Posted by Ignacio on
Fri, 28/07/2006
Like every Friday, from Raj Nallari and Breda Griffith's lecture notes.
Inflation
Simply put, inflation is defined as the increase, over a given period, in the price of a representative basket of goods and services.
Inflation is measured by observing the change in the price of a representative basket of goods and services in an economy. The prices of goods and services are weighted in order of importance and combined to give a price index measuring the average price level; the inflation rate is the percentage rate of increase in this index.
Some common inflation measures include:
- Consumer price indexes (CPI) - these measure the price of a selection of goods and services purchased by the average consumer. These measures are often used in wage and salary negotiations since employees wish to have pay raises that equal or exceed the cost of living, best proxied by rate of increase of the CPI.
- Wholesale or Producer price indexes (WPI) – measure the price paid by a representative producer. This differs from the CPI since price subsidies, profits and taxes cause the amount received by the producer to differ from that paid by the consumer.
- Commodity price indexes measure the change in price of a selection of commodities.
- The GDP deflator is a measure of the changes in prices of all goods and services produced in an economy. Although this measure has the advantage of being comprehensive, it typically is only available quarterly, with a long lag, and is subject to revision.
Inflation is a sustained rise in the general price levels, combined with a fall in the purchasing power of money. If inflation is zero or very low, this is referred to as price stability. Under conditions of price stability, inflation is seen as having no material impact on individual economic decision making. Moreover, a low, but positive inflation rate (say 2 percent a year or less) can have positive effects on the economy since it allows relative prices or wages to adjust more easily. This can keep unemployment lower than it otherwise would be. However, once inflation rises above certain levels, it can distort decision making and can have negative effects on the economy and growth.
Types of Inflation
Economists distinguish between two types of inflation:
- Demand-pull inflation – occurs when there is too much money chasing too few goods, because the demand for current output by consumers, investors and government exceeds available supply. Because, under such conditions, resources are fully employed, the business sector cannot respond to this excess demand by expanding output, so they typically react by pushing up prices instead. If these conditions are sustained, the result is demand-pull inflation.
- Supply-side inflation or cost-push inflationt - occurs when a firm passes on an increase in production costs to the consumer in the form of higher prices. The inflationary effect of increased costs can be the result of: i) increased wages leading to: a) wage – price spiral, which occurs when price increases spark off a series of wage demands which lead to further price increases and so on. b) a wage-wage spiral, which occurs when one group of workers receive a wage increase which sparks off a series of wage demands from other workers ii). increased import prices which can be the result of: a) a rise in world prices for imported raw materials b) a depreciation in the local currency.
Central banks can impact inflation to a significant extent through setting interest rates and the use of monetary policy. High interest rates are the method of fighting inflation that Central Banks often resort to in order to fight inflation, using the resulting decline in production and unemployment to prevent price increases. However different central bankers have varying approaches to fighting inflation.
Some emphasize increasing interest rates by reducing the money supply through monetary policy to fight inflation. Another school of thought advocates fighting inflation by pegging the exchange rate between the currency and a stable reference such as the dollar. These different methods have met with differing measures of success: in spite of efforts to curb inflation, some nations have experienced double-digit, triple-digit or even astronomical annual rates of inflation in recent years.
The Cause of Inflation
As we have seen, inflation is often explained by excess demand conditions or through producers passing on higher costs in the form of higher prices. But for either condition to hold, the central bank plays a critical role. If the central bank pursues a tight monetary policy – by using instruments to increase interest rates or restrict the money supply – excess demand will be wrung out of the system and producers will not be in a position to pass on all their costs in the form of higher prices. On the other hand, an accommodative monetary policy stance – low interest rates of rapid expansion of the money supply - will allow prices increase to continue or even accelerate.
Fiscal policy can either support or hinder monetary policy operations. Prudent fiscal policies allow the government to get by with zero or minimal central bank borrowing (leading to zero or minimal excess money creation). By contrast, profligate fiscal policy and high central bank borrowing can force a central bank into a looser monetary stance.
Next week: Inflation and Economic Growth / Inflation and the Poor
Posted by Ignacio on
Wed, 26/07/2006
Posted by Ignacio on
Mon, 24/07/2006
From Raj Nallari's lecture notes on Gender and Macroeconomics.
Globalization, defined as the increasingly free flow of ideas, people, goods, services, and capital that leads to the integration of economies and societies, has become a major force for global change, but much remains to be understood about the transmission channels and potential impacts. The developing countries commonly complain that the global system is a ‘creditor-run trade and financial system’ and as such, maintaining the stability of the trading and financial systems is more important for the advanced countries than the developing world. As interdependence between the developed (North) and developing countries (South) becomes greater, the economic policies of the North will probably become more and more important for the South.
More than merely the expansion of worldwide trade, globalization is based on improvements in the last two to three decades in telecommunications and information technology, and financial sector reform that has opened domestic markets to foreign investors, especially in services, and the differences between local and international markets is blurred. These developments are impacting upon the structures of employment. Women's employment and income earning prospects must now take account of the globalization (Joekes 1995, p.6). For example, some developing countries which exported a rising proportion of their manufactured output to the developed countries tended to employ a rising proportion of females in their manufacturing sectors (Wood p. 171). No strong export performance in manufactures by any developing country has ever been secured without reliance on female labor. (Joekes 1995, p 12.) Women now comprise about one third of all industrial sector workers in developing countries (Ibid. p.4). In a series of articles Guy Standing details several aspects of globalization that have affected labor conditions and use of modern technologies, with direct consequences for male-female work patterns and labor regulations (Standing 1999, p. 584).
The full paper is attached.
Posted by Ignacio on
Fri, 21/07/2006
From Raj Nallari and Breda Griffith's lecture notes on Economic Growth and Poverty Reduction.
Introduction
As discussed in previous postings, poverty can be reduced by increasing economic growth and by increasing the share of this growth going to the poor. Economic growth can be fostered by a set of policies aimed at macroeconomic stability. By this we mean low budget deficits, a low and stable rate of inflation and sustainable external debt. Fiscal and monetary policies are of central importance to the rate of inflation in the economy. As we saw, one of the ways of financing a government deficit is to print money. Excessive money creation results in inflation and can lead in turn to macroeconomic instability. A second way of financing the deficit is to borrow from abroad, which adds to external debt, a third way is to run down foreign exchange reserves increasing the likelihood of an exchange rate crisis. This week we provide an introduction to monetary policy and the main instruments of monetary policy. In upcoming weeks we will continue with a description of inflation, its causes and its impact on economic growth and on poverty. Finally, we will focus on exchange rate policies and on fixed versus flexible exchange rates.
Monetary Policy
Monetary policy may be loosely defined as the Central Bank’s decisions on money supply and inflation and exchange rate objectives.
Demand for Money Curve
Monetary policy works through changes in the money supply and interest rates. For example, in the face of a recession and high unemployment, the central bank may choose to use expansionary monetary policy to stimulate demand. In such a case, the central bank would expand the money supply (M), and bring down interest rates. We can think of the interest rate as the price of money. If the supply of money increases relative to the demand, the price (interest rate) falls. The lower interest rates mean that it is cheaper to borrow money which stimulates business investment. As businesses invest more, they hire more workers, increasing employment. There are now more workers with a paycheck and their spending creates an increase in aggregate demand for goods and services. Lower interest rates also stimulate additional consumer spending directly. Businesses respond to the increased AD for their products by increasing investment and employment. This creates more AD and so on.
Two types of monetary instruments exist:
Direct instruments of control include (1) credit ceilings on individual banks, (2) control of interest rates, and (3) use of discriminatory capital/asset ratios. While these instruments have fallen out of favor in industrialized countries, most developing countries use these instruments.
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Once the overall credit ceiling is in place, individual ceilings are then established for each major financial institution based on past market shares. Direct controls are reasonably effective in preventing excessive credit expansion in the short term but lose their effectiveness over time. They tend to reduce competition among banks – once a bank reaches its credit ceiling, it has no incentive to continue to attract additional deposits. Banks may concentrate on their established clients and be unwilling to finance new projects that may turn out to be more profitable. Thus the flow of capital in the economy is restricted. Furthermore, when credit is disbursed based on administrative criteria rather than profitability, corruption tends to increase. Disaffected depositors and borrowers create incentives for financial intermediation outside the control of the Central Bank. Thus there is a loss of monetary control as credit operations are conducted outside of the banking system.
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Interest rate controls are often introduced along with credit ceilings. Over time, these may be ineffective as it is generally not possible to control both the cost and quantity of credit. Fees may be imposed thus raising the cost of credit and defeating the original purpose. Moreover, imposing excessive fees and/or imposing other restrictions on loans reduce the transparency of the price system in providing the correct signals for the allocation of resources.
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A minimum capital/asset ratio is often used by the central bank to force branches of foreign-owned banks to increase their capital.
Indirect instruments include (1) reserve requirements, (2) Central Bank lending facilities, (3) open market operations and (4) deposit management.
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Reserve requirements, which are held in the form of cash in banks’ vaults and deposits with the central bank, affect the demand for reserve or base money and, working through the money multiplier, assist in controlling the broader money supply and credit conditions. An increase in reserve requirements typically raises banking system costs (as interest rates paid to banks for reserve holdings are typically less than rates banks pay to depositors), which tend to be passed on in the form of higher interest rates on loans. However, frequent changes in reserve requirements can confuse market participants and lead to excess holdings of reserves. This can in turn hamper the effectiveness of monetary policy.
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The Central Bank’s lending facilities should only provide short term or emergency financing to the banking system. By expanding or restricting access to the central bank credit and refinancing/rediscounting facilities, credit expansion in the economy is influenced. But in some of the developing countries, political pressures have led to the use of this instrument to extend credit to commercial banks with inadequate reserves (such as state-owned banks) or to provide support to troubled financial firms. Reduction in access to central bank rediscount facilities and credit is very effective as it curtails credit to the private sector through the banking system. The discount rate – the interest rate that a bank must pay the central bank when it borrows money from it - is generally high to discourage borrowing by the commercial banks which could offset the impact of open market operations. The central bank also operates as lender of last resort in emergency circumstances. In doing so, it will generally provide credit at high interest rates and only when borrowing banks are in a position to supply high-quality collateral. This encourages banks to first seek to raise funds from the public or the interbank market.
- Open market operations refer to the Central Bank’s buying and selling (or borrowing and lending) of securities to inject or withdraw liquidity respectively into the system. There are a number of advantages to developing open market operations, including the development of a money market, and the flexibility it lends to the central bank in conducting its monetary policies.
- The Central Bank is generally the government’s bank, managing government deposits. Transferring government deposits between the banks and the central bank affects the level of reserves. While performing an essential ‘fiscal agent’ role for the government, viewed from a narrower monetary policy angle, it is not the most transparent instrument of monetary control and a key disadvantage is that it does nothing to encourage market development and competition.
Posted by Ignacio on
Thu, 20/07/2006
Our friend and colleague from the PSD Blog, Pablo Halkyard, is leaving the World Bank. In his farewell post he reflects about the development blogosphere and includes a few links of interest, including their development blogroll with almost 200 entries.
http://psdblog.worldbank.org/psdblog/2006/07/moving_on.html
Good luck and thank you to a pioneer of blogs at the World Bank.
Posted by Ignacio on
Tue, 18/07/2006
From Raj Nallari's lecture notes on Gender and Macroeconomics.
Fiscal policies are a key determinant of national economic developments because achieving the MDGs have given special roles for both private and public sectors. In this chapter, we discuss some of the fiscal issues, such as the ways governments can use their fiscal policies to achieve macroeconomic objectives relating to growth, inflation, and gender equality. Fiscal adjustment has been blamed for having a negative impact on women and child, and therefore on communities. Therefore, key issues related to gender-responsive fiscal policy are discussed around the following broad questions.
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What is fiscal adjustment and why is it needed?
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How does fiscal adjustment impact on women?
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What is gender-budgeting?
Download the full lecture.
Posted by Ignacio on
Fri, 14/07/2006
As every Friday, from Raj Nallari and Breda Griffith's lecture notes.
Fiscal Policy and the Poor
In a developing economy context taxation is generally less effective than spending programs in pursuing pro-growth policies. The rich generally have more options open to them in avoiding high taxes on their income. Furthermore, even exempting some food items from consumption taxes (VAT) may not benefit the poor as the rich can afford to spend a larger absolute amount on the exempted good, so they derive the largest benefit. Moreover, there’s always the question of whether the exemption could yield revenue that could be spent in a more pro-poor way.
On the expenditure side, there is evidence that increased spending on physical and human capital formation can promote economic growth and reduce poverty. Protecting investment in physical and human capital during times of fiscal consolidation tends to be more sustainable and therefore better for economic growth. Easterly and Rebelo (1993) show that an increased government expenditure on transport and communication of 1 percent of GDP is associated with an increase in annual per capita GDP growth of approximately 0.6 percentage points. Increased government expenditure on health and education contributes to the well being of a population and increases worker productivity. Reducing communicable disease also increases worker productivity and helps to promote tourism and attract foreign direct investment. The World Health Organization (2001) estimate that for each 10 percent improvement in life expectancy at birth, per capita GDP grows by 0.4 percentage points.
Pro poor budgeting
The national budget is the instrument that governments use to regulate and prioritize public expenditure. Processes requiring participation of citizens and the poor in resource allocation, expenditure tracking, and monitoring service delivery systems, can help make fiscal institutions more demand-driven and pro-poor. For example, participatory budgeting has been used in many Brazilian municipalities since the mid-1980s. It involves, first, checking that the previous year’s budget was adhered to and in line with stated policies; and second, bringing together people from different geographical areas and interest groups to define expenditure priorities for the next budget. Participatory budgeting has allowed public expenditure to more closely reflect citizens’ preferences. In Itabuna, Brazil, for example, participatory budgeting resulted in a large shift toward investment in water and sanitation, the top priorities expressed by its citizens.
Attached, a case example from Uganda: Can the poor influence the budget?
Next week we will start looking at monetary and exchange rate policies, and their influence on the poor.
Posted by Ignacio on
Thu, 13/07/2006
Posted by Ignacio on
Tue, 11/07/2006
The International Poverty Centre's journal Poverty in Focus highlights in its June issue the importance of social protection in the fight against global poverty. Various authors write about social protection and cash transfers programs in different regions.
- Targeting and universalism in poverty: are social benefits a basic right for all citizens or only for the truly needy and deserving?
- Social protection for the poorest: a broad view of social protection for the poorest is presented, which envisages social protection as having both short- and long-term roles in poverty reduction, based on case study material
- Income grants for all South Africans?: the implications of such a scheme are analysed, including both poverty reduction outcomes and the macro-economic feasibility
- Cash transfers in Africa: a summary of an IPC study of conditional cash transfers in 15 African low-income countries, and a presentation of an unconditional cash transfer pilot scheme in Zambia
- Employment guarantee laws in India: outline of new legislation promising employment for all poor households and the right to public information for full transparency, with an example of a similar initiative in Bangladesh
- Conditional cash transfers in Latin America: what are the challenges and lessons from this region and are they transferable?
- Social protection for pro-poor growth: a bilateral donor representative's view of the role of social protection in promoting pro-poor growth and poverty reduction, and how donors are working together with developing country partners for providing more effective support towards this end.
Read the full issue of Poverty in Focus:
http://www.undp-povertycentre.org/newsletters/Poverty_in_Focus_June_06.pdf
Via Eldis.
Posted by Ignacio on
Fri, 07/07/2006
From Raj Nallari and Breda Griffith's lecture notes.
Fiscal Policy and its Impacts
Through its decisions on fiscal policy, government can attempt to smooth business cycles and redistribute income. While these are good goals, overreaching on the fiscal side can lead to crowding out and inflation. Today we discuss these important issues.
Fiscal policy and the business cycle
Fiscal policy can help smooth the business cycle through its impact on aggregate demand (AD) .The change in AD is typically greater than the initial change in government expenditure because of the so-called multiplier effect. The government may use expansionary fiscal policy by raising government expenditures (G) or lowering taxes to increase output or aggregate demand. Business responds to the increased demand for their goods and services by increasing business investment. As businesses invest more, they hire more workers, increasing employment. There are now more workers with a paycheck and their spending creates an increase in AD for goods and services. Businesses respond to the increased AD for their products by increasing business investment. As businesses invest more, they hire more workers and increase employment and so on (the multiplier effect). With contractionary fiscal policy, the opposite happens. The appropriate fiscal policy stance for an economy depends on the economic situation and time frame. While short-run fiscal policy may aim at smoothing the business cycle, over the long run the aim of fiscal policy should be to keep the deficit at a low and stable level to help underpin economic growth. (As we shall discuss, high and sustained deficits lead to crowding out, inflation and/or balance of payments problems.) In developing countries, under good macroeconomic conditions, the government may also pursue higher public spending as part of a poverty reduction strategy.
Crowding Out, Inflation and other Deficit Effects
Unchecked increased government spending or the pursuit of expansionary fiscal policies to promote output and economic growth can impose a cost on the economy in terms of increased inflation and/or crowding out of private sector investment. Under expansionary fiscal conditions, at some point inflation is likely to rise as AD (spending) outstrips the aggregate (total) supply (AS) of goods and services. Under such conditions, businesses can hardly keep up with orders and respond to the 'excess' demand by raising their prices. Under tight labor market conditions, employers may also be forced to raise wages in order to attract new workers and retain old workers. This can also be looked at from the financing side. Sustained high fiscal deficits, if financed by the central bank printing money, will set the stage for higher inflation. Sustained higher government spending can also lead to crowding out of private investment. If, for example, government chooses to finance its deficits by borrowing in the bond market or from private banks, rather than the central bank, interest rates will increase of the conditions for private sector bank lending will be mad more difficult. Either way, private investment will likely be hurt under such conditions. By contrast, low and stable levels of the fiscal deficit send a positive message on a government’s ability to service its debt and thus may prevent the probability of economic crises. Macroeconomic stability associated with the low probability of economic crises yields further benefits in terms of higher rates of investment, growth, educational attainment, increased distributional equity and reduced poverty (Gavin and Huasmann, (1998), Flug, Spilimbergo and Wachtenheim, (1998)).
Next week: Fiscal Policy and the Poor
Posted by Ignacio on
Tue, 04/07/2006
The ILO has carried out an audit of 14 selected PRSPs in Asia, Africa and Latin America to find out whether indigenous and tribal people have participated in the PRSP process and whether their interests have been taken into account.
Indigenous and tribal peoples represent about 5 per cent of the world’s population, but over 15 per cent of the world’s poor. The incidence of extreme poverty is higher among them than among other social groups and, generally, they benefit much less than others from overall declines in poverty.
The 14 countries are: Bangladesh, Bolivia, Cambodia, Guyana, Honduras, Kenya, Lao PRD, Nepal, Nicaragua, Pakistan, Sri Lanka, Tanzania, Viet Nam and Zambia. The main findings of the report include:
- there are significant differences between and within regions and between countries, in terms of whether and how indigenous and tribal questions are addressed.
- there is a lack of indigenous-specific indicators in most developing countries
- the nature of many PRSPs reflect an understanding of poverty primarily in terms of material deprivation, and as a state rather than in terms of powerlessness and vulnerability linked to systemic discrimination
- with a few Latin American exceptions, indigenous and tribal peoples have not been involved in consultations leading to the formulation of the PRSPs
- a few PRSPs recognise that indigenous or tribal peoples' disadvantages have a strong political dimension and are linked to their inadequate political representation within government
- only a few PRSPs examine the gender dimensions of indigenous or tribal poverty - gender aspects are generally addressed separately from the status and needs of indigenous and tribal men and women
- only a couple of PRSPs mainstream indigenous and tribal issues and address them consistently throughout.
Via Eldis.
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