Controlling the cost of living – an explainer

In the battle to bring the cost of living [inflation] under control, there will be no quick fixes or magic wands.  What the government can do is provide short-term relief while simultaneously undertaking longer-term structural reform.  Here is why.

First and crucially, seasonal variations (particularly good rains), and the Central Bank Bank of Kenya’s (CBK) interventions notwithstanding, inflation has taken on a strong and sustained upward trend, doubling from four to eight percent over the last six years (figure 1).

Second, the primary drivers of the consumer price index (CPI) are food and fuel prices. To manage both requires deep changes – increased food production, and a switch to renewables.

Increasing food production is far more complex than offering subsidized fertilizer.  This policy has been around for last 15 years and through three successive administrations with mixed results. It almost always suffers logistical problems.  The Central Bank’s July agriculture survey found that less than half the farmers had received the subsidized fertilizer by the close of the main planting season. Farmers also need seasonal credit for other inputs, and high interest rates are hurting. The irrigated agriculture program has all but stalled over governance and procurement issues in the dam construction.

Switching to renewables will take time, and needs strong incentives to attract the necessary investment for the infrastructure to make it possible. The investments will of course create much-needed jobs.

A strong shilling could help both. Food imports (in dollar terms) are up 36%, year to August 2023.  The 25% depreciation of the shilling transmits directly to the cost of that imported food.  A strong shilling would, however, hurt exports. 

Third, a large and growing structural deficit makes it harder to control inflation. The administration is increasing, instead of re-orienting, spending.  That increased spending adds to the very aggregate demand that the Central Bank is trying to slow down! 

Worse, to finance it, the government has been offering incredibly high-interest rates, with the benchmark 91-day treasury bill now at 15%.

These high-interest rates are hurting both farmers and businesses, who are crowded out of the credit market.

The realistic policy choice is to reduce the budget deficit, and re-orient spending to both provide short-term relief, and stimulate production. On this, the administration should borrow a leaf from Biden’s Inflation Reduction Act, 2012.

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