CBK must think beyond figures to fix economic challenges

Recent inflation targets, during the Economic Recovery Strategy of Narc for example, adopted the goal of maintaining core inflation below five per cent annually.

Gauged by its ability to reach this measure, the CBK mandate is a flop.

Even in long-run perspective, inflation has fallen below five per cent only twice since 1973: in 1995 and 2002. Over the full decade of 1997–2006, inflation averaged 8.7 per cent.

Part of the failure is attributable to the relative neglect of Kenya’s supply-side shocks that have a major impact on inflation.
Important examples are the commodity prices of food and drinks, fuel and power and transport and communication.

Price movements of these are excluded from the so-called underlying (or core) inflation. The CBK tracks this index to test whether its mandate has policy traction.

The paradox is that it contains only 39.6 per cent of overall inflation as calculated from Consumer Price Indices (CPIs). The important “policy-excluded” items form about 60.4 per cent of the so-called overall (or “headline”) CPI inflation.

Their role as drivers of price movements has a high weight in expenditures of Kenyans relative to comparable shares in richer countries. The anomalies are evident from the current composition of the CPI issued by the National Bureau of Statistics.

Food prices are by far the most significant component of the overall CPI, with a weight of 50.5 per cent of the overall CPI basket.

The figure rises to 56 per cent, for lower-income households in Nairobi. Housing and clothing are the next most significant components of the overall CPI, with weights of 11.7 and 9.0 per cent respectively.

With the current weights and choice of commodity items, the demarcation between underlying and overall inflation is thus self-defeating in the Kenyan setting.

It breaks down, obstructs policy solutions and invites contradictions in monetary policy at a time like the present when droughts and collapse in the country’s food production will drive up the price pressures from the excluded items in overall price escalation that also lowers living standards, particularly of poorer households.

For a country in a crisis, it should never be business as usual.

It is intuitive that if the CBK pursues its principal monetary policy objective of the inflation target, tightening monetary policy in response to current events, it runs the risks of worsening the economic impact of the economic crisis.

On the other hand, pushing lower interest rates to sustain access to credit and resuscitate growth, as it has attempted in recent months, will derail its targeting.

Furthermore, by raising the money supply to support lower interest rates while credit remains scarce, CBK falls into the trap of commercial banks and their traditional strategies in Kenya.