What is inflation?Sunday, October 17, 2021
By KALILAH REYNOLDS
FORGIVE me for stating the obvious, but the cost of living is going up! Yup, inflation is on the rise — and it's only gonna get worse. Today I'm gonna break down what exactly is inflation and how it is measured.
Inflation is the general increase in prices of goods and services. This can be caused by increases in raw materials like gas, agricultural produce, shipping costs or simply because people have too much money and want to buy everything. When demand is high and supply is the same or lower, prices go up. In the US, it's believed that all those stimulus cheques have created increased demand as people had extra money to spend. US inflation for the past 12 months just hit a 13-year high of 5.4%, the highest since the great recession of 2008.
In Jamaica, point-to-point inflation for August was 6.1%. This means that the prices of goods and services in August 2021 were 6.1% higher when compared to the prices of goods and services in August 2020.
Shipping costs have gone through the roof due to a global shortage of shipping containers, the delays caused by the Evergreen shipping vessel getting stuck in the Suez Canal in March 2021 and closure of major Chinese shipping ports to control COVID-19 cases. Many companies ship goods — ranging from food items to equipment — from China and so with the increase in shipping costs they have had to raise their prices to their customers. Gas and oil prices have gone up as economies recover and demand increases. Also, heavy rains reduced the supply of agricultural produce, causing an increase in prices. These factors have led to the inflation we are now experiencing and which, for all these reasons, is about to get worse.
Each country's central bank, in our case the Bank of Jamaica (BOJ), monitors inflation to ensure that prices do not go up by too much too quickly, as this would reduce the value of our money. The BOJ monitors inflation using the Consumer Price Index (CPI). The CPI is a basket of goods and services that represents what we spend money on. Let's see: food, rent/mortgage, transportation, clothing and shoes, light and water bill, to name a few. The Statistical Institute of Jamaica, Statin, collects the prices of these items each month, ranks them according to what we spend most on to what we spend the least money on, then finds the average price of all the items in the basket. Changes in the average price give the inflation rate. The BOJ uses these observations to make decisions on what they will do to control inflation.
The BOJ has been telling us for some time now about inflation targeting. The inflation target is a range that they have set for inflation. They've calculated that an inflation rate between 4% - 6% does not significantly reduce the value of our money or our purchasing power, but instead helps the economy to grow.
When we work and get our pay, we usually go to the supermarket to buy groceries. How many items you are able to buy with your pay is called your purchasing power. If you go to the supermarket this month with $10,000 and you are able to buy 10 items, your purchasing power is the 10 items that you bought. But what if next month when you go to the supermarket you are only able to purchase 5 of those same items with your $10,000? When this happens, we say your purchasing power has decreased or has been eroded. That price increase is inflation. Inflation reduces the number of goods or services you can afford. Inflation makes you poorer.
The BOJ does not want this to happen so they use what they call monetary policies to try and keep inflation within its target range of 4%-6%. The August point-to-point inflation rate of 6.1% is slightly out of the BOJ's target and, based on their forecasts, they expect more price increases. To keep inflation within their targeted range the BOJ has increased the supply of US dollars available, and they've also raised their policy interest rate from 0.5% to 1.5%. The policy interest rate is the interest they pay to banks that keep money with them.
The governor of the central bank, Richard Byles explained how the interest policy rate works in an interview on Taking Stock. “[With the increase in the policy rate], they [banks] may have to start paying depositors more. So they may find that they have to raise rates to keep your deposit or attract further deposits. When the rates that they pay depositors rise, they may have to increase the rates at which they lend at.”
An increase in lending rates will likely mean that people will borrow less and in so doing, have less money to buy goods and services. The BOJ hopes that this move will help to reduce demand, and therefore, reduce inflation.
So how can we protect ourselves from inflation? So far we have learned that if our annual income is fixed, meaning, we earn the same amount of money every year, then the value of our annual income is actually decreasing because of inflation. Our purchasing power becomes less and less each year. To protect ourselves from inflation we must earn more each year at a rate in line with inflation or more than inflation. Apart from getting a raise each year if possible, we can earn more by investing in stocks to benefit from stock price appreciation and dividends, investing in index funds or bonds that generate returns that are equal to or higher than inflation, starting a profitable business, owning an income-generating property or benefiting from appreciation in the value of the property. Not only should we earn more money from these sources, we should reinvest the money earned to compound our returns. We'll discuss compounding returns and interest in another article.
Get money tips from Kalilah Reynolds Media at youtube.com/kalilahrey and kalilahreynolds.com.