Inflation has recently wedged itself as a topic of popular conversation with many still trying to wrap their head around it.
While the economics and the theory could be mind-boggling, the societal effects are very real and warrant understanding.
What is inflation anyway? Is it good news or bad? Are there winners and losers when inflation rises?
Simply put, inflation is the loss in purchasing power of money over time. You can’t buy as much with your dollar in the future as you did today.
No matter the complexity, the simple concept of supply and demand is at the core of all inflation effects. If the supply of money outpaces the availability of goods and services, prices will rise.
This happens either with governments printing more money or making credit easily available or when supply chain problems lead to a shortage in the supply of goods.
The biggest losers in periods of high inflation are sellers of discretionary goods – items you could push out buying for a while. Makers of essential goods may be able to pass on increased raw material costs to consumers and sustain higher prices.
Prices of goods and services can always fluctuate. You might see some veggies getting cheaper and perhaps sugar getting costlier.
Inflation, however, indicates the annual change in prices for a basket of goods and services. This basket can include goods/services ranging from cereal and milk to clothing, house rent, appliances, and transport.
In India, that range is between 2 and 6 percent.
Like it or not, Inflation is similar to friction in science, a ‘necessary evil’. While it haunts most people, especially the poor who struggle to make ends meet, a healthy amount of inflation is necessary.
A moderate price increase encourages buyers to spend or invest more money, encouraging production and eventually economic growth.
While moderate inflation is good for the economy, unchecked inflation can be devastating for an economy by making goods unaffordable and pushing people into poverty. Extreme levels of inflation also increase the gap between the rich and the poor.
In any country, the central bank (such as the RBI in India or Federal Reserve in the US) plays a pivotal role in keeping a check on inflation.
The obvious question then becomes how do the Central Banks measure inflation in the first place? Because, anything that cannot be tracked, cannot be improved, right?
Headlines such as “Retail inflation soars to 7.5%, highest in 10 years!” are something that most of us are seeing now on a monthly basis.
Like stock indices such as Nifty/Sensex that measure the market performance by tracking the stock prices of the top 30 or 50 companies of India, price indices track the prices of major goods and services that form a part of a consumers’ regular needs.
The central banks target to keep the inflation range bound and use levers such as repo rate and cash reserve ratios to influence the supply of money in the economy.
“RBI keeps the repo rate unchanged at 4%”. We all do come across these headlines often on a quarterly basis. What is the repo rate and what is its implication on the economy?
It is the rate at which you borrow money from banks is ultimately determined by the rate at which the banks can borrow money from the central bank.
History has shown that periods of high inflation are a common occurrence. However, every inflationary period happens due to a different reason and the one we’re witnessing today isn’t a common occurrence and hasn’t happened for a long time.
Having a decent understanding of inflation, the next obvious question becomes, “what can you do to sail through high inflationary periods?”
Most people who save put their money in fixed deposits get 5% annual returns (let’s say). But if the inflation in the economy is 7%, that means your real returns on FDs would be -2%.
This means you are essentially losing money every year.
One of the ways to navigate periods of high inflation is to invest in asset classes that provide returns higher than inflation so that you don’t lose purchasing power. Equity or stocks as an asset class over the long run have generated returns that have beat inflation.
If there is an expectation of high inflation, one strategy to beat inflation is to push forward your spending on items that can be bought and stored in advance.
This doesn’t apply to perishables such as milk, veggies, etc. and that’s the reason why inflation on these commodities hits people the most.
Inflation also impacts businesses in terms of rising costs for producing goods and services.
While some monopoly businesses might be able to pass on these costs to the consumers, most of them don’t have the luxury to do that due to the price-sensitive nature of their customers and ultimately take a hit on their profits due to rising costs.
Inflation is a cyclical economic trend beyond an individual’s control. While public institutions strive to steady the ship, at a personal level it might pay off to call out wants masquerading as needs.
We are now in a time where inflation is very real. Most countries outside Asia and Africa haven’t seen inflation rates beyond 3% for decades.
Assets and other prices have wildly moved because very few investors have not seen inflation. Inflation is a vicious cycle because it is an expectation that is influenced by expectations. If people expect inflation to go higher, it will.
We just learn how to manage it better.