Inflation is the rate at which prices of commodities keep rising. When the amount is hiked, each unit of the available currency buys fewer items. In turn, the purchasing power of money drops. Like many other countries around the world, causes of inflation in Ghana are linked to an increase in the price of commodities, with no increase in the consumer’s income.
Many people do not have an idea the causes of inflation or even what inflation is. They just wonder why sometimes good and services are expensive.In this article we will tackle the causes of inflation and also define inflation. Read on.
Which is the best definition of inflation?
This question can be best answered by first looking at inflation definition economics from an economist’s perspective. In economic terms, inflation arises from two main concepts, namely supply and demand. These are competing factors which if not controlled in a sustainable manner, have a grave impact on the economy. For instance, when the demand is higher than the supply, cost of products or services tend to go high.
On the other hand, high supply and low demand lead to a reduction in costs of products or services. These dependent factors are usually controlled to avoid inflation. The nature of inflation varies from one economy to the other; hence distinguishing the types of inflation is essential. The following types of inflation that may be experienced.
- Currency inflation due to excessive printing of money
- Credit inflation due to financial institutions sanctioning more loans and advances to consumers than what the economy requires. As a result of this credit expansion, the increase in the costs of products and services is experienced.
- Deficit induced inflation which occurs when the government asks its central bank for more money to meet the shortage it has in its budget. Budget shortage arises when the expenses are more than the revenue generated.
- Demand-pull inflation which arises when the aggregate demand for products or services are higher than their supply
- Cost-push inflation brought about by an increase in production cost
Therefore, inflation can be best defined as the rate at which the general level of costs of commodities or services is increasing, and, accordingly the purchasing power of the currency is declining.
Why does inflation occur?
Inflation is a key component of the economy which mainly occurs when there is an overall increase in demand for goods or services in the country than the supply could meet. If not properly controlled, a country’s currency significantly loses its purchasing power to the extent that its economy crumbles.
What are the causes of Inflation in Ghana?
There are numerous causes of inflation and they are influenced by other factors which if managed, can help in lowering the level of inflation to sustainable levels. This is usually done by the government in collaboration with other key players in the economy. The main causes of inflation in Ghana and the factors that influence them are discussed as follows:
This means that the aggregate demand for products or services grows faster than the aggregate supply resulting in an increase in prices. Generally, when the demand for goods and services exceeds its supply, prices tend to go high and this leads to inflation. The following factors cause demand-pull inflation:
Reduction in the interest rates charged by financial institutions may result in many people taking loans. A consequence of this is the availability of excess money circulating in the economy leading to increasing prices of commodities. Goods and services sought become limited compared to the available money.
Higher demand from an economic stimulus, for example, elevated government expenditure and lower direct taxes. A decrease in direct tax means that people have more money to spend. Furthermore, increased government spending and borrowing create additional demand in the circular flow.
Flooding or excessive supply of money into the economy also results in inflation. In any economy, supply and demand of either goods or services determine their prices. Consequently, the overdue supply of product results in its price reduction. Similarly, if the product that is in excessive supply is money, its value diminishes.
When money has low purchasing power, the prices of goods and services goes up resulting in inflation. Monetary factors affecting inflation can also occur through actions such as printing of more money by the central bank.
Inflation can also be brought about by increased production cost of companies. In the event of this situation, the companies transfer this cost to their consumers by increases prices so that they are able to retain their profits. Other factors that contribute to cost-push inflation include rising wages and increasing material prices, in particular, oil.
The former is a major component of cost-push inflation. This occurs especially when trade unions demand an increase in wages of their members thus leading to an increase in demand for products and services as people have more money.
Increase in global oil prices has a significant effect on the cost of most products in the economy resulting in inflation. High oil prices lead to high production cost and consequently rise in product prices.
In addition, declining productivity by firms also results in cost-push inflation. This is because it results in increased cost of available products. Moreover, it also means that the revenue collected by the government will be low, thus the government may not be able to meet its expenses.
More so, an increase in taxes such as VAT and excise duty by the government also causes inflation as the effect is passed to the consumers. Firms would want to maintain their profit levels or they risk going out of business if they are to incur the costs.
A decline in the exchange rate is another example of a cost-push factor that results in inflation. The cost of imports increases hence, companies importing raw materials will have to pay more thus their production costs also hikes. Users of their products bare this charge as a result of cost transfer.
Monopoly employers especially corporations which huge market share in the economy tends to hike the prices of their goods or services resulting in inflation. This misuse of market power negatively impacts the economy.
Besides the three main factors that cause inflation in Ghana, other examples of inflation factors that cause hiking of prices include a constant supply output, a rise in restrictive trade practices and insufficient production factors. When the output of a country is constant and there is increased demand from factors such as population growth and export demand, the costs of products goes high.
Constant output can be due to lack of capital equipment and poor management of the people leading to low productivity and wastage of available resources. The limited resources available are therefore strained and cause inflation.
Restrictive trade practices such as over taxation and poor laws discourage investors and this result in inflation as the production cost is high. Additionally, a constricting business environment due to poor laws may lead to investors transferring their business to other countries where the laws are more accommodating or increasing product prices to stay in business.
Impact of inflation on business in Ghana
The high level of inflation in Ghana of which currently is about 9.8 percent has negatively affected business in the country. A real life example of inflation effect in businesses is; if there is an increase in production factors such as oil fuel prices, cost of electricity and water, monetary exchange rate, interest rate, cost of natural and human resources. Companies react by transferring the cost to the consumers.
This is because, on their end, they experience high production cost and since they want to maintain profit levels and stay in business, customers have to bear increased costs of products. This situation was experienced during the presidency of John Dramani Mahama in 2013-2016. During his reign, the cost of doing business in Ghana was very high. The productions factors were not favorable to firms. The unfavorable conditions resulted in some companies closing down their business as they could not sustain themselves.
Another effect of high inflation rate in business is a retrenchment of workers. Companies do this in order to cut their costs. This is due to reduced profits resulting from increased production costs. Therefore, to cut on some of their expenses, they reduce their wage bill.
High inflation rate also has an effect on investor and consumer confidence. For example, when investors find that their cost of doing business in Ghana is very high compared to other countries, they can transfers some of their business operations there or in the worst case scenario, completely shut down operations and move where conditions are favorable.
More so, low investor confidence due to inflation also discourages them from taking loans from banks. Causes of inflation in Ghana pdf explain that this negatively affects banks profits and can result in them closing some of their branches or going out of business completely.
Low consumer confidence as a result of inflation, leads to less spending. People are afraid of spending their money on products and services leading to enormous losses for businesses. Consequently, enterprises may thus be unable to pay back their loans hence creating non-performing loans in banks. This causes huge losses to the affected banks and may lead to the winding up their operations. This is what transpired in UT and Capital Banks in Ghana in 2017.
In addition, inflation also results in the Central Bank escalating its Minimum Capital Requirements of banks. This is because of the trickling effect of high inflation rates. The high cost of doing business means investors require high capital to start or sustain a business. This may lead to nonperforming loans hence banks will not be able to finance such enterprises or investors with the right amount of money, as they afraid they may not be able to pay back on time thus significantly affecting their operations.
Moreover, banks which are not able to meet the minimum capital requirement set by the Central Bank will have to go out of business or forced to merge with other banks in order to remain functional. This has a negative effect on the banks as they may end up losing their brand.
Why does inflation happen?
In summary, the main causes of inflation in Ghana stemming from the demand-pull and cost-push factors are a higher demand for goods and services than the supply, reduced interest rates charged by financial institutions, high production costs, reduced productivity, increased taxes, and decline in exchange rate making costs of imports to go high.
This has resulted in poor living standards since the cost of commodities is high making the ordinary Ghanaian live in hardship. The wages they receive is insufficient to meet their basic daily needs. Others have had to resort to illegal activities such as theft in order to sustain themselves. Therefore, it is important that the government protects its citizen from adverse effects of inflation by lowering the production cost through regulation of interest rates and taxes.
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To conclude, inflation basically refers to a sustained increase in the prices of goods and services and this situation is normally non-seasonal in nature. In Ghana, demand-pull and cost-push factors have significantly contributed to the high rate of inflation being witnessed in the country.