It will be disastrous for economy if policy rate is increased – IEA

The Institute of Economic Affairs (IEA) warns of an interest rate (PR) hike, saying it will be disastrous for the economy.

However, it forecasts an unchanged 22% interest rate as the Bank of Ghana’s Monetary Policy Committee (MPC) meets today to review developments in the economy.

In a statement, the IEA said it expects the Bank of Ghana to work closely with the government to take additional targeted measures to tackle the inflation crisis.

“It is also clear, as we have argued time and time again, that PR alone cannot be relied on to deal with the current inflationary crisis, especially given the specific nature of the causes. If we take PR to the extreme, the consequences for the real economy could be catastrophic.”

“Indeed, many countries around the world have come to this realization and are taking unprecedented measures beyond their orthodox frameworks of inflation management to deal with what appears to be an unprecedented inflationary crisis. With that in mind, we expect the MPC to keep the PR at 22%. However, we expect the Bank of Ghana to work with the government to take additional targeted measures to address the inflation crisis,” she said.

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In the current era, with the exchange rate under so much pressure, the IEA added that it is incumbent on the MPC to keep its policies tight to counter the potential risk of capital outflows posed by the domestic economic difficulties and monetary tightening was increased the US, UK and Europe.

The MPC decision, it said, must therefore recognize the forecast outlook for the exchange rate based on the information available to the committee.

Overall, risks appear to be on the upside when it comes to the inflation outlook. “Upside risk factors include recent increases in fuel prices and utility tariffs, as well as expected increases in transportation prices. On the other hand, the expected seasonal increase in food supply and the expected stability of the exchange rate due to expected inflows, which may only be temporary, represent partially offsetting downside risks.”

Fighting inflation requires both fiscal and monetary measures

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Inflation reached 33.9% in August, a rate driven by supply and cost factors, particularly food, fuel and the exchange rate.

In it, it pointed to the inadequacy of the inflation targeting framework in dealing with these supply and cost drivers of inflation, particularly at the primary level.

“As we argued above, the current inflationary crisis is largely driven by supply and cost factors, notably food, fuel, transport and the exchange rate. The impact of these factors can be illustrated by breaking down August headline inflation from 33.9%: Diesel inflation was 116.9%; gasoline inflation 80.5%; transportation inflation (fuel costs embedded), 45.7%; imported inflation (reflecting the effect of the exchange rate), 35.2%; and food inflation, 34.4%. In contrast, in terms of relative contributions to inflation in August, food made the largest contribution (45.4%), followed by transport (14.3%). These factors have consistently dominated inflation for more than a year.”

“We have repeatedly pointed out the inadequacy of the IT framework in dealing with these supply and cost drivers of inflation, particularly at the primary level, although we recognize its potential role in containing second-round effects of these factors. The supply and cost factors should be addressed head-on with appropriate policy interventions,” it said

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To this end, she called for cooperation between the Bank of Ghana and the government to directly address the underlying causes of national inflation.

It therefore recommended interventions aimed at boosting supply and/or introducing subsidies where appropriate.

“Countries around the world, including large economies, where inflation tends to be primarily demand-driven and where demand-side management approaches such as IT may be more appropriate tools, have resorted to interventions modeled on those associated with Covid-19 and the Russia Ukraine war. The US passed the Inflation Reduction Act. The new UK Prime Minister has capped energy prices for two years. France has capped fuel prices and capped increases in electricity tariffs at 4%. If these countries are taking these unorthodox and innovative measures to cushion their citizens, who are far wealthier than we are, why can’t our policymakers be just as proactive?”

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