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EXPLORING THE NEXUS BETWEEN MONEY SUPPLY, INFLATION, AND THE IMPACT ON POVERTY: A COMPENDIARY

September 24, 2023

Teshome Abebe*

Introduction:

The Ethiopian economy witnessed significant changes and challenges between 2018 and 2023, characterized by a burgeoning money supply, skyrocketing inflation rates, and the adverse effects of ongoing conflicts. This report aims to dissect these economic dynamics, demonstrating the connection between the expansion of money and inflation while suggesting how both inflation and conflict contribut to economic hardships such as unemployment and economic instability for the poor.

 

Background and Context:

  1. A) Money Supply Expansion:

During the period between 2018 and 2023, Ethiopia experienced a notable increase in its money supply. Several factors contributed to this growth, including increased government spending, foreign aid, and limited investments in infrastructure projects. As a result, the money circulating in the economy expanded significantly, influencing various economic indicators.

  1. B) Inflationary Pressures:

Along with other factors, the surge in money supply inevitably led to skyrocketing inflation rates. The Ethiopian economy experienced double-digit inflation during this period, severely impacting the purchasing power of its citizens. The relationship between money supply and inflation is a well-established economic principle, and Ethiopia was no exception to this phenomenon.

 

  1. C) The Impact of Conflict:

One of the primary reasons behind Ethiopia’s economic challenges during this period was the ongoing conflicts in regions such as Tigray, Oromia and now Amhara, which led to sharp increase in military expenditures, diverting resources away from productive sectors of the economy. Moreover, these conflicts disrupted agricultural activities, already leading to food shortages and further driving up inflation. There is considerable evidence that food shortages will worsen next year and beyond as cultivation in parts of the country has almost stopped completely because of the interminable conflicts.

 

  1. D) Unemployment and Economic Chaos:

The economic consequences of conflict were deeply felt by the Ethiopian population. The displacement of communities and the destruction and/or closures of infrastructure had severe repercussions on livelihoods. As a result, unemployment rates surged, exacerbating economic hardships for many Ethiopians. Economic chaos ensued as uncertainty and instability hindered investment and economic growth.

 

  1. E) Governance Response:

The Ethiopian government’s response to the economic challenges is unrecognizable other than the effort to seek loans and grants from the international community and organizations. There has not been any measurable response aimed to curb inflation and stabilize the economy. However, even if there were efforts, the effectiveness of these policies would have been limited due to the ongoing conflicts, which continued to strain the nation’s resources.

In sum, we can state that the Ethiopian economy between 2018 and 2023 witnessed significant growth in money supply, which, in turn, helped contribute to skyrocketing inflation rates. These economic challenges were further exacerbated by ongoing conflicts that disrupted economic activities, led to unemployment, and created an atmosphere of economic chaos. The Ethiopian government’s efforts to mitigate these issues faced significant obstacles due to the protracted conflicts. It is crucial for policymakers to address both the monetary and conflict-related factors to restore stability and economic prosperity in Ethiopia.

 

The Impact of Increased Monetary Growth

I will devote the following section of this essay to address the impact of increased monetary growth on poverty in developing countries in general, and Ethiopia in particular.

 

The Data:

DATA FROM THE NBE 21-22 ANNUAL REPORT

All data in % Changes from Previous Year except for X-Rate

YEAR 17/18 18/19 19/20 20/21 21/22

M1 .30 .10 .16 .20 .34

M2 .20 .16 .15 .30 .27

GOVT. EXPEND. .08 .17 .16 .25 .30

 

X-RATE 26.1 28.1 31.3 39.0 48.57

INFLATION 14.6 12.6 19.9 20.2 33.8

FOOD INFL. 13.4 13.1 23.3 23.2 40.3

REAL GDP GROWTH 7.7 9.0 6.1 6.3 6.1

 

Data are the author’s calculations based on the NBE annual report.

Monetary growth, often associated with economic development, holds the promise of improving living standards in developing countries. However, an unchecked increase in monetary growth can paradoxically lead to rising poverty levels in these nations. This section of the essay explores the intricate relationship between monetary growth and poverty in developing countries, shedding light on the mechanisms that can turn seemingly positive economic indicators into a driver of poverty.

 

1) Inflation and Reduced Purchasing Power:

One of the primary mechanisms through which increased monetary growth can lead to poverty is inflation. As the money supply expands rapidly, the value of the local currency diminishes, leading to rising prices for goods and services. This erosion of purchasing power disproportionately affects the poor, who often struggle to keep pace with rising living costs. Inflation effectively reduces the real income of individuals, making it more challenging for them to afford basic necessities.

Ethiopia is among the countries globally grappling with a substantial decline in its currency’s value. Recent data from the Troubled Currencies Project (TCP), which tracks exchange rates in black and spot markets, reveals that the Ethiopian birr has depreciated by nearly 40% against the US dollar since January 2022. (July 4, 2023). In fact, because often, governments fabricate inflation statistics to hide their economic problems or simply choose not to report inflation data, the TCP uses the principle of purchasing power parity (PPP), which links changes in exchange rates and changes in prices as a reliable estimate of inflation during periods of elevated inflation. Indeed, TCP estimated the inflation rate in Ethiopia at 36% for December 2021, using the free-market exchange and official exchange rates at the time. The official inflation rate reported by the government in September 2021 was 34.8%. The heart of this estimation is the exchange rate. According to TCP, if free market exchange-rate data (usually black-market data) are available, a reliable estimate of an inflation rate can be determined. Applying the same method, my own estimate of inflation in Ethiopia today is roughly 50%–a figure so high that the country is on the verge of a hyper-inflationary trajectory.

We cannot underestimate the impact that such high rates of inflation have on the people of Ethiopia whatever their economic status. The TCP calculations are provided in the two figures below for easy reference.

TCP’s estimation of actual inflation (in blue) in Ethiopia.

 

2) Unequal Distribution of Wealth:

Increased monetary growth can exacerbate income inequality within a country. The benefits of economic growth do not always trickle down to the poorest segments of society. In many cases, wealth becomes concentrated in the hands of a few, leaving a significant portion of the population in poverty and limits opportunities for social mobility.

 

3) Speculation and Asset Price Inflation:

In developing countries who are experiencing rapid monetary growth, speculative activities in financial markets may flourish. This can lead to asset price inflation, particularly in real estate and, where they exist, in stock markets. While this may seem like economic prosperity, it can have detrimental effects on poverty levels. The rise in asset prices creates barriers for the poor to access housing and investment opportunities, locking them out of potential wealth-building avenues. Particularly worthy of note is that asset price inflation, especially in urban sectors, has been one of the main drivers of inflation in Ethiopia. Officially and in theory, land belongs to the Ethiopian state (before it belongs to a party!). However, common practice since the formation of ethnic federalism, is that urban land has been used as a reward for loyalty to the controlling party. As a result, both the Tplf government (1991-2018), and now the Oromo PP government (2018-), have been allocating huge tracts of urban land to loyal party cadres and to military personnel (generals) and other functionaries. The recipients of such land sell the properties at exorbitantly high prices to those who could afford them, and who in turn sell the assets at even higher prices. This way, millionaires are born instantly in the scheme! Many wonder how Ethiopia, a country in conflict with itself, could report high economic growth rates with chaos all over the country. The simple answer can indeed be partly found in the high asset price inflation! The poor are instantly outpriced and driven out of such land grab-schemes, giving birth to shanty towns or migration to other locations.

 

4) Vulnerability to External Shocks:

Developing countries with high monetary growth rates are often more vulnerable to external economic shocks. A sudden change in global economic conditions, such as fluctuations in commodity prices or changes in international trade, can disrupt these economies. As a result, the poor, who are more reliant on unstable sectors, may suffer disproportionately from economic downturns, further deepening poverty levels.

Indeed, the Oxford Poverty & Human Development Initiative (OPHI), in a briefing in 2022, provided that, for the year 2019 alone, the national severe poverty rate in Ethiopia was 41.9%. Of these, 17.4% was for Urban areas; and 51.0% for rural areas. However, the government, through the Ministry of Planning & Development, in a report titled Voluntary National Review 2022, states that the poverty rate has gone down from 23.5% in 2016 to an estimate of 19% in 2020. As bewildering as it is to see such variations in the data, it could be due to the specific measures used of poverty itself, and the fact that often, governments fabricate poverty and inflation statistics to hide their economic problems. In the extreme, some countries simply stop reporting these data. There has been no official reporting of poverty data for 2020-2023 that I could find.

 

5) Crowding Out Investment in Social Services:

Excessive monetary growth can lead to government budgetary challenges. As governments grapple with managing inflation and fiscal deficits, they may reduce investments in crucial social services such as healthcare, education, and infrastructure. They may even be unable to pay the monthly salaries of government workers. This reduction in public services directly impacts the poor, who rely more heavily on these services and can hinder their ability to escape poverty through education and healthcare access.

In summary, while monetary growth is generally seen as a positive sign of economic development, its impact on poverty in developing countries is complex and often negative. Inflation, unequal wealth distribution, asset price inflation, vulnerability to external shocks, and the crowding out of social services are among the mechanisms that can turn monetary growth into a driver of poverty. It is imperative for policymakers in developing countries to adopt measures that ensure the benefits of economic growth are equitably distributed and that inflation is kept in check to mitigate the adverse effects on the impoverished segments of society. Balancing monetary growth with poverty alleviation remains a formidable challenge for many developing countries including Ethiopia.

 

*Teshome Abebe, Ph.D. is a former provost and currently serves as Professor of Economics.

 

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