The paradox of falling prices in a broke economy

The high cost of living in Kenya reflected by a rise in inflation was a rallying cry in the run-up to the 2022 General Election and partly contributed to the recent Gen Z demonstrations.

Two years later, however, prices have come down. Is there anything to celebrate? What is bringing down inflation? Who should take credit for the fall in inflation?  It’s a confluence of several factors.  

Briefly, inflation goes up when there is too much money chasing too few goods, according to the law of supply and demand.

This could be due to shortages in foodstuffs and everything else. Prices are used to ration out the shortage. Why else does the bus fare go up after the rains?  

More money can result from devaluation or in some cases printing money by the government. Some people have asked innocently why the government can’t print money and distribute it to the citizens.

Why must we work to be paid?  The resulting inflation would make the money worthless. So what’s going on?  

The simple explanation is that there is no money! Without money, the demand for goods and services, from ice creams to cars goes down.

Have you noted the discounts in supermarkets or buy one get one free? How else do we coax the customers to spend money, if they have it? Where has the money gone? 

It has gone to taxes and interest rates. More taxes or higher tax rates get money from us, and we have less to spend, reducing the demand for goods and services. 

The effect of higher or more taxes is pronounced because the private sector or individuals are more efficient in investing or consumption.

Give the government Sh1 billion and the private sector the same amount of money. How much will that money be for each group after 10 years?   

I felt the tax bite recently through the shift from the National Health Insurance Fund (NHIF) to the Social Health Insurance Fund (Shif), rising from Sh1,700 to Sh9,665!  Add housing levy. Spare a thought for those who are servicing loans. 

Taxes also raise the prices of goods and services. This reduces the demand. Business owners have to reduce the prices to attract customers, at times making losses. Some could easily close shop or relocate.  

The other money is taken by interest rates. The government is borrowing to bridge the budget deficits. Some of the money goes to projects and hopefully none to recurrent expenditure, such as salaries and wages.  

How do you attract money from us? Raise the interest rates on treasury bills and bonds. Money flows from the private to the public sector. We have less money to spend, and that reduces inflation. 

Remember the Central Bank of Kenya (CBK) raised the base lending rate substantially recently.  The banks take a cue from that and raise the interest rates on loans. 

That makes it hard for Kenyans to borrow. We borrow to invest or consume. Investors, for example, in housing create demand in the economy.  Households and individuals borrow to consume, paying for food and other services. When the rates are high, they keep off.  

Let’s accept that the two key drivers of inflation - food and rain - have played their role Oil prices are down courtesy of reduced demand for oil in places like China.

The rains have been reliable with good harvests, leading to an increase in food supply and lower prices.  

Let’s get mathematical too: the gross domestic product (GDP) of a country is money in circulation (m) multiplied by the speed of circulation (v); GDP = mv. 

With many debts not paid to suppliers, that speed has reduced. Gen Z protests and the aftermath of it made many wary of spending what they have, further reducing velocity and demand. This reduces inflation.  

Inflation fall has an emotional and some would add fear factor. If citizens feel pessimistic, they are not good consumers and investors.

The feel-good effect usually after polls was too transient. Politically, many feel the greater expectations turned into a great disappointment. 

Speculation is also rife that corruption has taken away money from the economy, lowering growth and subsequent fall in demand. This allegation can’t be 100 per cent untrue. Does corruption money circulate? 

A fall in inflation could indicate a slowdown in economic growth. Forecasts can confirm that. When the economy is not growing fast enough, there is subdued demand and a fall in prices. Uncertainty after the polls and protests played their role. 

Who should take credit for the fall in inflation? By jerking up the interest rate substantially recently through CBK, the government can take credit.

Never mind the impact on jobs as borrowers keep off.  But there are external factors too like good weather and a fall in oil prices.  

We could be tempted to celebrate the fall in inflation. But it should not lead to deflation - a persistent fall in prices - which is equally bad.

That is why central banks have a band, the lowest and highest inflation levels to ensure we have optimal inflation levels.

Deflations lead to higher levels of unemployment and a fall in production. In a nutshell, a fall in inflation makes political sense but not necessarily economic sense. Have you felt the impact of falling prices?