed on it by the Allies. This triggered one of the highest inflation rates in global history. In more recent times, some countries in Africa, notably Zimbabwe, Mobutu’s Zaire and Ghana under military regimes in the 1970s, had carried out the same practices with similar devastating effects on inflationary pressures in the countries.
Other important government policies, notably running of high fiscal deficits, that are monetized, i.e. funded by the central bank, could also be major drivers of inflation in most economies. Additionally, some analysts point to imposition of high import duties or restrictive quotas, that can trigger cost-push inflationary pressures.
Exchange rate depreciations, which inevitably result in loss of value of domestic currencies, such as the Dalasi, also constitute an important triggering factor for rises in prices, especially of imported goods and services. This particular cause of inflationary pressures has been discussed in more detail above.
Wage increases also constitute significant drivers of inflation, particularly when they fall below the rate of improvements in productivity of the workers. Wage increases could arise from industrial action by workers in response to rising costs of living or to perceived discrepancies between productivity increases on their part on one hand and prevailing actual wage levels. Substantial wage increases in the public sector could constitute an important fueling factor in rising prices. This is why restraint is exercised by many governments with respect to salary and wage increases in their public sectors.
In this article we have reinforced the point with which many readers are already familiar as to why and how the phenomenon of inflation has become a critical socio-economic policy issue, with important political implications as well across the world. The data on the Gambia’s macroeconomic situation and cries on the part of the general public about incessant price rises over the past three years also indicate that this has been the case in the Gambia as well and that containing the inflationary pressures should be at the center of the country’s macroeconomic policies. This resurgence of inflation in the country has prompted numerous interviews on the part of senior Government officials and spurned a number of articles on the issue in the local newspapers. Many of the articles have a populist orientation, lacking the necessary rigorous and objective analysis that could come up with the right policy solutions under the circumstances while some are overly academically oriented, beyond the full comprehension of the general public.
It is for this reason that this article starts with provision of simplified conceptual clarifications about the various aspects of the phenomenon of inflation, backed by empirical examples, before analysisng the different drivers of inflation and potentially potent solutions. An important point about the latest bout of inflation globally that has preoccupied both academic researchers and policy makers is whether the inflationary pressures are being predominantly externally driven or mainly caused by domestic factors. Each of them has its own specific policy implications. For the Gambia, this issue will be dealt with in depth in Part 2 of this article.
The views expressed in this article are not necessarily those of the Central Bank of the Gambia