Johannesburg, May 22
Inflation is a process of sustained increase in the general level of prices over a period of time, usually 12 months.
Inflation can be calculated for a country, for specific regions of a country and for different income and demographic groups, for example pensioners.
These different calculations are important because the spending patterns of regions and groups differ. This means that their inflation rates also differ. It is therefore important that each household has a clear understanding of its own rate of inflation.
A number of countries allow the development of this better understanding. For example, South African households can use an Internet tool such as Statistics’ Personal Inflation Calculator.
A personal inflation calculator, based on household spending habits, is also available for the Eurozone, Canada and New Zealand.
The phrase describing inflation as “enemy number one” is borrowed from research done by South African businessman Anton Rupert on the global problem of inflation suffered in the 1970s.
He described inflation this way because of its distorting effect on countries’ economies and on the wealth and financial well-being of households.
But the word inflation has a much older origin. Its first use was in the United States between 1830 and 1860, when the US dollar began to lose value.
In short, people experience inflation when prices are rising steadily. Prices continue to rise and the same amount of money buys fewer goods and services over time.
Why is it so bad?
Inflation is bad because people on fixed incomes like retirees get poorer over time. The purchasing power of their money is eroded.
Another problem is that borrowers have an advantage over savers. With high inflation, the capital value of savings is eroded, while the real burden of borrowing declines.
It becomes easier to repay the debt. Although interest rates increase with higher inflation, the real value of the borrowed amount that must be repaid decreases as a percentage of inflation-adjusted wages.
Governments are the biggest borrowers in the world. They are therefore the main beneficiaries of inflation, because the real value of their debt erodes at the expense of the taxpayers of their country.
Tax revenue increases with higher inflation and government debt becomes a lower percentage of government revenue from taxes.
Who manages inflation and what instruments can they use?
Central banks have a responsibility to contain inflation. They use the level of interest rates to contain inflation.
This responsibility to contain inflation is more noticeable in countries that use inflation targeting. In these countries, central banks adjust interest rates according to the rate of inflation and its expected future level to keep it within the target range.
To contain inflation, central banks must keep interest rates above inflation. This difference between the inflation rate and the interest rate is called the real rate.
When the rate of inflation accelerates and is expected to continue this trend, the policy response of the central bank is a higher level of interest rate (both nominal and real), commensurate with the change in the path of inflation. inflation.
What can go wrong?
Central banks can make incorrect assumptions and use incorrect projections in their assessment of future inflation. This can cause them to set interest rates at an inappropriate level.
An example is the recent acceleration of the inflation rate in the United States to a level above 8%. At an average of about 3 percent per year, the rate of inflation in the United States has been at a very low level for the past four decades.
Recently, the rate accelerated to above 8%, without an appropriate policy response from the US Federal Reserve.
Consequently, US inflation could become a persistent problem.
This unexpected acceleration in prices took American households by surprise. Many households (eg retirees) who thought inflation would stay under control, are now faced with much higher expenditure without a commensurate increase in their income.
It is therefore important for central banks to be constantly vigilant and react to rising inflation. Inevitably, this involves setting interest rates at an appropriate real level above the rate of inflation.
Real interest rates can be calculated in several ways. The simplest and simplest method of calculation is to subtract the inflation rate from the nominal interest rate.
Some African countries suffer from persistent inflation problems, with rates much higher than in developed economies. Zimbabwe’s inflation rate for the year to April 2022 accelerated to 96.4%, while Ghana’s inflation rate was 19.4% over the same period.
Countries with high inflation experience pressure on exchange rates, with falling currency values. The currency’s exchange rate will remain under downward pressure as long as high inflation persists. Due to high inflation, investments in the country become unattractive.
The demand for the currency therefore decreases, which puts pressure on the exchange rate of the high inflation country.
The Ghanaian currency has already depreciated by 18% against the US dollar this year. Further decline in value is expected for the remainder of this year.
Over the past year, the Zimbabwean RTGS dollar has lost more than half of its value against the US dollar.
Due to the sharp depreciation of the currency, the domestic prices of imported goods and services in countries like Ghana and Zimbabwe have risen sharply and continue to rise whenever the currency depreciates.
Consumers in these countries who earn income in local currency find it increasingly difficult to obtain imported goods and services.
The trust deficit
A problem in an environment of sustained inflation is that people do not trust the official published inflation rate. Inflation rates are mistrustful for several reasons.
The first is a general distrust of government conduct. This results in a view that inflation rates are manipulated by the government agencies responsible for their publication to signal price increases that are lower than what is actually the case.
Second, the increase in prices of goods such as fuel, which is the subject of considerable publicity, gives the impression of a general increase in prices. This problem is related to the fact that price increases are much more visible to consumers and attract more attention than price decreases.
Finally, inflation measures price increases on a cumulative basis, using the price level of each previous year as the basis for calculation. This implies that the inflated price level of each previous year is used to measure the inflation rate of the following year. Over time, the cumulative effect of sustained inflation becomes quite significant.
Given the negative impact of inflation, it is in the interest of all consumers that authorities always apply policies that prevent price increases or keep price increases to a minimum.
Inflation does not make people rich, despite the fact that governments and borrowers reap the benefits of inflation. This is why the description that inflation is public enemy number one is so accurate.