If you drive a car, you know the difference between speed and acceleration. That is most important when considering inflation which is simply the rate of change of the price of a basket of goods and services. Acceleration is the rate of change of the speed of the car and is measured over a specific time period.
Also, and this is probably the most important point to emphasise for the understanding of commentary about inflation, is the recognition that if you are doing 100kmh (speed) and there is no acceleration (zero inflation) you are not slowing down. For that you need braking or deceleration or, for the cost to decrease, a negative rate of change or deflation.
Before expanding on that concept, let’s look at a few basics, such as "What is inflation?" and "How is it caused?" and "What should or can be done about it? And by whom?".
In elementary economics, inflation is defined as "a general rise in the cost of goods and services’’. More popularly, "too much money chasing too few goods".
The first statement is too general to be useful and the second relates to only one aspect or possible cause for inflation and, indeed, may be useless in a world where there is too much money chasing too many goods.
Another general, but in some ways more meaningful, concept as used for many years, the definition coincided with the intuitively obvious cost of living. Also, that provided no clear definition or agreement on what that meant for people at different levels of society either by wealth or income.
Also intuitively, and as used in much older economics textbooks, there is a general understanding and acceptance that there could be two main origins of price increases.
The first would be due to a shortage of supply of certain goods, that produces either a short-term spike in prices for those goods or a longer-term imbalance in supply leading to continuing rising prices — referred to as cost-push inflation.
The second is when, for what could be a wide variety of reasons, the demand for certain goods or services exceeds the ability of the market participants to provide enough, at least in the short term: this is referred to as demand-pull inflation. The reasons range from keeping-up-with-the-Joneses (fad) to FOMO (fear of missing out), a preference-related switch between alternative goods, or even governmental decree but they are usually associated with a higher availability of money for many consumers.
Readers should be able to identify current cases of almost all of the above cost-push and demand-pull inflation examples. In Part 2 we will look at some of the wider factors that can, do and could influence the current and, more importantly, expected future reported inflation numbers.
Another distinction is that, clearly, there is and should be a difference between two groups that can loosely be called Price-makers and Price-takers. More specifically the effect and impact on the first group and their ability to adjust their output prices has seen this referred to as Producer Price Inflation (PPI) while the latter relates to Consumer Price Inflation (CPI).
That brings us to the third question: "What should or can be done about it? And by whom?".
It is at present almost impossible to read any financial or business news sections without reference to the decisions, policy, official statements, minutes of meetings and statements by members, especially the chairperson, of their personal positions and then financial journalists’ opinions of the future course of interest rates, most often related to estimates of responses to the future trajectory of reported inflation.
There is a long history of banking and financial institutions, going back to Biblical times. The concept of a central bank (for each country, or group of countries) is much more recent. The most important one is the Federal Reserve Bank of the United States. The Federal Reserve Act only dates from 1913.
Typically, the central bank is independent of the government but the government sets the mandate for the central bank. Experience has shown that there needs to be close co-operation between the central bank (responsible for monetary policy) and the Treasury, or Ministry of Finance (responsible for fiscal policy).
After World War 2, the aim of most governments was for "full employment", recognising that reducing unemployment had previously led to higher inflation. At that time, central bank mandates typically had three objectives of employment, inflation and maintaining the value of the currency, not all of which could be satisfied simultaneously.
With potential problems of deflation for unemployment as evidenced by the Great Depression, the trend was towards a single mandate for central banks, purely related to a given inflation target in the form of a range of low inflation rates.
There are now international organisations, whose meetings are attended by nearly all central banks, to try to ensure similar regulations and systems are in place in their countries to avoid systemic failure of the integrated financial systems. That has led to most central banks having inflation targets as well.
All of which is simply to explain why governments and central banks are so concerned with inflation.
There is still a big question about whether the tools at their disposal are adequate to fulfil such mandates.
- Liston Meintjes is an independent consultant and analyst of business, economics and markets, with many years’ experience in the investment industry.
