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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

Sweet Poison of Emission

13 July, 1999 - 00:00

Pensioners first hostages to inflation

By Gerhard KRAUSE, economist at Deutsche Bank Research, member of the German
consultative group with the government of Ukraine
The October presidential elections are fast approaching. Looking at Ukraine's
neighbors, you can see that even in economically more stable countries,
the best projects of fiscal policy become scrap paper on the eve of making
important political decisions. Pragmatic views of the budgetary deficit
are pushed aside. Generous gifts are promised at election time to win votes.
The horizon of economic policy greatly narrows in a short period of time,
and long-term guidelines fall far back in the list of priorities.

The latest exemption of agriculture from taxes, the still existing exceptions
with respect to the turnover tax, and tax privileges for certain enterprises
are serious indications that the pendulum in Ukraine has swung this way.
Still rife is the debate on measures to reduce public-sector nonpayment,
since budget-supported employees and pensioners comprise a huge group of
electors. All this makes one worry that established fiscal objectives will
come under severe pressure in the next few months.

What could Ukraine do to make up for the financial deficit? Given doors
closed to international capital markets, the mistrust of national banks
and investors to governmental debentures, as well as a structurally weak
taxation base, the road leads directly to the National Bank's printing
machine. Even now, the National Bank of Ukraine is almost the only buyer
of governmental treasury bills. The much-publicized excessively low factor
of monetarization (ratio between the GDP and the overall amount of money
in circulation - Ed.), a hidden challenge to expand the money base,
builds up pressure on the National Bank.

The effect of enhanced money emission, so much speculated upon by Ukrainian
presidential candidates, creates an illusion that the Ukrainian population
has money. Increased incomes and wages are being construed as a respective
increase of real income, which may well result in higher living standards
for everyone. In this case, this psychological effect should exert a positive
influence on behavior in the elections. But the point is this effect is
short-lived. As soon as the population becomes aware that the price level
varies, it immediately becomes realistic. Such employment effects based
on monetary illusions and reinforced by stable prices and wages die out
fast. What is left are the negative consequences of monetary emission,
which the population is also aware of in the middle and long term. Moreover,
inflation also has other negative results.

Steep price rises impact negatively on investments. The development
of inflation becomes hard to forecast and thus leads to difficulties in
calculating future revenues. Risk-related interest rate increments grow
substantially. The weakening of the already insignificant investment activity
of residents brings down direct foreign investment. Since the exchange
rate, coupled with rapidly rising inflation, also gets greatly devalued
or even goes beyond the limits of domestic inflation, planned investments
are postponed.

The fact that high price rises distort the price-related structure of
the economy leads to the irrational placement of resources: the less the
relative prices reflect the shortage of certain goods, the less predictable
becomes the economic process. In general, the growing uncertainty leads
to reduced long-term planning. Long-term contracts in a constantly varying
environment are unprofitable.

Few advocates of inflation realize that if anybody stands to gain from
inflation, it is first of all the state. Since in Ukraine, too, maximum
tax rates are oriented toward nominal incomes, price rises would cause
an increased tax burden on the private sector. Inflation hurts the recipients
of fixed nominal incomes in the domestic currency, pensioners in particular.
The rather slow adaptation rate of pension-based incomes (non-market ones)
leads to considerable losses as a result of inflation.

Conversely, enterprises react faster to the variability of the economic
environment by raising prices for their products than do wage earners,
and the former can pocket profits derived from inflation. Debtors of nominal
values also stand to gain from inflation. The considerable reciprocal indebtedness
of enterprises in the Ukrainian economy seriously violates this economic
logic. Enterprises that have accumulated the highest debts as a result
of their inefficiency and low-solvency enterprises are rewarded through
the inflationary depreciation of their debts.

Estimates made by the German Consultative Group show that resort to
the printing press by an issuing bank steadily increases the inflation
rate. Even under a partial "monetarization" (emissionary financing -Ed.)
of public-sector nonpayments, an abrupt price rise could be expected in
the short term.

Ukrainian politicians should draw a lesson from this information: money
emission is not a legal way to dish out gifts at the time of elections.
Any budgetary deficit rise or increased emission by the National Bank on
the eve of the elections would not benefit the crucial target group, the
Ukrainian population. Nor is it a reliable instrument to solve the problems
of nonpayments: their causes should be sought in the structural imbalances
of the state budget. Precisely to the contrary, the high real economic
and social costs caused by a growing misplacement of resources, overrated
expenditures for transactions, and an erroneous distribution policy, are
bound to place an onerous burden on the population after the elections.
This would program further regress in the transformation process.

 

 

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