Inflation is a process of sustainable growth at a general price level over a period of time, usually 12 months.
Inflation can be calculated for a country, for a specific region of a country and for different income and population groups, for example pensioners.
These different calculations are important because regions and groups have different spending patterns This means that their inflation rate is also different. So it is important for each family to have a clear idea about its own inflation rate.
Several countries allow the development of this advanced understanding. For example, South African Household Statistics SA may use an Internet tool, such as a personal inflation calculator. A personal inflation calculator based on household spending patterns is also available for the Eurozone, Canada and New Zealand.
The phrase describing inflation as ‘enemy number one’ is borrowed from a study by South African businessman Dr Anton Rupert on the global inflation problem in the 1970s.
He described inflation in this way because of its distorted impact on the economies of countries and on the wealth and financial well-being of families.
But the word inflation has been around for a long time. It was first used in the United States between 1830 and 1860, when the US dollar began to depreciate.
In short, sustainable price increases cause people to experience inflation. Prices continue to rise and the same amount of money buys less goods and services over time.
Why is it so bad?
Inflation is bad because people with fixed incomes, such as pensioners, become poorer over time. Their purchasing power of money is eroded.
Another problem is that borrowers benefit from savers. With high inflation, the value of savings capital decreases, while the actual burden of debt decreases. It becomes easier to repay the loan. Although interest rates increase with higher inflation, the actual value of the borrowed amount that must be paid decreases as a percentage of the adjusted salary for inflation.
The government is the largest borrower in the world. So they are the main beneficiaries of inflation, because the actual value of their debt decreases at the expense of the taxpayers of their country. With high inflation, tax collection increased and government debt became a small percentage of government revenue raised from taxes.
Who manages inflation and what materials can they use?
The central bank is responsible for controlling inflation. They use interest rate levels to control inflation.
This responsibility to contain inflation is most notable given that countries use inflation targets. In these countries, central banks keep interest rates within the target range in line with inflation and its expected future levels.
To keep inflation under control, central banks must keep interest rates above inflation. This difference between the rate of inflation and the rate of interest is called the actual rate). When the rate of inflation accelerates and this trend is expected to continue, the policy response of the central bank is consistent with a higher interest rate level (both nominal and real), a change in the direction of inflation.
What could be wrong?
Central banks may make erroneous assumptions and use erroneous assumptions to assess future inflation. This could set their interest rates at an inappropriate level.
An example is the recent acceleration in the level of inflation above 8% in the United States. At an average of about 3% per year, the US inflation rate has been very low for the last four decades). The rate has recently accelerated above 8% without a proper policy response from the US Federal Reserve.
As a result, US inflation could become a permanent problem.
This unexpected rise in prices has taken American families by surprise. Many families (pensioners, for example) who assumed that inflation would be under control are now facing much higher costs without a consistent increase in income.
It is therefore important that central banks remain vigilant and respond to accelerate inflation. Inevitably, this means setting the interest rate at an appropriate real level above the inflation rate.
The actual rate of interest can be calculated in different ways. The simplest and easiest way to calculate is to subtract the rate of inflation from the nominal interest rate.
Some African countries continue to suffer from inflation, which is much higher than in developed economies. As of April 2022, Zimbabwe’s inflation rate has accelerated to 96.4%, while Ghana’s inflation rate was 19.4% over the same period.
Countries that suffer from high inflation experience exchange rate pressures as their currencies depreciate. Currency exchange rates will remain under downward pressure as long as high inflation continues. Investment in the country is not attractive due to high inflation. Currency demand therefore declines, which puts pressure on the country’s exchange rate, including high inflation.
Ghana’s currency has already depreciated 18% against the US dollar this year. Further price reductions are expected for the rest of this year
In the last one year, Zimbabwe’s RTGS has lost more than half its value against the US dollar).
Due to the sharp currency devaluation, the domestic prices of imported goods and services in countries like Ghana and Zimbabwe have risen sharply, and the currency continues to depreciate every time.
Consumers in those countries who earn in local currency face increasing difficulties in affording imported goods and services.
Lack of confidence
One of the problems in the environment of sustainable inflation is that people do not trust the officially published inflation rate. The rate of inflation is distrusted for a variety of reasons. The first is general distrust of government behavior. This leads to a scenario where the rate of inflation is driven by the government agencies responsible for their publications, which actually report lower-than-expected price increases.
Second, the rise in prices of products such as fuel, which receives considerable publicity, leads to the notion of general price rise. This problem is compounded by the fact that price increases are much more visible to consumers and attract more attention than price reductions.
Finally, inflation measures inflation on an ascending basis, using each previous year’s price level as the basis for calculations. This means that each previous year’s inflation level is used to measure the next year’s inflation rate. Over time, the growing impact of sustainable inflation has become quite large.
This can be explained in a different way. With a persistent inflation rate of 5% per year, the intuitive realization is that prices will double every 20 years. In reality, however, under these conditions, prices will double every 14.4 years. Price increases therefore exceed consumer perceptions.
Given the negative impact of inflation, it is in the interest of all consumers that the authorities should always pursue a policy that prevents or minimizes such growth.
Inflation does not make people rich, although the government and the borrowers enjoy the benefits of inflation. That is why the description of inflation as the No. 1 enemy of the people is so accurate.
Jenny Rossou, Visiting Professor at the School of Business, University of Witwatersrand
This article has been republished from Conversations under a Creative Commons license. Read the original article.