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The expansive road to inflation

By Admire Mavolwane

SO much has been written and said about the current high oil prices. Concerns range from the unilateral transfer of wealth from oil consumers to prod

ucers, anticipated impact on inflation and the role played by the Chinese economy on oil prices. A number of countries in Africa, Nigeria and Angola included, are enjoying trade surpluses mainly as a result of high oil prices, whilst Zimbabwe among other consumers are blaming the runaway prices for their woes.

However, this is by no means the first oil price shock that the world has gone through since the Second World War. The world economy has experienced roughly three oil price shocks, with the first one now known as the 1973-74 Opec crisis.

Countries responded to the supply side shock differently, but it is rather unfortunate that there is little documentation of what the developing world did when faced with the crises. Case studies have been confined to the first world countries, United States (US), Canada, Europe and Japan.

Most of these governments, with the exception of Germany and Switzerland, thought they would avoid high unemployment as companies downsized through loose monetary and fiscal polices aimed at absorbing the shock. The result was that annual inflation rates reached record “peace” time highs of 12% in the US, France 15%, Italy 25% and Japan 23%. Previously high inflation rates were associated with war times. By contrast in Germany (West Germany before unification), inflation never breached the 6% mark and was even lower for Switzerland.

When another oil price shock hit the world in 1979-80, other countries had learnt their lessons and tightened their fiscal and monetary policies in response, whilst the US initially responded, as it had done in 1973, with the similar double digit inflation figures being the outcome.

Ronald Reagan, after being elected in 1980 and realising the folly of his predecessor’s strategies chose to tighten both fiscal and monetary policies but at a huge cost. Although inflation had receded to 4% by 1983, unemployment had reached a peak 11% of Gross Domestic Product.

The oil price hike coming after the Iraq invasion of Kuwait in 1989 was well handled and world inflation has largely remained at around 2% since then. Since 1999, however, oil prices have moved from US$12/barrel to the current record levels of over US$70/barrel but with no significant impact on world inflation.

The fact that inflation has largely remained in limbo has been attributed to a wide variety of factors, the major one being better economic management by “independent” central banks, globalisation and the fact that the current oil problem is demand rather than supply induced.

The European Central Bank and the US Federal Reserve Banks have also been pro-actively and preemptively increasing their interest rates to choke off inflationary pressures as well as generally tightening both their fiscal and monetary policies. These moves have been likened to taking away the punch bowl before the party gets out of hand.

So faced with an exogenous shock, a country can either try to accommodate it or tighten both fiscal and monetary policies. Both moves have very painful initial results. Tight policies drive the economy into recession (like the one experienced in this country during the early part of 2004), a stronger currency and high unemployment. The alternative course of action results in higher inflation which ultimately leads to a weak currency and high unemployment as well, all of which are familiar to all of us.

The decision on which route to take when faced with an external shock, is one the authorities need to make. On paper, one option (a), that of adopting a strict and tight monetary policy accompanied by a sensible and complementary fiscal policy, is the more sensible one, but has adverse political implications. This option comes as a package such that it will not be effective, if a country adopts a tight monetary policy and a loose fiscal policy.

Option (b) — a favourite of the politicians — works well for as long as things are kept under control, and there is restrain on the use of the printing press. Option (b) is also supposed to be a temporal measure meant to absorb the shock from a temporary source. It has never been known to work, though, when the problem is internal, structural and of a permanent nature. Experience also shows that once one resorts to the printing press it is difficult to kick the habit.

Entrusting the purse to the fairer sex…..

After the de-merger craze of the post 2000 era on the ZSE, a new fad is emerging. The latest craze is the increasing number of female financial directors.

Only three listed companies, Barclays, RTG and Nicoz are led by members of the fairer sex. However, nine companies have opted to entrust their purse to the ladies. Nicoz has the added distinction of having ladies in both the CEO and FD positions. The list of companies with female financial directors has been growing with most of them appointed in the past two years. Does this have anything to do with the current hyperinflationary environment? Is it because women are deemed to be tight with the purse, a necessary attribute in this era of cost cutting?

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