Why do prices soar, who is at fault and what should we do

After inflation reached 43% in 2015, soaring prices became one of the main topics for manipulation between Ukrainian politicians, pseudo experts and not-so-independent media. Among the ones blamed for the price growth and the poverty of Ukrainians were the government, president and the National Bank of Ukraine.

Within the project “Truth percentage” VoxCheck and UA:Ukrainian Radio analyzed what does the term “inflation” actually mean, which types of inflation are there, what are the factors influencing the price growth, how to measure it,  dispelled the most common myth on inflation in Ukraine and assembled a list of reliable sources of information. 

Disclaimer: This article was prepared with the support of the American people through the USAID Media Program in Ukraine, implemented by the international organization Internews. Content is the sole responsibility of VoxUkraine and does not necessarily reflect the views of USAID, the US Government, or Internews.

What exactly is inflation and how does it influence Ukrainians?

It seems easy at first. Inflation means price growth. Its opposite, deflation, means price drop.  Do not mix deflation with disinflation – inflation slowdown. 

There are various types of inflation. With moderate inflation, prices increase within 5-10% per year. Ukraine has kept inflation within the one-digit range for two subsequent years: in 2018, consumer prices increased by 9.8%. By the end of 2019, the NBU expected 6.8% inflation, but it is now more inclined to reach 5% +/- 1%.

And then there is hyperinflation, when prices rise by more than 50% per month. So when they say that there was hyperinflation in Ukraine in 2015, it is not true. In 2015, prices increased by 43% for the year rather than the month. For comparison, there was hyperinflation in Ukraine in 1993, when prices increased by 10,000% a year. The situation is similar to Venezuela. According to IMF estimates, inflation in Venezuela in 2018 reached over 68,000 percent and is expected to reach 200,000 percent by the end of 2019.

The difference is glaring, but it has not stopped some politicians from comparing inflation in Ukraine to inflation in Venezuela.

Inflation reduces the purchasing power of our income, that is, how many goods and services we can afford. Yes, that sounds obvious, but this is what politicians are most often manipulated into: they either forget about adjusting for inflation when they talk about rising budget revenues, or they compare our dollar revenues, even though we pay in stores in hryvnia.

How do you measure price growth?

There are two main indicators.

Consumer Price Index, which shows the change in prices for goods and services purchased by Ukrainians. It covers changes in prices for food, clothing, medicines, medical services, transportation services, fuel, cost of education, changes in utility tariffs and more.

There also is a GDP deflator. It shows not only how prices for consumer goods have changed, but also how the prices for the economy in general have changed: for intermediate goods for production, for exports and for import goods for services, for goods purchased by the state and investment goods.

In addition, there are indicators showing changes in prices for manufactured goods, construction, agricultural products, housing, etc.

There are also alternative indicators.

For example, the Effective Regulation Platform of the Ministry of Economic Development, Trade and Agriculture calculates a “dummy index” or an inflation barometer. For analysis, they have selected a list of products of certain brands that are required for the preparation of dumplings, and monitor the change in their prices in stores.

Their index should not be compared with the State Statistics Committee’s CPI because of the difference in methodology of information collection and processing. But this interactive tool allows you to better understand what inflation is and how real prices are rising in Ukraine.

Why do prices grow?

For Ukraine at different times different factors have influenced consumer inflation:

• in the early 1990s, high budget deficits and an active inflow of money in a declining economy;
• in the 2000s, conducting non-sterilized interventions to keep the exchange rate against the dollar and overly optimistic intensive private consumption, which was not supported by productivity gains;
• inflation spikes after the devaluation of 1998, 2008 and 2014 are exacerbated by the fact that the Ukrainian economy is too open (vulnerable) in the international economic system.
• On the other hand, prices in Ukraine have not always increased. For example, in 2001 and 2012 there was deflation in Ukraine.

Does inflation have any positive effects? 

Let’s go from the opposite. And what’s bad about deflation, or falling prices?

If a person expects that the product will be cheaper tomorrow than it is today, then they will  probably postpone the purchase until tomorrow. But if everyone does so, then nothing produced in the economy today will be bought, and no income will be received to support consumption.

Therefore, consumer demand for goods and services will fall. Consumers’ reluctance to make purchases in any way will not encourage manufacturers to manufacture more products. Then the growth of the economy will slow down.

However, inflation losses are more significant. They can be divided into two main categories: uncertainty and inflation (rate of change in price level). Even if inflation was fully predictable, it creates problems for both producers and consumers. For example, manufacturers incur additional costs in order to count in the change in prices, and consumers constantly have to determine the amount of money they need in their hands. The increase in uncertainty is the main negative impact of inflation.

How to fight inflation and who is responsible for it? 

In 2015, the NBU switched to inflation targeting and flexible exchange rate. This policy ensures that there is a formal anchor (low and stable inflation) and a powerful factor in the amortization of internal and external shocks (flexible exchange rate). This is a significant step forward, as the NBU’s previous fixed-rate policy made the economy very vulnerable to banking and currency crises (Ukraine experienced three major crises between the mid-1990s and 2014).

The essence of the inflation targeting regime is to publicly announce quantitative inflation targets and the central bank’s commitment to achieve those targets over the medium term. Monetary policy decisions are made taking into account the inflation forecast.

The main monetary instrument and the operating benchmark for such a monetary regime is the interest rate. If inflation is above the target level, a policy of “expensive money” is implemented to contain it, i.e. the interest rate rises. Conversely, at a lower projected inflation rate than the target level, a policy of “cheap money” is pursued when the interest rate drops.

Why are fakes and misinformation about price growth only aggravating the situation?

The results of inflation targeting depend on inflation expectations, that is, what price changes consumers expect. If people expect prices to fall, they will hold back their purchases, thereby deterring manufacturers from raising prices for their products. If consumers expect prices to rise, they will intensively buy more and more goods (especially those that can be stored for a long time), which in turn will encourage manufacturers to raise prices.

Therefore, the NBU communicates with the public in such a way as to explain as often as possible how much prices are rising, what level of inflation the National Bank expects, what is the reason for the rise in prices or the slowdown of their growth rate.

Misinformation and fakes about rising prices will cause negative inflation expectations, which will make all NBU measures fail.

How do politicians manipulate and lie about price growth?

Comparing the income of Ukrainians in dollars

If we compare the minimum pension in 2014 (UAH 949) and in 2019 (UAH 1669.2, or 40% of the minimum wage), it will be $118 and $42 in dollars (at the average rate for January 2014 and January 2019, respectively).

The living wage was UAH 1,176 or $147 in 2014 (at the January 2014 average exchange rate). As of January 2019, it is UAH 1853 or $66 (at the January 2019 average exchange rate)

But this comparison is incorrect, because we buy goods for hryvnia, not for dollars, and therefore the purchasing power of income is directly influenced by inflation rather than devaluation (the exchange rate affects consumer spending only because of the increase in the value of imported goods). Therefore, it is necessary to compare the minimum social standards in UAH, adjusting them for inflation.

Thus, the minimum pension of 2019 will be 762.19 UAH in the prices of 2014, and the living wage of 2019 will be 846.12 UAH  in the prices of 2014. The calculations are here.

Therefore, in real terms, the minimum pension in 2019 is lower than in 2014, by 20%, and the living wage in January 2019 is less by 28%, not 2.2 times, as Tymoshenko states in both cases.

The abolition of state regulation of prices in 2016 led to a rapid rise in prices

As of October 1, 2016, the government has abolished price regulation until January 1, 2017 as a part of the pilot project. As a result, prices for previously regulated goods rose less than general inflation in Q4 2016 and did not exceed Q4 2015. Therefore, on July 1, 2017, the Cabinet finally abolished state regulation of food prices as a throwback to socialism for good.

In 2017, food prices increased by 18.3% due to a rise in the minimum wage, higher tariffs for utilities, an increase in world commodity prices, including oil, which led to a rise in fuel prices in the domestic market.

The manipulation is that food prices have not increased due to the abolition of state regulation of prices. By the way, in 2007, 2008, 2010, food prices rose faster than other consumer goods despite the state regulation.

Prices grow, earnings don’t

The real incomes of citizens really fell in 2014-2015. However, since then the situation has improved and now the average wage is rising faster than inflation. So consumer opportunities are gradually increasing, not decreasing, as Dmytro Dobrodomov says.

If we look at last year’s increase in pensions, its average size increased from 1828 UAH to 2480 UAH (Article 24). Growth – 35.7% with annual inflation  at 13.7%. The average salary for 2017 increased from UAH 6008 to UAH 8777 or by 46%. Therefore, consumer spending opportunities are increasing.

The economy doesn’t really grow, only the prices do

3.2% of GDP growth is real growth, i.e. already adjusted for inflation.

National Bank needs to lower the interest rate

Rates on loans for business in Ukrainian banks range from 17.87% to 25.85% pa in UAH. The cost of commercial loans, in addition to the discount rate, also depends on the protection of creditors’ rights and the quality of borrowers (transparency of their business and prospects for its growth).

Since the end of January this year the NBU interest rate has been raised from 14.5% to 17%. Such actions by the NBU are aimed at slowing down inflation, which is also detrimental to the economy, since inflation exceeds 10%, long-term planning is extremely difficult. If the government pursued a more prudent fiscal policy, the discount rate would probably be lower today. The real (inflation-adjusted) discount rate in Ukraine is just over 2%.

VoxCheck does not comment on the advisability of changing the National Bank’s policy.

Where to look for truth?

The State Statistics Service and the National Bank of Ukraine are the ones responsible for calculating inflation in Ukraine. The State Statistics Service estimates how prices increased compared to the end of last year (for example, the consumer price index, CPI “up to December of the previous year”), the previous month or the corresponding month of the previous year.

The NBU is still forecasting and detailing the reasons for the changes in prices on a monthly, quarterly and yearly basis. The NBU’s inflation analysis is set out in the “Inflation Reports”.

Other useful information from the National Bank: the dynamics of the discount rate, which is inflation targeting, is all about the NBU’s monetary policy and its prospects for 2020.

The following experts write in detail, simply and professionally about inflation:

• Oleksandr Zholud, Chief Expert, NBU Department of Monetary Policy and Economic Analysis;
• Dmitry Sologub, Deputy Chairman of the National Bank of Ukraine;
• Yuri Gorodnichenko, Associate Professor, Department of Economics, University of California Berkeley;
• Oleksandr Petryk, Member of the NBU Board, Deputy Executive Director of the IMF Board of Directors from Ukraine (2013–2017);
• Bogdan Danylyshyn, Academician of the National Academy of Sciences of Ukraine.