INFLATION - PUBLIC ENEMY NUMBER ONE

INFLATION

PUBLIC ENEMY NUMBER ONE

Stes de Necker

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.

When the price level rises, 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.

A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time. 

The inflation rate is widely calculated by calculating the movement or change in a price index, usually the consumer price index.

The inflation rate is the percentage rate of change of a price index over time. The Retail Prices Index is also a measure of inflation that is commonly used in South Africa. It is broader than the CPI and contains a larger basket of goods and services.

South Africa Inflation Rate 1995:

South Africa Inflation Rate 2015-05-22:

Other price indices used for calculating price inflation include the following:

·        1. Producer price indices (PPIs) which measures average changes in prices received by domestic producers for their output.

This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any eventual increase in the CPI.

Producer price index measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" to consumers, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index.

·        2. Commodity price indices, which measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.

·        3. Core price indices: because food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore most statistical agencies also report a measure of 'core inflation', which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.

Before collecting consistent econometric data became standard for governments, and for the purpose of comparing absolute, rather than relative standards of living, various economists have calculated imputed inflation figures.

Most inflation data before the early 20th century is imputed based on the known costs of goods, rather than compiled at the time. It is also used to adjust for the differences in real standard of living for the presence of technology.

Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate. While there is no widely accepted index of this type, some central bankers have suggested that it would be better to aim at stabilizing a wider general price level inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation only. 

The reason is that by raising interest rates when stock prices or real estate prices rise, and lowering them when these asset prices fall, central banks might be more successful in avoiding bubbles and crashes in asset prices.

Inflation affects an economy in various ways, both positive and negative.

Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future.

Inflation also has positive effects:

·        Fundamentally, inflation gives everyone an incentive to spend and invest, because if they don't, their money will be worth less in the future. This spending and investment can benefit the economy.

·        Inflation reduces the real burden of debt, both public and private. If you have a fixed-rate mortgage on your house, your salary is likely to increase over time due to inflation, but your mortgage payment will stay the same. Over time, your mortgage payment will become a smaller percentage of your earnings, which means that you will have more money to spend.

·        Inflation keeps nominal interest rates above zero, so that central banks can reduce interest rates, when necessary, to stimulate the economy.

·        Inflation reduces unemployment the extent that unemployment is caused by nominal wage rigidity. 

      When demand for labour falls but nominal wages do not, as typically occurs during a recession, the supply and demand for labour cannot reach equilibrium, and unemployment results. By reducing the real value of a given nominal wage, inflation increases the demand for labour, and therefore reduces unemployment.

Economists generally believe that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. However, money supply growth does not necessarily cause inflation.

Some economists maintain that under the conditions of a liquidity trap, large monetary injections are like "pushing on a string".

Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities.

However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.

Today, most economists favour a low and steady rate of inflation. Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities.

Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. There were different schools of thought as to the causes of inflation.

Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation.

The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer.

The quantity theory of inflation rests on the quantity equation of money that relates the money supply, its velocity, and the nominal value of exchanges. 

Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.

Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the long run. Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of money supply relative to the growth of the economy. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates.

The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian economists.

In monetarism prices and wages adjust quickly enough to make other factors merely marginal behaviour on a general trend-line. 

In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy