The long and difficult road of fighting inflation was mapped out in a recent study. Mona El-Fiqi reviews the findings A recent study conducted by the Egyptian Centre for Economic Studies (ECES) entitled Relative Price Adjustment and Inflation Dynamics: The Case of Egypt attempted to investigate the reasons behind the sudden and intense rise in inflation rates in Egypt in recent years. After a period of stability in the second half of the 1990s, inflation rates hiked to double-digit levels and have been subject to higher volatility amid lack of a coherent understanding of its underlying dynamics. Inflation reached 16.4 per cent in April 2008 according to the Consumers' Price Index, while it reached 23 per cent in March of the same year according to producers' price index. The recent surge has caused heated debate in academic and policy making circles, as well as among the average man on the street. The main reasons for it include the effect of the exchange rate devaluation; the absence of a nominal anchor after the floatation of the pound; excessive monetary growth; demand-pull factors due to rising household spending; supply-side factors due to price adjustment in energy-related products; and the outbreak of Avian Flu. Other reasons, according to the study, are the impact of continuing structural adjustments in the economy; increasing market concentration in some industries and lack of competition which drove up mark-ups; and an increasing tendency towards ad hoc pricing strategies by producers. One last factor playing a significant role in driving inflation higher more recently is the increase in world food prices. In five sections, the document seeks to measure the extent of relative price adjustment on inflation, discuss the two recent inflationary waves during the periods of July to March, 2005, and June, 2006, to April, 2007. It also provides a review of the literature, presents the empirical results, and concludes with ensuing policy implications. The findings warned that high inflation tends to reduce economic efficiency, and has a negative impact on income and wealth distribution. "It disrupts saving and investment decisions with a negative impact on long-term growth and employment," stated the study. "Moreover, it reduces the efficiency of the price system in allocating resources, as it makes it harder to distinguish between relative and absolute price movements." It also penalises fixed income earners and tends to benefit debtors at the expense of creditors, according to research. If high inflation is correctly anticipated by economic agents, research suggested, some of its negative consequences could be mitigated through indexation of contracts. However, in a high inflation environment, inflation rates tend to be more volatile and hence less predictable. This means that the negative impact of high inflation cannot be avoided due to the uncertainty it creates about future inflation. Since inflation uncertainty has increased, it is the task of the CBE to devise appropriate measures to anchor inflation expectations. Findings propose that the ability of the CBE to control inflation outcomes in the future is conditioned by having a well-functioning monetary policy transmission mechanism. CBE policy instruments should be effective in influencing output and inflation developments, especially the recently adopted interest rate corridor system. The document also recommended that the CBE actively engage in communication with the public about the underlying reasons and effective measures being taken to meet the inflation target rate in subsequent periods. "The success of the target rate of inflation as a nominal anchor is crucially dependant on the credibility capital of the monetary authority," it argued. While it is not easy to gauge the credibility of the CBE among the public, the study asserted that the current turbulence in prices harms its credibility. The paper explained that the correction of the numerous price distortions created by administered prices is an important step in Egypt's economic transition, and it has been one area where reforms were excessively slow due to social economic and political considerations. However, there is a need for the formulation of a comprehensive strategy to guide these reforms and moderate their negative inflationary impact. According to the study, the strategy should address the timing and the frequency of price adjustments, as well as tackling market imperfections to ensure that the cost of adjustment will not be borne solely by consumers. The paper noted that if an individual price of a particular commodity has increased it is usually not clear whether this increase represents an absolute or relative price increase. The relative price is the price of one commodity or service relative to other commodities in the economy. The observed price increase could be of the same magnitude as prices increases in all other commodities, which means it is rising proportionally with the price level but its relative price remains unchanged. Relative price changes according to different determinants of demand, as well as supply of particular commodities. On the demand side, changes in real income, tastes and expectations about future prices are key determinants. On the supply side, changes in resource prices, the tax structure, trade policies, subsidies on inputs to production, technology and expectations about future prices all play a key role in deciding the relative price of goods. In a dynamic economy, all of these factors are always interacting to bring about continuous changes in relative prices. The first section of the research uncovers the role of the relative price adjustment factor in current inflation dynamics, as well as addresses some policy concerns about the turbulent behaviour of prices. The redistributive impact of inflation is unfavourable to fixed- income earners and savers, and hence has negative socio-economic implications. For instance, recent price increases more than outstripped the rise in nominal public sector wages, which renders the government's initiative ineffective. It also implies a continued decline in real incomes with negative consequences for low-income groups. The study added that this may affect long- term growth and employment outcomes, by diverting resources away from productive investment venues and into speculative channels. In this regard, a number of policy implications need to be tackled, such as the role of the monetary authority in anchoring inflation expectations during transition; full- fledged inflation targeting; the strategy for domestic price liberalisation (or the removal of subsidies); and the implications of the evolution of the consumer price index composition (the relative weights of tradables and non- tradables).
