The IMF&rsquo;s favourite method of controlling inflation monetarily will cause recession in markets for non-basic products and fail to curb inflation in basic products, while placing future pressures on the pound.
Recent weeks brought worrying news about an additional wave of global inflation as a result of the war between Russia and Ukraine, two of the largest grain and oil exporters in the world. This takes place after an earlier wave of high inflation caused by pent-up demand as COVID-19 lockdowns subsided globally. The Central Bank of Egypt devalued the pound by about 15% in the last month as a result of mounting pressure on the Egyptian pound due to a multiplicity of structural factors &ndash; namely trade and payments imbalances &ndash; and circumstantial factors such as the recent war and the COVID-19 pandemic (Enterprise, 2022).
In this light, Egypt and the IMF are currently discussing the implementation of a new &ldquo;comprehensive economic program&rdquo;. Although we know very little about the new program, the brief press statement points to the usual &ldquo;prudent fiscal and monetary policies&rdquo; (Allard, 2022, para. 3) which is evidently a euphemism for fiscal austerity policies and the increase of interest rates (i.e., tight monetary policy).
Pound devaluation adds a drive for inflation in Egypt to the global factors mentioned above. The typical IMF response to increasing inflation is monetary by increasing interest rates, of which we have already seen some signs following the latest pound devaluation (Magdy, 2022). However, the impact of high interest rates on the unemployment rate is established both theoretically and empirically (Feldmann, 2013).
A series of economic difficulties since 2008 and unsuitable policy responses have placed extreme downward pressure on job creation as clear from Figure (1) below, where the employment to population ratio fell from around 45% in 2010 to about 37% a decade later. Particularly sharp slopes in this downward trend are the impact of the 2016 reform program and the impact of the 2019 global pandemic.
Figure 1
Employment to Population Ratio, Total Percentage (Modeled ILO Estimate)
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1653919609imagefig1.png" alt="" width="500" height="177">
Source: World Bank, 2022
It is well known that in 2016 the most sweeping result of the IMF-mandated economic reform programme was high inflation caused by pound devaluation. To control inflation, the IMF pushed for the increase of interest rates, where it approached the 20% mark in 2017 up from about 9% before the program. The impact of the increased interest rate was two-fold, on the one hand it meant that with less jobs, the wage share of the national income has dropped, while financial investments in high-interest government bonds have extracted more of the national income, reaching about 10% of the national income and a third of government spending (Gad, 2020), diverting vast fiscal resources to the benefit of a small class of national and international financial investors.
It is worth noting that interest rate hikes should be considered in real rather than nominal terms. Real interest rates is the difference between current nominal interest and projected inflation.
Accordingly, multifaceted challenges that are the results of decades of questionable policy choices must be addressed with a set of both innovative and progressive tools. These should revolve around the well-being of the most marginalized groups that typically pay the largest price with every round of economic reforms. While the IMF has been&nbsp; vocal in recent years about protecting vulnerable groups, research shows that this is little more than rhetorical (Kentikelenis et al., 2016).
In mainstream economics and traditional policy making, inflation control is an almost exclusive function of monetary policy and particularly interest rates. Even when it comes to curbing inflation, results are at best mixed. In the context of the Global South, high real interest rates may be needed to curb inflation caused by dollarization. However, when employed to curb inflation by reducing aggregate demand, it becomes problematic since it will only reduce demand for non-basic products for the simple reason that people will not save money spent on eating, drinking and housing just because saving has become more lucrative.
Therefore, high real interest rates will cause a slowdown in the general economy while being quite unable to curb inflation for basic goods and services, whose prices are the most crucial to keep under control in times of high inflation. We have already seen that dynamic in place in Egypt&rsquo;s recent history during the high real interest period (2017-present). For example, the inflation of food products between 2015 and 2019 was 103%, while for clothing it was significantly lower at 72%. Even within the food category, basic products such as cereals and vegetables increased at a higher rate than &ldquo;luxury&rdquo; products such as meat.<a href="applewebdata://4E7B7ED8-DD81-4822-AED5-4115400F74FB#_ftn1" name="_ftnref1">[1]</a> As for furniture and housing equipment, prices during the period increased by 70%. For recreation and culture and restaurants and hotels, the increase was 95 and 83% respectively (see Table 1). Although housing is an essential product, its inflation was lower than average&nbsp; since its cost is usually bound by contractual agreements that are not as easy to change immediately.
Table 1
Cumulative Inflation of Main Product Items between 2015 and 2019
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1649839382image 10.42.06 AM.png" alt="" width="603" height="445">&nbsp;
Source: Author&rsquo;s calculations based on data published in the <a href="https://www.capmas.gov.eg/Pages/Publications.aspx?page_id=5107&amp;YearID=23352">Monthly Bulletin of Consumer Price Index</a> published by the Central Agency for Public Mobilization and Statistics (CAPMAS).
<h3>Fighting inflation beyond providing rewards for not spending</h3>
The answer to this conundrum might lie at least partially in fiscal policy, which has been largely ignored when it comes to inflation control. First, let us establish that some inflation could be good for growth, and is typically created by the government to stir up the economy and reduce the value of its liabilities in real terms. Therefore, the objective is to only avoid excessive inflation, especially of basic consumer goods.
Reduction of value added taxes (VAT) is usually an easily implementable measure that is sure to have immediate and measurable effect. If the government reduces the VAT on specific products by 3%, this will mean nothing else but reducing its price by 3%. This can be an effective strategy for bringing down the prices of durable and capital goods, of which most are subject to VAT rates of at least 14%.
However, this might be less straightforward for essential commodities since many are VAT-exempt. Here, VAT reduction for factors of production, such as fuel, should indirectly contribute to inflation control by lowering the cost of production. The government seems to already be aware of this since some measures have already been taken to lower VAT rates for food production inputs (Egyptian Tax Authority, 2022). Additionally, carefully selected subsidies along the supply chain of basic products can help control inflation and keep trust in the pound&rsquo;s value, avoiding mass selling of our national currency.
Although fiscal measures to control inflation lie squarely outside the realm of mainstream economics, it is still not unheard of. In 2009, as part of its counter-cyclical policy package to counter the effects of the 2008 crisis, the Brazilian government enacted cuts in federal indirect taxes amounting to about 0.3% of GDP (Barbosa, 2010). Stimulus VAT reduction in Germany in 2020 led to lowering of inflation rates (Nienaber, 2020). The same policy led in Germany to an additional EUR34 billion of household spending while only resulting in about EUR7 billion of lost budget (Look, 2021).
The obvious question at this point is the means of funding such measures. As mentioned above, interest payments swallow about a third of government spending, meaning that even the slightest downward or upward movement in interest rates could contribute to tens of billions in extra savings/expenses. For example, in FY2019/2020 interest payments amounted to about EGP568 billion, whereas in the same fiscal year, total VAT collected amounted to EGP330 billion (Ministry of Finance, 2022). Therefore, resources saved from not controlling inflation monetarily could be used to control it fiscally, with the extra advantage of supporting demand through VAT reduction and supporting supply through subsidies, rather than spending them as profits for a small class of financial investors, many of which are non-residents who would want to dollarize their returns down the road, placing more pressure on the pound.
However, with a policy context heavily influenced by the austerity-minded IMF, it might become more difficult to enact such countercyclical policies. The Brazilian former minister of finance Nelson&nbsp; Barbosa (2010) argued in a research paper based on Brazil&rsquo;s actual experience with countercyclical policies that the political economy of governing is crucial when implementing such measures; he contends that the belief in counter-cyclical policies allows policy makers to act efficiently and swiftly by not wasting too much time debating the ideological implications of such measures.
Fighting inflation fiscally is far from a panacea to Egypt&rsquo;s economic ills, which, as mentioned above, are a result of a complex interplay of multiple historical factors of which many are transnational, such as unequal trade relations and Egypt&rsquo;s position in global value chains as a Global South economy. However, in addition to some limited immediate benefits, this could mark a welcome reversal of austerity policies that have substantially increased social inequalities and economic volatilities in recent decades.&nbsp;
<hr>
<a href="applewebdata://4E7B7ED8-DD81-4822-AED5-4115400F74FB#_ftnref1" name="_ftn1">[1]</a> Author&rsquo;s calculations based on data published in the Monthly Bulletin of Consumer Price Index published by CAPMAS.
<hr>
References
<ul>
<li style="font-size: 10pt;">Allard, C. (2022, March 23). International monetary fund statement on Egypt. International Monetary Fund. <a href="https://cutt.ly/lDR91zw">https://cutt.ly/lDR91zw</a></li>
<li style="font-size: 10pt;">Barbosa, N. (2010). Latin America: Counter-cyclical policy in Brazil: 2008-09. Journal of Globalization and Development, (1)1, Article 13. <a href="http://www.bepress.com/jgd/vol1/iss1/art13">http://www.bepress.com/jgd/vol1/iss1/art13</a></li>
<li style="font-size: 10pt;">Egyptian Tax Authority. (2022, January 31). Tax exemptions.. in implementation of presidential directives to reduce burdens on citizens and industry ('I&lsquo;fa'at daribiya.. tanfeedhan l-il-tawjihat al-riyasiyat bi-takhfif al-a&lsquo;ba&rsquo; &lsquo;an al-muatinin w-al-sina&lsquo;a). [In Arabic]. <a href="https://cutt.ly/PDR94Lb">https://cutt.ly/PDR94Lb</a></li>
<li style="font-size: 10pt;">Enterprise. (2022, March 21). It&rsquo;s surprise interest day. <a href="https://enterprise.press/stories/2022/03/21/its-surprise-interest-day-67354/">https://enterprise.press/stories/2022/03/21/its-surprise-interest-day-67354/</a></li>
<li style="font-size: 10pt;">Feldmann, H. (2013). Real interest rate and labor market performance around the world. Southern Economic Journal, 79(3), 659&ndash;679. <a href="http://www.jstor.org/stable/23809689">http://www.jstor.org/stable/23809689</a></li>
<li style="font-size: 10pt;">Gad, M. (2020, July 7). The largest budget in history is loaded with debt (Akbar mowazna fil tarikh mukabala bil duyun). Mada Masr. [In Arabic]. <a href="https://cutt.ly/sDR9ady">https://cutt.ly/sDR9ady</a></li>
<li style="font-size: 10pt;">Kentikelenis, A., Stubbs, T.H., &amp; King, L.P. (2016). IMF conditionality and development policy space, 1985&ndash;2014. Review of International Political Economy, 23(4), 543-582. <a href="https://doi.org/10.1080/09692290.2016.1174953">https://doi.org/10.1080/09692290.2016.1174953</a></li>
<li style="font-size: 10pt;">Look, C. (2021, November 2). German VAT cut unleashed $39 billion spending spree, study finds. <a href="https://cutt.ly/QDR9WhU">https://cutt.ly/QDR9WhU</a></li>
<li style="font-size: 10pt;">Magdy, S. (2022, March 21). Egypt's central bank raises interest rates, cites Ukraine. The Washington Post. <a href="https://cutt.ly/KDR9L7N">https://cutt.ly/KDR9L7N</a></li>
<li style="font-size: 10pt;">Ministry of Finance (2022). Fiscal indicators tables (Jadawil mu&rsquo;ashirat al-malia al-&lsquo;ama). [In Arabic]. <a href="https://cutt.ly/LDR8bhl">https://cutt.ly/LDR8bhl</a></li>
<li style="font-size: 10pt;">Nienaber, M. (2020, August 31). VAT cut pushes German inflation into negative territory. <a href="https://www.reuters.com/article/uk-germany-economy-inflation-idUKKBN25R1MR">https://www.reuters.com/article/uk-germany-economy-inflation-idUKKBN25R1MR</a></li>
<li style="font-size: 10pt;">World Bank. (2022). Employment to population ratio, 15+, total (%) (modeled ILO estimate) - Egypt, Arab Rep. <a href="https://data.worldbank.org/indicator/SL.EMP.TOTL.SP.ZS?end=2020&amp;locations=EG&amp;start=2010">https://data.worldbank.org/indicator/SL.EMP.TOTL.SP.ZS?end=2020&amp;locations=EG&amp;start=2010</a></li>
</ul>
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