Is rising inflation that bad?

Howdy folks!
Price stability is one of the four key macro-economic objectives of governments. Ideally, price stability means that inflation should be kept as low as possible.

But just how low should it go?

Generally, it is accepted that inflation should stay between levels of 1-2 percent, while rates greater than 3 percent are regarded as taboo. Zimbabwe’s inflation rate averaged 0,86 percent from 2009 until 2017, and hit an all-time high of 5,3 percent in May 2010 and a record low of -7,50 percent in December of 2009.

The country has been trapped in deflation since February 2014, only to slip out in February this year. Inflation has been gaining since then and stood at 0,21 percent the last time the thermometer was taken from the armpits of the economy in March. We might actually be looking at a marginal increase of inflation tomorrow when the Zimbabwe National Statistical Agency announces the April statistic.

But what does the transition from deflation to inflation really mean for businesses? One gets the impression that it is like jumping out of the frying pan into the fire, if the sentiments from the market are anything to go with.

Deflation can be taken to partly imply that there is low domestic demand.  During the era of deflation, businesses were complaining that they were forced by falling demand to reduce their prices in order to abet and rejuvenate demand and push their sales. But consumers also responded by delaying purchases, anticipating further price declines, causing them to fall still further. The International Monetary Fund forecasts consumer prices to average 3 percent this year and close the year at 5 percent.

Having now been ejected from the deflation realm, with inflation now gaining, businesses are again complaining that their input costs will rise and that consumer spending power might be eroded, which will affect their operations.  But the question we ask is: Which one is a better devil — inflation or deflation?

The rise in inflation partly manifests two things: That interest rates in the formal markets have gone down following the cap imposed by the central bank and domestic demand has increased due to the fruition of protectionist measures which led to demand shifting from imports to local goods. It also manifests that interest rates on the black market where some producers somehow acquire foreign currency has been rising, resulting in their costs of production surging.

It is the consumer who normally bears that increase at the counter in a supermarket.  Earlier, we mentioned that inflation is one of the four macro-economic objectives that governments always focus on.

Other objectives are economic growth, full employment and an optimal balance of payment. Interestingly, no country can get the best of all as these objectives are difficult to satisfy simultaneously.

Countries, therefore, usually pick the ones that are mainly crucial for a certain period and then design policies that are in line with them. During the time Dr Gideon Gono was Reserve Bank of Zimbabwe governor, for example, inflation was labelled “the number one enemy”.  Dr Gono, who was a classical inflation hawk, was actually on record saying, “Inflation has ceased to be just the number one enemy; it is actually the economic HIV of this country.”

But can inflation earn the same title right now or we should be worried more about high unemployment and widening trade deficit? Just how bad can inflation hurt or help the economy at the levels it is so far predicted to rise to?

At certain levels, inflation tends to redistribute income and wealth from creditors to debtors. Borrowers are advantaged because if someone borrows, say, US$1 000 today and repays it next year, where inflation is projected to close the year at 8,8 percent, the US$1 000 they will pay back then is worth less than the one they borrowed.

Again, rising inflation has the effect of redistributing income and wealth from the elderly to the younger generation.

Most creditors are usually elderly people who have acquired wealth over time, while young people are the ones who tend to borrow more. In a country with high inequality levels, as has been established by studies done by Zimstat, rising inflation can do some form of justice in addressing the inequality anomaly, acting as a Robin Hood. While it is certain that inflation decreases the amount of goods that money can buy, reducing purchasing power of consumers, inflation may encourage them to spend it right now instead of leaving it to be eroded while under the pillow.

As consumers spend, it will also encourage more production in the economy.  Granted, higher inflation is bad in that it can wipe away people’s savings as was the case in 2008 when it reached shocking levels of 231 million percent in the month of July of that year.

Continuously rising inflation can also create uncertainty and make it difficult for companies to plan for the future in terms of prices and costs; which might compel them to delay or streamline their planned investments. But what should be noted as we come out of deflation is that companies also require pricing power, and that power can be provided by rising inflation.

During the era of deflation, most businesses have been meeting their sales estimates through price-cuts and trying to compensate for that by lowering their costs and enhancing efficiency.

That strategy is not sustainable, eventually.  In the end, they get to a point where they are unable to cut prices to push volumes as that would require more investment in modern infrastructure to increase efficiency. But inflation can provide the opportunity for companies to have a bit of fiscal space through relative price increases to loosen their cost models.

Inflation is, therefore, a double-edged sword that, on the other side, can negatively impact margins because of increasing input costs. It is, however, important to have an inflation management strategy in place to ensure inflation won’t get out of hand.

And the question that comes to mind is: Can our monetary policy be potent enough to tame inflation?  The challenge is that some monetary policy tools that should be used to control inflation are already deployed to sustain other macro-economic objectives.

For example, while inflation can be dealt with by raising interest rates, the central bank is actually capping interest rates and encouraging lower interest rates so that productive sectors can access concessionary loans to increase production to contribute towards the economic growth objective. But elsewhere, in the United States for instance, inflation targeting is at the centre of their priorities right now, with more interest raises hikes being implemented by the Federal Reserve.

The Fed is actually planning about five more interest rate hikes between now and end of next year. Another way to deal with inflation would have been to fix the exchange rate, but we cannot do it since we don’t have a currency of our own.

Government can also fix prices of goods and services to checkmate inflation, but history has already taught us how it can result in shortages. The bottomline is that a bit of inflation might be good for the economy, but a concrete inflation management toolbox should be in place to keep it within the radar.

Later folks!

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