INFLATION AND THE ECONOMY

inflation movement curve

The global economy has been expanding at a rapid pace since the adoption of fiat by all countries in the world. The rise in fiat usage for transactional purposes allows countries to print their local currencies at will. Undoubtedly, fiat has become the most feasible means for exchanging goods and services globally, but it has its negative sides. The monetarism school of thought position on the impact of the money supply is that the quantity of money in circulation is a key factor in stabilizing the economic growth of any country. So, inflation becomes a reality when the money in circulation exceeds the value of goods in circulation.

WHAT IS INFLATION?

Inflation is the rise in prices of goods and services over a period. An economy is said to be inflation when the power’s purchasing power reduces against commodity prices. Inflation cannot be studied in isolation. To understand the procedures measuring inflation, you need to understand the goods basket standard. When economists calculate inflation, they compare the current prices of goods against the good’s previous prices. If the current price exceeds the previous price, that indicates that inflation has taken place. For instance, if the price of one kilogram of meat was sold for #500 in March 2023, and the price moves higher to #1000 in April of the same year, that implies a price increase. The difference between the old and new prices is the inflation value.

INFLATION VERSUS DEFLATION AND DISINFLATION

Inflation is different from deflation and disinflation. Inflation is the increase in the prices of commodities in an economy. Deflation mode is when the prices of goods and services crash. Disinflation is when the price of goods and services drops marginally within a short period. Monetary authorities use disinflation to measure the percentage drop in the inflation rate. For instance, if an economy’s inflation rate drops from 10% to 9.9% within a short period, that is deflation. The sharp difference between deflation and disinflation is that deflation represents a drop in prices continuously, while disinflation measures that snail pace drop in the inflation rate. If the price Coca Cola continues to fall continuously over a period, that is deflation. But if the price of Coca-Cola drops slightly, that is disinflation.

HOW TO MEASURE INFLATION?

Economists make use of three instruments when computing inflation data. The three instruments are Consumer Price Index (CPI), Purchasing Price Index (PPI), and Manufacturing Price Index (MPI).

Consumer Price Index

The consumer price index is a mathematical inflation process to calculate the inflation rate of individuals. To do this, we have to put a basket of goods forward. The next phase is to calculate the price changes of items inside the basket. After that, we check the average price of the goods against their weight in the whole basket.

Wholesale Price Index

Before goods reach the final consumer, they pass through different production stages. The wholesale price index measures a change in price at the wholesale level before the good gets to the final consumer. The change in the material price for production is subject to the wholesale price index. To understand when there is an increase in the price of bread at the wholesale point, you need to check the price changes in the material bakers use for bread production. A change in the price of flour, sugar, yeast, water, labor, and wages will directly increase the production cost.

Producer Price Index

The consumer price index focuses on individual consumers, while the producer price index focuses on the seller. The producer price index is a tool economists use to measure price changes from a seller’s perspective.

TYPES OF INFLATION

Demand-Pull inflation

Traditionally, demand-pull inflation is the commonest form of inflation. Demand-pull inflation is evident in an economy where an injection of the money supply to consumers increases their purchasing power. For instance, if Mr. A, Mr. B, and Mr. C earn $500 monthly, and their employer increases their monthly salary to $1,000, that will lead to an increase in money supply for Mr. A, Mr. B, and Mr. C. The impact is that their purchasing power has increased, implying that they can go for items they could not purchase when earning $500. If the three individuals always wanted to own a car valued at $1000 respectively but couldn’t because of their previous earnings, the new monthly wage can help them afford the car without a blink of an eye. However, if three other people, like Mr. A, B, and C, want the same car and are willing to pay the amount, there will be a pricing problem, especially if the car has only three units. In the end, six willing buyers will compete for three units of the car. Since the demand exceeds supply, the supplier will have no option but to increase the price. Demand-pull inflation takes root in an economy where people have the money to spend, but there is no correlated supply to meet the mammoth demand of consumers.

Built-in inflation

An economy will experience inflation where the majority of the people within an economy psychologically believe there will be a further price increase of a commodity. A good example of built-in inflation is when people expect that the value of land will increase within an area in the future, so everyone wants to get a piece of the cake before the lands become unavailable. Built-in inflation is speculative. Several factors can be responsible for built-in inflation. Using real estate as a good example. For instance, the Lagos state government is massively investing in the Epe area of Lagos state through road and sighting of key infrastructures. As the government is making its move, the people are watching people’s reactions to moving into the Epe area. As more people move into the Epe region, it automatically alarms land sellers to hike the land price. The higher the price, the more people are willing to buy because the buyers are convinced that the land value will appreciate astronomically.

Cost-Push inflation

Cost-push inflation occurs when the price of raw materials for producing finished and intermediate goods increases. The increase in raw materials and factors of production will eventually rob the final product. As the money supply increases, the value of money reduces in proportion to the money supply. In this case, the money value at the hands of the producer has reduced. So, when the cost of production skyrockets, producers will have no option but to spread the cost increase on the goods they produce.

In an economy, consumers will prefer deflation and disinflation to inflation. Inflation reduces the value of money, and it also reduces the purchasing power of the consumer. The power to reduce inflation lies with the government because only the government has a monopoly over the money supply in the economy. The government controls the money supply through monetary authorities like central banks and monetary policy committees. For stability to exist in an economy, the government must have a threshold for inflation. There should always be a maximum and barest minimum for a country’s inflation rate. Using the right monetary policy instruments, the government can successfully tame the inflation rate before it destroys the real and nominal value of the consumers.