Nov 13

What does inflation mean to the common man?

In Economics, Inflation is a rise in the general level of prices of goods and services over a period of time. When this happens, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of (real) value in the medium of exchange and unit of account within the economy. Consumer price inflation is the one usually in the news, and it takes an average of various items purchased by any typical household. The average can rise while some prices have actually fallen, and how much it reflects your personal situation is based on closely the basket of goods and services in the index matches your buying patterns. But, the bottom line is that we say that inflation has occurred when the average price of those goods and services has increased.

It’s also important to note that whereas Inflation is deemed a bad situation in an economy, it is not necessarily all bad and has some benefits. Different countries set different targets for inflation which only gets bad when that target is exceeded. The higher the inflation, the more serious the problem it is. Ideally, if your personal income increased at the same rate as inflation, there would be no hardships. Unfortunately, inflation is not an across-the-board price increase. Prices of different commodities or services may increase at different rates and at different times thus affecting different sections of the population. An example can be the rise of fuel prices usually growing faster than your own annual salary, hence the need to either get a new job with better bonuses or have a side income from a legal business of sorts.

Here in Uganda, as the government (through the Uganda Bureau of Statistics – UBOS) announces monthly inflationary rates, these facts will guide you through how inflation affects the common man;

  • Purchasing power of the shilling falls – a UGX 50,000 note, with which you used to buy a bunch of matooke, 2 kilogrammes of beef and 2 kilogrammes of sugar will probably buy you a small bunch of matooke, 1 and1/2 kilogrammes of beef and 1 kilogramme of sugar over time.
  • Speculative commodity wholesale dealers and middlemen may try and hoard essential commodities like food grains on hopes of reaping profits when prices increase further on dwindling supplies. This is very common during the harvest season and only gets prices going up with time after the harvests.
  • Fixed income groups (basically talking of salary earners like you and me) are the worst hit because their salaries will not be revised to include the cost of living even as prices of items soar.
  • Inflation reduces the value of savings. Just because Inflation leads to a fall in the value of money, it makes savers worse off (that is if you do not earn interest on your savings or that interest rate is lower than the rate of inflation). In the same way, high inflation is really bad for your retirement planning because your target has to keep getting higher and higher to pay for the same quality of life. In other words, your savings will buy less. As a result, you will need to save more today to pay for higher priced goods and services in the future. Since everything you buy today costs more, so you have less left-over income available to save.
  • Inflation can make an economy uncompetitive. For example, higher rate of inflation in Uganda can make Ugandan exports uncompetitive while making. This is particularly important for countries in the Euro-zone because they can’t devalue to restore competitiveness.
  • Inflation tends to discourage investment and long term economic growth. This is because of the uncertainty and confusion that is more likely to occur during periods of high inflation. It is only rational that most people will play safe rather than invest at times when savings are dwindling, interest rates are rising and the country’s trade competitiveness is diminishing among others.

And so, many people still question themselves on what causes inflation. Many circumstances can cause inflation. I will focus on three.

This is not an all-inclusive list, but I would think that it covers the vast majority of what affects us most.

  1. First, the economic agent could have market power. This means they have the ability to avoid (at least to some extent) competitive pressures. It is the latter that forces firms to please consumers. Taking an example of a utility provider like UMEME for the sake of electricity which is a sole provider of grip power and the consumers have limited substitutes. Any increase in the power tariff will most probably contribute to increasing inflation. This is so because, anything that uses electricity or electricity -based products, it would raise the prices of manufactured goods and may also raise the prices of other sources of energy like petrol, diesel, charcoal and firewood among others as consumers seek more of the substitutes of electricity.
  2. Another means by which inflation can take place is a rise in demand relative to supply. Say there is an increase in the demand for housing during an economic expansion. Bottlenecks may arise in certain building supplies like cement and bricks. Contractors bid up these prices in an attempt to secure the materials they need; these price increases then ripple through the economy. Firms and consumers again desire a larger money supply to be able to operate, which the country presumably accommodates. The producers of cement and bricks may also experience a rise in their incomes as part of this process. This is how a market system is supposed to work. Those selling goods and services in highest demand should see their profits and wages rise, even though by definition this will almost certainly cause inflation.
  3. Thirdly is a supply shock. If a hailstorms rage through many parts of the country, badly affecting gardens, plantations and eventually reducing the yield from that season’s crop, this may well raise the price of food. Poor agricultural out-put due to the disaster will lead to low supplies that will not be sufficient for the entire population. The shortage of food will definitely drive the prices up thus leading to inflation.

It should also be noted that how governments decide to curb inflation will in-turn affect each one of us. Taking an example of the approach Bank of Uganda (BoU) has largely used over the past 2 – 3 years; its decision to raise its policy interest rate commonly referred to the Central Bank Rate (CBR), which acts as a benchmark for other interest rates in the economy, including commercial bank lending rates.The economists refer to this approach as the monetary policy.

As you should always expect, the approach has attracted a lot of criticism. This does not mean that the approach is wrong, but there is always a cost to pay in the short-term. The cost that a common man may have to pay is when this Central Bank Rate indeed causes the interest rates to at which borrowers access credit from the commercial banks to rise thus making it more expensive for you to access a loan.

So, the next time you see the fuel pump prices go up or hear about the taxi operators crying over a high increase in the fuel prices, or the number of tomatoes you used to buy at your regular amount dwindling or when you see the notices in newspapers that commercial banks are increasing their lending rates, it’s a signal that you should not take lightly but prepare and cautiously spend on everything that you step out to buy and above all hope that it lasts less than the proverbial next six months.

By Brian Ahabwe Kakuru

 

BrianBrian is the Managing Director at BLEGSCOPE®, and has over 9 years of management consultancy experience notably in the finance and banking industry, MSMEs, FMCG companies and in the service industry. He has a BA (Econ). You can follow him on twitter: @BrianAhabweK

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