Senior Special Adviser to the Governor,
Central Bank of the Gambia
Introduction
In Part 1 of this article, we reechoed the imperative to contain inflationary pressures that have reemerged on a significant scale across the globe over the past three years, starting with the onset of the COVID19 Pandemic and its deleterious impact on supply chains. As it is well known by now, this has been aggravated by the adverse ripple effects of the Russian invasion of Ukraine, particularly on food and energy prices. Persistent and rising levels of inflation directly and indirectly erode the living standards of the general population and seriously challenge investors in terms of managing input costs as well as medium to long term corporate planning. It presents governments with serious political problems and overall management of economies. All this is very much evident in the current ongoing global bout of inflation that is also being acutely felt in the Gambia.
But inflation has already been a longstanding and recurring major policy issue for governments and their policy makers in both developed and developing countries for many decades, and it is essential that each bout be subjected to serious diagnostic analysis in terms of the key drivers in order for appropriate policy responses to be formulated and applied. As Lawrence B. Krause and Walter S. Salant aptly put it in the book on Worldwide Inflation they edited in 1977: “No subject of inquiry is older yet fresher than that of inflation. It has bedeviled governments and their economic advisers ever since the invention of money. Despite all efforts to understand inflation, there are always surprises when a new bout appears.” It is for this reason that in the Part 1 of this article, we devoted a significant portion of the space to recalling the different types of inflation and their underlying causes as set out in the literature and in numerous empirical analyses carried out by operational researchers on the phenomenon.
The various articles that were published in the national papers since the onset of the current inflationary pressures in the Gambia have made only oblique references to the debates that have raged during each bout of worldwide inflation since the early 1970s as to whether its drivers are externally driven (imported) or domestically generated. In either case, these debates have important implications for formulating appropriate responses to persisting inflationary pressures at any given time at the national level. In this article, we will subject to a more rigorous but eclectic analysis the nature and underlying drivers of inflation in the Gambia, which has been on the upward trend since the onset of COVID19 Pandemic in early 2020. The hypothesis we will be testing is that even though the principal underlying factors behind these persistent price rises in the country have been externally driven, domestic factors have also not been insignificant at certain times. In the light of this, we will then look at whether the policy mixes deployed by the national authorities so far, particularly the monetary and fiscal ones, have been the appropriate or sufficient ones. But we deem it useful to clarify a little bit more the conceptual differences between what externally driven inflationary pressures (imported) mean as opposed to domestically generated ones, and what can be done in either case.
Imported Vs domestically generated inflation: What does it mean and what are the policy implications?
Even though we extensively discussed the various types of inflation and their causes in Part 1 of this serial article, we did not explicitly differentiate them in terms of being either imported or domestically generated. We did attempt to differentiate between demand driven inflation, normally associated at the national level with excess money supply in the system, on one hand and structural inflation on the other, mostly associated with supply side factors, notably supply chain disruptions. It should already be clear to the reader at this point that reigning in excess money supply or containing high demand in the economy that is exerting pressures on domestic prices (“Demand Pull Inflation”) requires different policy mixes (such as increasing interest rates or commercial bank reserve requirements by the Central Bank) that will be different from those needed to tackle inflation caused principally by supply bottlenecks, as it is the case presently in most parts of the world, notably in Africa.
Thus, inflation is imported into a country or countries when the initial inflationary pressures are sparked principally by external factors. The small open economies like the Gambia’s are particularly vulnerable to this type of inflationary impulses. This is best illustrated by looking briefly at how the current episode of global inflation started and spread to say African countries. As it has been extensively analysed, the outbreak and rapid spread of COVID19 pandemic caused significant supply chain disruptions, both internally and externally, in most industrialized countries like the US and European countries, with compulsory shutdowns of enterprises and institutions as well as shipping operations. The Quantitative Easing adopted by their Central Banks to stave off economic recession combined with direct welfare payments to a large proportion of the general public exerted serious demand pressures and rises in inflation rates. These were aggravated by the adverse effects of the Russia-Ukraine war, especially on fuel and food costs.
In order to stabilize the macroeconomic conditions in the developed countries and support recovery in economic growth, the monetary authorities had to take measures aimed at curbing aggregate demand and their associated inflationary impulses through interest rate hikes and other associated measures. Inflationary impulses were transmitted to many parts of the world from the US through the appreciation of the US Dollar, higher interest rates and elevated prices of imported goods, particularly basic food items, and services. Added to all this was the increased prices of oil and gas. It is evident from these developments that the initial major drivers of the Gambia’s inflationary pressures have been mainly externally driven. In order to better appreciate the externally driven nature of the Gambia and other African countries’ inflation over the past three years, it is useful to put their case in the global context and with a historical perspective. The reality is that externally driven bouts of inflation have been occurring at certain intervals for almost the last century.
This is very well illustrated by a seminal paper prepared by the (US) White House’s Council of Economic Advisers in April 2021 on the “Historical Parallel’s to Today’s Inflationary Episode”. Seeking to better understand the key drivers of the ongoing inflationary episode in the US, which tends to also trigger inflationary pressures in other parts of the world, they argued that there have been a total of six such episodes since the end of World War II: The first episode occurred in the immediate post WWII period as a result of the removal of price controls, setting in of supply constraints and pent up demand for goods and services that had not been made available to consumers; the second episode took place during the Korean War (1950 – 1953), as a result of a combination of increased demand for consumer goods and diversion of much of the production facilities to those for military materials; the third episode took place between early 1969 and 1971, when a booming economy fueled significant price increases; the fourth episode took place between 1973 and 1982, owing to successive surges in oil prices to the global effects of the Iranian Revolution and the prolonged Iran-Iraq War; the fifth episode occurred between 1989 and 1991 due to first Gulf War in the aftermath of Iraq’s invasion of Kuwait; the sixth episode took place in 2008 following the serious financial crisis that started that year and sharp increase in oi prices.
These inflationary episodes are well illustrated in the chart above (Figure 1), whose source is the above-cited report of the White House Council of Economic Advisers. A granular review of all these historical inflationary episodes over the decades since WW II indicates that the main triggering factors have been the following: supply chain disruptions, combined with pent up demand; oil price shocks; and major financial crises. With the US economy at the epicenter of the global economic system, these crises invariably get transmitted to most parts of the world, including Africa. Hence, their inflationary impulses have tended to be principally externally driven in the initial stages, which of course tend to be aggravated by domestic factors subsequently.
In its recent interrogations into the rising trend of inflation in Africa over the past three years, the International Monetary Fund also underscores the externally driven nature of the major factors behind this. This is clearly stated in the Analytical Note for its October 2022 Regional Economic Outlook for Sub-Saharan Africa and I quote: “Inflation has risen significantly in the past two years, driven largely by external factors, including global food prices, oil prices, and supply chain disruptions. Because domestic demand has played a more limited role given the slow recovery, central banks potentially have scope for a more gradual approach to monetary policy tightening. But the pace of tightening must be fine-tuned to changes in inflation expectations, the credibility of policy frameworks, and the extent of exchange rate pressures.” In this regard, for Africa, the IMF specifically identified the following as the key drivers of inflation in the continent: sharp rises in food inflation, high imported fuel costs, exchange rate depreciations and to some extent domestic demand pressures and rising inflation expectations.
The above paragraph provides us with an opening for looking at what is meant by “domestically driven inflationary pressures”. As pointed out in Part 1 of this article, this would normally be due to loose fiscal policies, which result in widening fiscal deficits, as well as accommodating monetary policies. The latter sometimes occurs through printing of money by the Central Banks. Domestically driven factors could also arise from such structural factors as domestic food supply disruptions and natural disasters.
What has been the Gambia’s experience and how efficacious have the policy responses been so far? We will strive to look into these in the next section, even though the limited space cannot allow for a more extensive exposition.
Gambia’s experience with inflationary pressures : A review of historical and recent trends
In order to come up with useful analytical underpinnings, we deem it necessary to first review the Gambia’s experience with inflation over the past twenty – five years. In this regard, it is useful to recall again that the desired inflation target for the country has been 5 -6 % annually. So what has been the country’s record vis-à-vis this set policy target? Figure 2 below provides clear insights into trends in the country’s inflation rates over the past quarter century.
Figure 2
Source: Research Department, Central Bank of the Gambia
The chart shows that the inflation rate in the country was in the double digits (up to 12%) in the late 1980s. This could be attributable mainly to the country’s loose fiscal and accommodating monetary policies of the second half of the 1980s, which led to the introduction of the first Structural Adjustment Programme, that focused on reigning in such expansionary fiscal and monetary policies. So the inflationary pressures then were principally driven by inappropriate domestic policies. But between 1991 and 2002, the rate of inflation was contained in the single digit threshold. In fact, by 2000, it had been pushed down to below 2%. However, owing to external factors, it began to rise again in 2000, reaching a peak of 18% in 2003. This period also coincided with difficult global external developments, although some domestic factors also contributed as well. Again between 2006 and the onset of the current bout of global inflationary pressures in 2020, inflation was checked in the Gambia in large measure, with its being maintained in single digits most of the time. Coordinated approaches by the Fiscal Authority and the Central Bank of the Gambia have contributed significantly to containing inflationary pressures during this period, even though slippages did occur at certain times.
But as already noted, inflation in the country began to take a rapid upward trend following the outbreak of COVID 19 Pandemic and the transmission of the adverse effects of the Russian invasion of Ukraine in early 2022. Consequently, the major underlying factors in the rapid ascent of the inflation rate have been measurable and sustained increases in the food and energy prices. The exchange rate depreciation has also been an important contributing factor to the country’s creeping inflation. But during this period there have also been notable slippages in fiscal policy such as unchecked public sector expenditures, especially during the last election cycle, sharp upward adjustments in electricity and fuel prices, for instance. Consequently, headline inflation reached a peak of 18.5% in September 2023.
It is, therefore, encouraging that since end October 2023, there has been signs of moderation of inflationary pressures in the country. The effective and judicious deployment of monetary policy, combined with efforts to contain some fiscal expenditures as well as deliberate measures to bring down prices of necessities have contributed to this. It is notable that, in addition to the deployment of monetary policy tools to help check inflationary pressures, the Central Bank of the Gambia has also vigorously championed measures to bring down the prices of basic commodities through facilitating their supplies at affordable prices. As of the last meeting of the Central Bank’s Monetary Policy Committee in late November 2023, the rate of inflation had moderated to 18.0%, thus allowing it to maintain the key monetary policy rate at 17.0%, compared to the earlier series of upward policy hikes.
In spite of these encouraging developments on the inflation front, due in large measure to the determination of the monetary authorities to contain the inflationary pressures, there are still upside risks. In addition to maintaining an active policy stance to check the inflationary pressures, in coordination with the fiscal authority, the Central Bank management is also proactively working on initiatives that are aimed at increasing domestic production of a wide range of basic commodities, that could contribute to dampening their prices, while helping the country to conserve foreign exchange. The latter will also help in reducing the widening trade balance and contribute to exchange rate stability as well.
In conclusion, one of the key messages of this two-part article is that it is imperative to contain inflationary pressures to the desired medium-term policy targets in order to prevent deterioration of living standards and ensure conducive and predictable conditions for sustainable and inclusive growth. The second key message is that in order to guarantee effectiveness of anti-inflationary measures, it is essential to get right the diagnosis of the initial and secondary drivers of price increases. Our historical review of global episodes of inflation indicates that even though external factors tend to recur at certain intervals, domestic drivers tend to constitute important contributing factors as well. External drivers will no doubt continue to play an important role in bouts of inflation in small open economies like the Gambia’s. Thus, the durable solution is for them is to maintain both dynamic and prudent macroeconomic policies and strive for transformation of their economies to ensure they are broad based and resilient. The latter will allow them to both rise up to external challenges and continuously take advantage of opportunities provided by the global economy. It is for this reason that the Central Bank of the Gambia’s Economic Transformation Initiatives, which have the blessing of the country’s highest leadership, are well placed.
The views expressed in this article are not necessarily those of the Central Bank of the Gambia.
