IMF Posts inflation study for Iraq

[Kent]

I am just posting the summary and then the conclusion section. Hit the link if you want to read the whole thing (20 + pages). Obviously inflation is an important issue relative to monitary policy.

http://www.imf.org/external/pubs/cat/longres.cfm?sk=24035.0

Summary: Containing inflation has turned out to be one of the most challenging aspects of economic management in Iraq. This paper posits that conventional as well as unconventional factors explain inflation dynamics in the recent past. We build a theoretical model based on the insights into the workings of socialist economies under supply shortages provided by Shleifer and Vishny (1992) to help explain price dynamics. In the model, strategic behavior of the fuel distribution monopolist results in fuel shortages, with implications for fuel and non-fuel inflation. A number of step-wise adjustments of administered prices for fuel products since December 2005 offer an interesting experiment to help study this behavior. Our findings show that inflation may have been influenced by shortages in fuel and non-fuel commodity supplies, which themselves are driven by violence and rent-seeking.

V. CONCLUSIONS AND POLICY IMPLICATIONS

Since the invasion in 2003, inflation in Iraq has been high, and in 2006 it increased sharply. Our findings show that inflation may have been influenced by shortages in fuel and non-fuel commodity supplies themselves driven by violence and rent-seeking behavior in the fuel distribution sector. We also conjecture that trend inflation may have been influenced by adjustment of the real exchange rate to a new (appreciated) equilibrium in the context of improved terms of trade and a fixed exchange rate.

The results also suggest that, while raising administered fuel prices may contribute to inflation in the short run, raising such prices to international levels would eliminate rent-seeking via induced shortages, and thereby help reduce inflation. The fuel monopolist has an incentive to engage in behavior that is socially sub-optimal by suppressing the supply of oil products and keeping it below market equilibrium levels.

Given the focus on supply shortages as a factor in driving inflation in Iraq, the findings also provide strong support for the authorities’ policy of liberalizing the importation and distribution of fuel products and allow the private sector to freely operate in this sector. Adjusting fuel prices closer to international levels helps in reducing shortages but does not change the underlying incentives of the fuel monopolist to maximize and collect rent by supplying less than what the market could consume at any given price. It is clear that full convergence of both prices and quantities towards the equilibrium levels will be achieved through liberalization of the supply network to allow the private imports of gasoline. These policies have helped reduce inflation from 65 percent at end-2006 to single digits in the last quarter of 2008.

The econometric results presented in the paper also highlight the important role that the continuing violence has played in hindering efforts to reduce inflation. The effect of violence is stronger for non-fuel commodity supplies than for fuel commodity supplies.

Finally, the result shows a strong pass-through from the exchange rate to inflation which supports the government’s policy of a gradual appreciation of the exchange rate to control inflation.

[pt497]

Rec'd 7/12/10

Working Paper No. 10/159: Inflation and Conflict in Iraq: The Economics of Shortages Revisited

Author/Editor: Grigorian, David A.; Kock, Udo

Summary: Containing inflation has turned out to be one of the most challenging aspects of economic management in Iraq. This paper posits that conventional as well as unconventional factors explain inflation dynamics in the recent past. We build a theoretical model based on the insights into the workings of socialist economies under supply shortages provided by Shleifer and Vishny (1992) to help explain price dynamics. In the model, strategic behavior of the fuel distribution monopolist results in fuel shortages, with implications for fuel and non-fuel inflation. A number of step-wise adjustments of administered prices for fuel products since December 2005 offer an interesting experiment to help study this behavior. Our findings show that inflation may have been influenced by shortages in fuel and non-fuel commodity supplies, which themselves are driven by violence and rent-seeking.

http://www.imf.org/external/pubs/cat/longres.cfm?sk=24035.0

[Matched: Iraq]

DISCLAIMER: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

[kingjaffi]

I am just posting the summary and then the conclusion section. Hit the link if you want to read the whole thing (20 + pages). Obviously inflation is an important issue relative to monitary policy.

http://www.imf.org/external/pubs/cat/longres.cfm?sk=24035.0

Summary: Containing inflation has turned out to be one of the most challenging aspects of economic management in Iraq. This paper posits that conventional as well as unconventional factors explain inflation dynamics in the recent past. We build a theoretical model based on the insights into the workings of socialist economies under supply shortages provided by Shleifer and Vishny (1992) to help explain price dynamics. In the model, strategic behavior of the fuel distribution monopolist results in fuel shortages, with implications for fuel and non-fuel inflation. A number of step-wise adjustments of administered prices for fuel products since December 2005 offer an interesting experiment to help study this behavior. Our findings show that inflation may have been influenced by shortages in fuel and non-fuel commodity supplies, which themselves are driven by violence and rent-seeking.

V. CONCLUSIONS AND POLICY IMPLICATIONS

Since the invasion in 2003, inflation in Iraq has been high, and in 2006 it increased sharply. Our findings show that inflation may have been influenced by shortages in fuel and non-fuel commodity supplies themselves driven by violence and rent-seeking behavior in the fuel distribution sector. We also conjecture that trend inflation may have been influenced by adjustment of the real exchange rate to a new (appreciated) equilibrium in the context of improved terms of trade and a fixed exchange rate.

The results also suggest that, while raising administered fuel prices may contribute to inflation in the short run, raising such prices to international levels would eliminate rent-seeking via induced shortages, and thereby help reduce inflation. The fuel monopolist has an incentive to engage in behavior that is socially sub-optimal by suppressing the supply of oil products and keeping it below market equilibrium levels.

Given the focus on supply shortages as a factor in driving inflation in Iraq, the findings also provide strong support for the authorities’ policy of liberalizing the importation and distribution of fuel products and allow the private sector to freely operate in this sector. Adjusting fuel prices closer to international levels helps in reducing shortages but does not change the underlying incentives of the fuel monopolist to maximize and collect rent by supplying less than what the market could consume at any given price. It is clear that full convergence of both prices and quantities towards the equilibrium levels will be achieved through liberalization of the supply network to allow the private imports of gasoline. These policies have helped reduce inflation from 65 percent at end-2006 to single digits in the last quarter of 2008.

The econometric results presented in the paper also highlight the important role that the continuing violence has played in hindering efforts to reduce inflation. The effect of violence is stronger for non-fuel commodity supplies than for fuel commodity supplies.

Finally, the result shows a strong pass-through from the exchange rate to inflation which supports the government’s policy of a gradual appreciation of the exchange rate to control inflation.

Thanks for the post! Nice break down...now let that exchange rate appreciate even higher! Go RV!