The spike in Kenyan inflation and why it might offer a (partial) solution to the euro crisis

The euro zone is suffering from deflationary pressures and there is an obvious a need for monetary easing. On the other hand Kenya do not have that problem. In fact Kenyan inflation (and NGDP) has risen sharply since 2009. In some sense you can say that Kenya has what the euro zone needs and it is therefor interesting to examen why Kenya inflation has risen in recent years. I should of course stress that I don’t think the the euro zone need Kenyan monetary policy, but monetary developments in Kenya in recent years might nonetheless tell us how we could get monetary easing in countries like Greece and Spain – even if the ECB maintains it’s “do-nothing” stance (in fact the ECB is passively tightening monetary policy on a daily basis these days).

There are a number of reasons for the increase in inflation in Kenya, but notable reason undoubtedly is the increase in money-velocity since 2010. The increase in money-velocity to the financial innovation called M-pesa. M-pesa is a mobile based payment system operated by the mobile telephone provider Safaricom.

See here from African Development Bank (ADB) report on East African inflation from 2011:

“In the case of Kenya, the advent of financial innovation such as e-money may have contributed to the increase in velocity of money as seen by the corresponding rise in the number of M-PESA subscribers (Figure 8). The M-PESA has brought more than 14 million customers into virtual banking. According to the IMF (IMF, 2011), M-PESA processes more transactions domestically within Kenya than Western Union does globally. The M-PESA platform also provides mobile banking facilities to more than 70 percent of the country’s adult population. Evidence shows that the transactions velocity of M-PESA may be three to four times higher than the transactions velocity of other components of money.

The increase in the velocity of money induced by these activities may have in turn propagated self-fulfilling inflation expectations and complicate monetary policy implimentation. The monetary authorities may inadvertently follow looser monetary policy if the stock of e-money grows more rapidly than projected.

Further, since effective monetary policy is anchored on a constant money demand function, under conditions of unstable money, rising velocity and deep supply shocks, monetary policy based on interest rate targeting has a limited impact in controlling inflation.”

This of course is an argument why the Kenyan central bank should stop operating a “monetary policy based on interest rate targeting”, but it also shows that if the central bank operationally targets the interest rate (this is what both the Federal Reserve and the ECB do) then a positive or negative shock to velocity will impact nominal GDP and inflation.

And this also provides a partial solution to the euro crisis. Imagine if M-Pesa was introduced in Spain and/or Greece and had the same impact on money-velocity as in Kenya then that would obviously increase Greek and Spanish nominal GDP even if the money supply is kept unchanged.  That would seriously reduce the pressure on public finances and improve the general macroeconomic environment by reducing deflationary pressures.

Obviously this would not work if the ECB would counteract the increase in money-velocity by reducing money supply and given the track record of the ECB that can unfortunately not be ruled out (remember that few other central banks would have hiked interested under the circumstances the ECB hiked last year). That said, a sharp increase in Greek and Spanish money-velocity would certainly do no harm at the the moment. In fact it is badly needed.

So is this in anyway realistic? Well, I doubt the introduction of a M-Pesa style system would in anyway be enough to solve the euro zone crisis. Furthermore, it should be noted that M-Pesa has not in general been regulated within the framework of the regular Kenyan banking regulation and this is clearly part of the reason for the success of the scheme. I doubt that any European central bank would have a similar open-minded view of e-money as the Kenyan central bank. However, that does not change the conclusion that technological development and a liberalization of banking legislation in the crisis hit European economies could give an badly needed boost to money-velocity – and the ECB would not have to buy one-single Spanish government bond to achieve it. Just allow M-Pesa mobile banking and you can at least make some sort of monetary easing more likely.

PS the clever reader might realize that this is a very moderate Free Banking style proposal to reduce monetary disequilibrium in the euro zone.

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6 Comments

  1. Sydney

     /  June 5, 2012

    I have been reading your blog for a few months now. From bitcoin to Kenyan inflation, it is rare to find a opened minded global approach to finance news. Good job.

    Reply
  2. Thanks Sydney – I am trying to make it interesting and as I have said since I started blogging I want to make it less US centric than a lot of the other economics blogs out there.

    Reply
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