Mechanisms to Target Inflation in The Existence of Dollarization in Somalis’ Economy
Somalis economy is daunted by the dual tender where two currencies are legally acceptable in the domestic markets. Economists call this effect as currency substitution which is a situation that occurs when the citizens of the country use, fully or partially by foreign currencies. This effect is not specific to one market, but, is common to all markets and transactions in Somalis Economy.
The prime implication of the dollarization is currency depreciation as domestic currency loses value over the dollar. Currency depreciation is a favorable by itself when the country is an export maximizing and striving to gain competitiveness in the international markets. In import dominated economies like Somalia, currency depreciation leads to inflation as domestic prices rise, which in effect raises the living costs of the nation and put pressure to the working class. This is very true in Somalia, where inflation is greater than 40% in all the markets.
Although the causes and the curries of the inflation is beyond the scope of this text. This article assumes that inflation in these economies, is partially caused by dollarization. How inflation could be targeted in existence of dollarization is this article’s purpose.
Dollarization is the Main Source of Somalis Inflation
Dollarization is a procedure in which one country embraces to substitute its currency with a foreign currency in all main basic roles of money. Previously in Somalia, dollarization was mostly linked to the role of money as a medium of exchange where people use foreign currency to buy some of the imported goods. Somali Shilling’s defacement led a new term financial dollarization that refers to the substitution of the role of store of value of domestic currency to the foreign currency.
Dollarization in Somalia is a more limited form of dollarization, real dollarization, which is the use of the foreign currency for price and wage contracts. It is a phenomenon that is very common in many countries in Latin American those fully dollarized their currencies, gave up their monetary policy autonomy and spared all the stabilization policies to be undertaken by monetary authorities.
Although the dollarization is a universal issue resulted from the globalization and openness of financial markets, dollarization in Somalia reaches the highest value as the economy suffers from high inflation, lost trust in home currency, currency devaluations, fiscal deficits or illegal trade.
Monetary economist argues that dollarization has the advantage of lower transaction costs and higher involvement in the international markets. These advantages are outweighed by its hindrances those are loss in monetary policy independence, inability to adopt strict fiscal policy and the vulnerability of the banking system. In addition, dollarization devalues the home currency and as result inflation accelerates. Monetary authorities that aim to achieve price stabilization need to consider the pitfall pose by dollarization.
What do we mean by inflation targeting, and it is realized?
The most common definition of the inflation targeting is a monetary policy aiming to achieve price stability in the economy. Put it in another way, any policy that attempts to eliminate the inflationary pressure is said to be inflation targeting. Macroeconomist agree that the inflation target should not be zero, but in somewhere that balances employment and inflation.
Inflation can be targeted by a central bank by taking these measures:
Defined quantitative targets for inflation in the medium term should publicly be declared by the central bank. The central Bank’s main goal of monetary policy is to attain price stability; and know that target of the aggregate demand.
The central bank needs to be highly transparent and accountable during the application of the monetary policy and its performance in achieving the target. The central Bank constantly communicates to the public the objectives set, choices made by the bank authorities and outcome;
The policy framework of the central bank would emphasis on future inflation by taking into account a lot of information in defining the settings of policy instruments.
Unless these characteristics are developed by the central bank of Somalia , any policy taken to achieve the inflation target would ineffective and unable to attain its nominated goals.