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Monetary containment of inflation and strengthening of the hryvnia inevitably lead to a loss of economic dynamism Few people like inflation, which is usually called anything but predatory. According to the domestic State Statistics Committee, over the 12 months of last year, nominal incomes of the population grew by almost a third — 27.4%. However, due to the simultaneous rise in prices, their real growth turned out to be much more modest — 16.8%. Of course, even a 17 percent increase in purchasing power is a completely good result. However, it is easy to understand the irritation of public sector employees and pensioners over the fact that inflation "ate up" up to 12% of their more than modest salaries and pensions. And not only them: regardless of income level, people do not like it when their purchasing capabilities decline. The obvious relationship between price dynamics and real incomes underlies many economic concepts, from the aggregate demand function to the principles of IMF stabilization programs. At the same time, it is logically noted that by reducing real demand, inflation also negatively affects production volumes. Given this, one might expect that any economic policy should provide for a simple "nullification" of price dynamics. Especially since under modern conditions this is not at all difficult to do — it is enough merely to tighten the central bank's monetary policy by raising, for example, interest rates, reserve requirements, or the exchange rate of the national currency. However, contrary to the "obvious," finding examples of sustained non-inflationary development in recent history is very difficult. Attempts at full monetary containment of inflation, as a rule, are not successful. In Japan, for example, with its twofold reduction from 2.5% in the 1980s to 1.2% in the 1990s, there occurred the same twofold slowdown in economic growth — from 3.8 to 1.7%. In Argentina, one-percent deflation in 2000—2001 was accompanied by an annual GDP decline of 2.6%. And conversely, in 2003 its economy grew by almost 7% with a 13.4 percent rise in consumer goods prices. At the beginning of the current decade, industrial countries managed to reduce the average annual growth of consumer prices to the lowest level in 50 years (less than 2%). However, contrary to expectations, production in Germany, Italy, France, and Japan not only failed to demonstrate a growth miracle but also found itself in a state close to stupor (its annual growth rates fell to less than 1%). Finally, last year's increase in US economic dynamism to 3.7% was accompanied by an increase in inflation from 1.9 to 3.4%. Tying economic growth to inflation alone is, of course, incorrect. However, it is equally improper to ignore the statistics presented. Especially since economists do not have a unified view of its causes. While the mechanism of inflation's negative impact on real incomes does not provoke discussion, a generally accepted explanation for why production grows when prices rise has not been offered. It may seem incredible, but in analyzing "aggregate demand" and "aggregate supply," economic theory provides an unambiguous interpretation only in the first case. Whereas in the second — it operates with several models. And it does not consider any of them as universal. The range of diversity of views can be evidenced by the fact that two world authorities in the field of inflation and money circulation, two Nobel laureates — Milton Friedman (1976) and James Tobin (1981) — proposed practically mutually exclusive interpretations of economic activity and price growth. Moreover, they did so at approximately the same time. In works with the same title — "Inflation and Unemployment." At the same time, J. Tobin emphasized that a certain percentage of inflation is economically expedient, since it allows overcoming market distortions under conditions of "nominal rigidity" of prices (a phenomenon reflecting the long-term trend of their growth and resistance to decline). M. Friedman noted: if market participants accurately forecast inflation, then all business contracts reflect the same level of it, whereby relative prices remain unchanged, as if inflation did not exist at all. This made it possible to assert that sustained inflation does not positively affect production activity. Today, J. Tobin's interpretation is known as the inflationary "grease effect." M. Friedman's interpretation, in economic "jargon," has received the name "sand effect." And although in theoretical research there is no longer the former confrontation between them, "ideologically" M. Friedman's reading clearly dominates. The reason for this is evidently the painful stagflation of the 1970s and its no less difficult overcoming in the 1980s of the last century. Meanwhile, despite formal adherence to the idea of "price stability," in no industrial economy is zero inflation considered a price target. The latter, as a rule, is set at the level of 2—3%. Such practice serves as recognition not only of the "grease effect" but also of simple common sense. If one abstracts from external factors, the effectiveness of zero inflation turns out to be nothing more than an economic idyll. Since it presupposes the ability of production to instantly neutralize any price spikes. If the latter were the case, then the year before last there would have been no grain crisis in Ukraine at all, since agricultural producers would have instantly... grown a new harvest, instantly returning the supply of grain and its prices to the initial level. Absurd? Of course. However, only under such utopian conditions can price stability be naturally maintained. Its effectiveness is a question not of money supply but of the presence of perfect market institutions. With their presence, for example, the existence of depressed regions and unprofitable Donbas mines would be impossible, since the latter would be instantly closed with full consideration of all technical, sanitary, and environmental norms. The resources released in the process, together with the labor force, would be just as lightning-fast employed in more efficient productions. At the same time, completely fantastic metamorphoses would be observed: miners would instantly acquire new professional knowledge and skills (for example, as accountants or lawyers), work, and a place of residence. The latter could be changed within a day: all those who moved, say, to Kyiv, would immediately have not only an apartment but also all the accompanying infrastructure, including polyclinics, kindergartens, schools, etc. There would be enough... a day for their construction as well. Zero inflation is natural and effective only under conditions of a perfect market capable of lightning-fast redistribution of production resources across the entire matrix of inter-sectoral links, eliminating any commodity shortages and the price increases that accompany them. Hardly anyone would recognize such a model as realistic. However, when it comes to price stability, the analysis does not go beyond the utopian framework of perfect mobility of factors of production. The latter is nothing more than a figment of the imagination. In practice, both the speed and quality of producers' response are far from perfect. Aggregate supply cannot constantly be instantly increased simply because it is impossible to instantly build a factory, drill a well, explore new oil reserves, or, for example, grow an additional grain harvest and process it. As, indeed, to accumulate the financial, material, and labor resources necessary for this. At the same time, the deeper the distortions of market mechanisms, the greater the price incentives needed to expand production. For example, the less developed the insurance mechanisms, the greater the price incentives investors and financial intermediaries need to compensate for entrepreneurial risks; the narrower the base of the stock market and bank credits, the slower the reaction of producers, the longer unsatisfied demand persists, and the more significant the price increase; the higher the barriers to entry into monopolized markets, the greater the price premiums needed by "external" investors to overcome them. So it is not surprising that the expansion of production in non-competitive markets is accompanied by rising prices for the products produced. The latter also becomes more expensive due to the imperfection of procedures for the exit of "low-quality" consumers from the market. For example, in Ukraine, mass non-payments are a formal basis for raising tariffs for electricity, communal services, and public transport. At the end of February of this year, the mayor of Kyiv addressed the residents of the capital with an insistent request to "urgently pay off debts and pay for current housing and communal services." At the time of the address, the debt of the capital's energy workers for gas consumed in January amounted to over UAH 58.3 million. There is no doubt that the next step will not be disconnection of non-payers from services but an increase in tariffs. Regardless of the dynamics of the money supply. In all the mentioned cases, price growth acts as "grease" that compensates for the imperfection of market mechanisms. At the same time, the deeper their distortion, the more "lubricating material" is needed to increase production volumes. Under conditions of its "deficit," production may not react at all to insufficiently high price growth. And conversely, the development of a competitive environment contributes to lowering inflation. For example, in 1990—1999, its average indicators in economies with per capita incomes of USD 2.5—5 thousand were several times higher than in countries with incomes of USD 25 thousand (Fig. 1). Considering that the first group included countries such as Guatemala and Zimbabwe, and the second — Austria and Belgium, it would hardly be correct to reduce the entire difference between them solely to excess money supply. Especially since cases of its possible dominance (inflation of 40% or more) were not taken into account in the indicated sample. Since the process of improving economic institutions is endless, the need for inflationary "grease" is hardly likely ever to disappear. At the same time, the optimum of price dynamics is observed at the point where the difference between inflationary effects and losses reaches its maximum value. Its estimates vary from less than 1 to 20% depending on the specifics of the analysis, its methods, and the economies studied: in developing and transition economies, they are, as a rule, higher. For example, studying employment problems in 1997—1998, E. Groshen and M. Schweitzer concluded that in the US labor market, the difference between the "grease" and "sand" effects reaches its maximum at 3—4% inflation and approaches zero at 6—7%. At approximately the same time, P. Christoffersen and P. Doyle estimated the optimal inflation for transition economies at 13%. Interesting in this sense is the relationship between inflation and production observed in 1961—1999 in the group of economies with high per capita incomes (according to the World Bank classification, which distinguishes countries with low, medium, and high per capita incomes). Fig. 2 presents the results of smoothing forty-year series of prices and GDP in the indicated group of countries, which included, among others, the economies of Western Europe, the USA, Canada, Japan, Australia, etc. The presented figure is interesting not only because it clearly illustrates the practical use of the "grease" and "sand" effects. It also gives grounds to doubt the exclusively negative relationship between prices and production, and also demonstrates the effective limits of monetary reduction of inflation. The optimal level of the latter is in the area of 5% — it corresponds to the maximum GDP growth rates (also approximately 5%), which slow down at all other values of price dynamics. At the same time, monetary restriction of inflation turns out to be expedient only at values exceeding the indicated optimum. The effectiveness of further disinflation depends not on the money supply but on the effectiveness of institutional reforms. Of course, the indicated parameters are not universal. In each specific case, the ratio and resulting balance of inflationary losses and effects are unique to the extent that the market distortions of various economies and national methods of overcoming them are specific. But these peculiarities only detail the institutional causes of inflation, its optimal limits, and the expedient limits of monetary restrictions. As for Ukraine, last year its real GDP grew by a record 12.5%, and average annual inflation was 8.8%. It is noteworthy that in the previous three years, lower price dynamics were accompanied by more modest economic growth: in 2003, Ukrainian GDP increased by 9.4%, and in 2002 — by 5.2%. At the same time, consumer goods rose in price by 5.2 and 0.8%, respectively. Meanwhile, assessments of inflationary trends in Ukraine remain contradictory. For example, in a 2003 study, IMF representative in Ukraine B. Lisovolyk found no confirmation of optimal inflation ("threshold effects") in the domestic economy. Which made it possible to conclude that further efforts "for its progressive reduction" were expedient. Last year, certain domestic and foreign experts began to express concerns about too high price growth, the "overheating" of the Ukrainian economy, and the need to reduce the dynamics of prices and production. The indicated remarks require unconditional support regarding the inadmissibility of political games with the budget, which became acutely evident in the last six months. They also correctly draw attention to the problem of outpacing price growth in production and the threat of subsequent transfer of inflation to final products. But at the same time, of course, it should have been noted that similar rates of price growth in industry were observed in 2000 and did not lead to any fatal consequences. Moreover, the dynamics of domestic production only accelerated in subsequent years. Lowering inflation is, of course, necessary. But today the effectiveness of solving the indicated task depends not so much on the restrictive policy of the National Bank as on the elimination of market distortions, which are mostly in the zone of government responsibility. At the same time, it must be taken into account that since the resumption of economic growth (2000), a relationship has been traced between inflation and GDP in Ukraine in which even 10% price growth is not associated with a decline in production (Fig. 3). It is noteworthy that the same 10 percent inflation reflects price dynamics in countries with a level of economic development comparable to Ukraine in terms of per capita incomes (Fig. 1). The latter in 2003 amounted to USD 5,410 in our country and was lower than in Gabon — USD 5,700. In such a context, the threat of "overheating" of the domestic economy is doubtful. Especially since what is meant is a distorted market that generates unemployment. Today, according to various estimates, between 1—3 and 7 million Ukrainians work abroad. Of course, it is hard to believe that a quarter of the working-age population works abroad. However, even in the case of 15%, one can speak of an indicator comparable to the intensity of labor migration in the Balkans, where national unemployment levels reach 20—40%(!). The assumption of economic "overheating" does not look convincing against the backdrop of the economic dynamics of CIS countries either, whose average growth rates have held at 8% for the second year in a row. If in 2004 GDP in Ukraine grew by 12.5%, then in Belarus this growth was 11%, Tajikistan — 10.6%, Azerbaijan — 10.2%, Armenia — 10.1%, Kazakhstan — 9.4%, Georgia — 8.4%, Moldova — 7.3%, Russia and Kyrgyzstan — 7.1% each. Given that today the most dynamic are the economies that reduced production the most in the 1990s, what is meant is still "recovery" growth. The idea of limiting it defies any logic at all. If China had heeded such advice over the past 30 years and oriented itself toward the average rates of developing economies (5—6% per year), it would still remain a third-rate country today. The Chinese model, however, made people talk about it not in spite of but thanks to sustained 12 percent growth. At the same time, inflation of 10% and above did not repel investors. Just as Slovenia's 8—9 percent price growth (2000—2003) did not prevent it from successfully completing negotiations and joining the European Union last year. Ukraine is still recovering what was lost. After which it will have to catch up on what was missed. In doing so, one can rely exclusively on ultra-high rates and quality of economic growth. The solution to the indicated task lies in the sphere of institutional reforms: demonopolization of entrepreneurship, transparent and competitive access to resources, ensuring equality of owners' rights, etc. If they are successful, inflation will also begin to gradually decline. Attempts at its monetary containment (as, for example, is proposed today — through revaluation of the hryvnia) are inevitably associated with a loss of economic dynamism.

Serhiy KORABLIN (Doctor of Economic Sciences, Institute of Economic Forecasting of the NAS of Ukraine)