To kick-start this segment, let’s make it clear that a small amount of inflation is a good thing. But too much or little inflation can sink or ruin an economy. Inflation, which is the movement of prices, is constantly under radar by central banks around the world. It is something that governments want to forecast to keep steady. Inflation is beneficial because it causes money to lose value over time, which encourages investments to retain that potentially lost value. If inflation was low or zero, then this suggests there is no economic growth and economic recovery is very fragile. The policies that governments may have to take on to combat a low inflation environment may be detrimental to an economy such as overbearing taxes. On the other hand, if inflation became too high, the economy could sink into a deep recession and the economy itself could collapse. Therefore, keeping prices steady is important for governments to allow for businesses to flourish in an economy.
What is inflation?
Inflation is a term to describe the movement of prices. It is essentially the rise in the general level of prices of goods and services in an economy over a period. That means that when general price levels increase, each unit of currency buys fewer goods and services. To measure increase in prices and goods, economists rely on a consumer price index (CPI). The CPI represents changes in prices of all goods and services purchased for consumption by households. There are also different types of inflation which are caused by a variety of movement in the economy:
1. Cost push inflation: costs to businesses rise and is then passed on to consumers. This could be because of higher prices for raw materials. The other reason is that workers may be asking for more money.
2. Demand inflation: increased demand for a certain service or product but supply is unmatched. This is usually a sign that consumers have more disposable income or consumers are experiencing tax breaks.
3. Printing money: another type of inflation occurs when governments increase the number of notes in circulation. However, this can backfire if the same notes in circulation are buying the same number of things which means that prices will increase.
We didn’t see it coming
Recently, inflation has been driven by supply chain disruptions and pent-up consumer demand for goods following the reopening of the economy in 2021. The COVID-19 pandemic has slowed consumption of goods due to lockdowns, airport closures and strict COVID-19 protocols for businesses. But the world is reopening and, while many expect things to normalize, the economy will not see this effect anytime soon. The problem is that no one really expected inflation to come. The sudden rush in buying and spending meant that demand for goods and services became high; therefore, prices continue to soar. The sudden rise in inflation has also put a dent in living standards across the world with The Bahamas being no exception. This means that consumers and business owners everywhere are now facing higher prices for consumption/materials with fewer items in their cart.
When inflation hits, financial regulators such as the Federal Reserve raise interest rates as a policy response. The idea behind this is that, by raising interest rates, this would lessen the desire of consumers to spend. Lower spending translates to lower demand and this will eventually lower prices. In an economy where inflation exists, prices for consumables such as essential foods and services (groceries, medication, clothing) can skyrocket. Rising costs of items such as food and fuel will drive the CPI measure and further erode any wage gains workers may have seen in the last year.
Who does inflation impact?
During a period of inflation, financial regulators must be careful when using interest rates as a tool to combat inflation. If interest rates are too high, the market can respond by stalling spending. This stalled spending results in less money coming into the pockets of lenders, employees, producers, people on fixed incomes (pensioners), and consumers in general. For households that are poor, or below the poverty line, inflation becomes a tremendous burden because they are largely “hand-to-mouth consumers”.
On the other hand, inflation is considered a win for businesses/governments with high public sector debt, employers and landowners. For businesses with high debts, inflation can make it easier to repay debt by increasing prices to consumers and using extra revenue to pay off debt. For governments, the real value of any debt can be lower. And for property or landowners, physical wealth tends to retain its value versus savings during a period of inflation.
In The Bahamas, and many other countries, wages simply cannot keep up with inflation. Slow wage growth can make dealing with rising prices very difficult since there is less value for money for every dollar spent. But the purchasing power of the USD has declined over the years due to higher costs of living outside of the recent bout of inflation. Therefore, any increases in wages or minimum wage may have little effect since the purchasing power is less when inflation rises.
Wages and inflation
Another aspect of inflation is wages is not directly related to inflation. Wages are based on the market price for services in a particular industry. This knowledge is usually known by industry stakeholders. That is why people with low skills get paid less than people with high skills. But inflation may impact the market price for certain skills that are needed in a market, especially if those skills are specialized. As prices rise, consumers demand more compensation for the work they do. If there are enough people demanding a higher wage and employers can’t find people willing to work for lower wages, they will be forced to either increase compensation or reduce their workforce. In addition, a response such as higher wages is not always the first line of action if there is high unemployment. If there are plenty of people available for most jobs, then an employer doesn’t need to raise what they are prepared to pay to encourage applicants.
How can governments mitigate?
The main way to do this is to try to keep prices steady. This can be done by increasing prices at a rate that is applied straight across the economy every two or three years. Therefore, all stakeholders are well informed of what is expected. If inflation does occur, then it is easier to mitigate by decreasing the amount of money in the economy. The quickest way to do this is to raise interest rates. Increased interest rates encourage people to save money and discourages people from spending money.
Another way to ensure that prices remain steady and fair within an economy is through legislation. In a free market economy, companies can form their own pricing and marketing strategies to consumers. However, some companies may practice price gouging which occurs when retailers and others take advantage of spikes in demand by charging exorbitant prices for necessities, often after a natural disaster or other state of emergency.
In The Bahamas, the Price Control Act is legislation implemented by government to provide for the control and regulation of the price of goods and services and matters incidental and/or connected to the sale of these items. However, in periods of inflation, organizations such as the Consumer Protection Commission or the Price Commission would have very little impact on inflation since the rise in global prices often impact the suppliers who have no control on what price they are able to purchase goods/materials at.
There is no perfect solution to inflation since it is a natural occurrence in an economic system of capitalism. The US inflation rate continues to be at an all time high since last year and continues to show signs of rising beyond seven percent. Therefore, to combat inflation, both the government and Bahamian consumers must be ready to adopt changes that will support the ease of doing business, add value to consumption and become more stringent in purchasing habits.
• Roderick A. Simms II is an advocate for sustainable family island growth and development. Email: RASII@ME.com.