Is it time to celebrate as inflation heads south?
BY JOSEPH MVERECHA
I will preface this article with reference to history, but not monetary. We are in September 1942; A brutal and defining war rages in vicious hand-to-hand combat in the ruined city of Stalingrad (Volgograd), on the banks of the Volga, between Europe’s greatest nations, Germany and Russia.
But the German Sixth Army under General Paulus was clearly in the ascendant and by September had taken control of 95% of the city and was carrying out mopping-up operations to clean up the stubborn resistance of General Chuikov 62nd Russian Army, desperately fighting on the banks of the Volga.
For the German Sixth Army and its commander, it was time to celebrate and prepare for the victory parades; Where was it? Fate and the reversal of the tide would be more favorable to the Russian army – they would surround the Sixth Army, then march from Stalingrad to Kursk, Kiev, Warsaw and to Berlin in 1945.
So much for the history, perhaps also a dream that fate would be sweeter for us as we move towards macroeconomic and price stability. For those of us who longed for price stability – low and stable inflation, the news of a sharp annual deceleration in headline inflation from 106.3% to 56.2% (although anticipated due to basic technical effects from year to year)) is very good news.
Indeed, we may already dare to beat the drums. But we know that in all battles – from the fall of Jerusalem in AD 70 to Stalingrad, Kursk, Kiev – every battle – the war is not won until all vestiges of resistance are eliminated and the enemy asks for peace.
The pursuit of the enemy for peace, in macroeconomic policy parlance, is tantamount to the collapse of all inflation expectations, following consistent and sustained policy implementation.
To answer the question of whether there is still time to celebrate, we must answer the question: have we actually reduced inflation expectations?
Necessary to ensure that inflation decelerates irrevocably along the path to single-digit levels as the ultimate goal.
First of all, the authorities are to be commended, both the Reserve Bank of Zimbabwe and the Ministry of Finance and Economic Development for maintaining the disinflation policies over the past year which have seen headline inflation. slow down from a peak of 834.01% in July of last year. at 56.2% this month (July 2021).
Although partly reflecting technical base effects, inflation is indeed trending downward and this could be a watershed moment in the fight against inflation. It is also the first time that headline inflation has reached double-digit levels, since June 2019 – 24 months ago, when the annual inflation rate fell from 97.9% in May to 175.8%. in June.
The annual headline inflation rate is at the level last seen in January 2019 and that’s good news for consumers and the economy.
It is also correct to assume that those in a hurry will probably notice the importance of it all, as the economic plight of millions of people remains a desperate daily struggle.
Again, the fall in the annual inflation rate in July does not mean that prices are falling in the economy – prices continue to rise, but it is the pace of price increases that has slowed. It is difficult to explain to hard-pressed citizens that things are improving as prices all around continue to rise (also correct in text)
Even harder to explain is the rate at which prices are rising that has slowed down.
The public benefit is really much more advanced – if the fundamentals of price stability take hold, any future adjustment to civil service or private sector wages becomes a true wage adjustment, as that wage adjustment exceeds inflation.
This trip is quite long, but it is the only viable route for the country. As has always been the case, the pain of adjustment to correct macroeconomic imbalances comes first, with achievable benefits beyond the short term, provided the authorities stay the course.
If disinflation policies are maintained, the path remains that of a further deceleration of inflation, with headline inflation likely to be between 35% and 40% by December 2021, assuming there is no no new shocks.
This implies a fall in average inflation from an average of 610% in 2020 to 139% in 2021. This would create a very solid platform for a sustained fall in inflation to 12-15% by December 2022. and single digit in Q1 2023.
It’s understandable and sometimes easy to be overly optimistic after a definite decline in a trajectory and think that we are already on the verge of single digit inflation. Both caution and patience are required – this journey is a bit longer than you might think.
Despite the visible progress, there is probably less than 10% single-digit inflation, even next year. Disinflation can be intractable, especially in the presence of exogenous shocks, in addition to internal political shocks. However, if we hit single-digit inflation next year, that would be a welcome miracle.
In view of the progress made so far, the most effective approach would be to anchor inflation expectations, which remain high and fueled by the parallel market premium. Forward guidance is only useful as an anchor for inflation expectations if the forecasts communicated by the authorities are credible, consistent with developments on the ground and well communicated.
We are in a good space, however, there are high risks associated with sustaining disinflation in the future.
The main threats remain the same – a vicious and escalating parallel market, driven mainly by the sub-optimal functioning of foreign currency auctions, a pseudo-fixed exchange rate and the creation of new money.
At some point, in a short time, it will be the parallel market that will determine prices in the economy with damaging implications for price stability.
The inflection point is earlier and not later – it may take a month, two or three, but sooner rather than later prices will increasingly reflect the premium.
The most important aspect of this is also that the longer we hold an overvalued exchange rate, the larger the adjustment will be and the greater the impact on price formation. The costs to the economy will be considerably high.
The exchange rate is overvalued and it is not sustainable – we have been here before. In the short run, currency (not necessarily macro fundamentals) is the only significant variable, with respect to the determination of the exchange rate, especially in an environment of high inflation. Since November of last year, high power silver has grown from ZW $ 15.2 billion (US $ 177.5 million) to ZW $ 24 billion (US $ 280 million), an increase staggering 57.9% in six months.
Other countries in the region where inflation is low and stable – Botswana, Tanzania, Kenya, Uganda, South Africa, among others, rarely allow high power money above 10%. per year. No country can achieve lasting stability in inflation while still allowing double-digit growth in high (reserve) money growth.
Money deposits are predominantly short term, reflecting entrenched expectations, and furthermore, the money multiplier increases, as does the speed of circulation.
The increased speed of circulation means that the real demand for money is falling and no economy is supporting growth beyond the short term with a fall in the real demand for money – we’ve been here before. Real demand for money and real GDP growth are two sides of the same coin, just as the exchange rate and interest rate are two sides of the same coin (monetary policy).
As such, high and volatile recurring inflation for small open economies (as well as episodes of hyperinflation) is still largely a monetary phenomenon operating through multiple transmission processes collectively known as the cash flow mechanism. monetary transmission.
Overall, this is a reflection of too much money in the economy – leading to a buildup of inflation expectations, uncertainty, exchange rate pressure and ultimately account, a price revision and an escalation of domestic prices.
Our economy has many complex unknowns. There are threads and patterns that we see clearly, but others imperfectly and some are well hidden in the underground macroeconomic landscape.
What is clear and indisputable, however, is that in today’s environment, dominated by inflation expectations, the exchange rate is reacting disproportionately – more than one to one to any injection of new money. , leading to a depreciation of the exchange rate and additional pressure on prices.
The recent study by University of Zimbabwe economics professor Dr Carren Pindiriri on behalf of the Zimbabwe Confederation of Industries (along with other studies) put this question aside.
Back to my original question: the annual inflation rate is heading south, is it time to celebrate?
Yes, unambiguously, this is an important and decisive step!
But let’s also keep in mind that the road to price stability is long, and the climb ahead is no less steep, probably more difficult.
The key is for the authorities to stay the course, tighten fiscal and monetary policy further.
They also need to revamp the foreign currency auction to ensure that it is a genuinely Dutch auction and not a foreign currency auction rationing system.
Will the authorities stay the course?
Time will tell us.
Mverecha is an economist at a local bank. He writes in a personal capacity.