Basic questions you need to know about inflation

The Bank for International Settlements (BIS) has warned that the world is facing a new era of high inflation and interest rates as relations between the West, Russia and China deteriorate and globalisation reverses in the wake of the Covid-19 pandemic. Soaring global energy and food prices have contributed to annual inflation of more than 5% in nearly 60% of advanced economies, the highest rate since the late 1980s, while more than half of developing countries have inflation of more than 7%. %.

What is inflation?

Simply put, inflation expresses the rate at which the prices of goods and services are rising, usually expressed in the Consumer Price Index (CPI). Month-to-month rises in prices may be imperceptible, but in the long run, the impact of inflation is obvious - with continued inflation, 100 yuan 10 years ago can buy significantly more than 10 years later.

The inflation rate shows how much the cost of living has risen. Inflation is higher than the level of rising incomes, meaning less real incomes.

What are the implications for livelihoods and the economy?

High inflation means that money loses value, its purchasing power decreases, and the same amount of money can buy less; if inflation is high and wages rise slowly or even stagnate, the result is similar to a pay cut.

In order to control inflation, the central bank and the government have a variety of macro-control tools, but the most commonly used method in theory is that the central bank raises the benchmark interest rate, which makes the cost of borrowing money higher, and the interest on saving money is higher. Consumption and investment cool down, thereby curbing prices. rise.

In addition to increasing borrowing and financing costs, higher interest rates and job market changes due to high inflation, as well as changes in the overall economy, can also directly or indirectly affect the lives of individuals.

For example, the interest on regular savings increases, but so does the monthly payment on a variable-rate mortgage.

Generally speaking, the losers in a situation of high inflation include: people saving cash, working and retirees living on fixed incomes, borrowers of variable rate loans, exporters, and the economy as a whole (due to heightened uncertainty ).

Winners are broadly: fixed-payment loan lenders, land and real asset owners, the public sector with high debt, and businesses that can afford to lower real wages.

How is inflation calculated?

Inflation is generally tracked and measured by national statistical offices. There is a "basket" that includes prices for hundreds of goods and services, from milk and bread to vacations abroad, bus tickets to smartphones.

According to this "basket", the consumer price index (CPI) is calculated, which measures the overall price level within a month, and then compares it with the CPI of a year ago. The change in price level in a year is the inflation rate.

The items of goods and services in this "basket" are constantly adjusted, increased or decreased, to reflect the overall price changes as accurately as possible. For example, with the change of various new products, lifestyles and trends, popular commodities such as e-books, smartphones, canned soy products and sports underwear will be included, and items that have gradually become unpopular and eliminated, such as paper encyclopedias, will be excluded. .

Why is high inflation so scary?

Moderate and stable inflation is conducive to the healthy development of the economy. After several ups and downs of hyperinflation and stagflation in the 20th century, controlling inflation and setting quantitative targets have become routine operations.

Different countries set different target inflation based on their own economic conditions.

The UK's target inflation rate of 2%, which the central bank, the Bank of England, is responsible for maintaining, has been around 2% for most of the past 20 years, at times above 4% and at times below 1%.

However, high inflation and high volatility can be harmful. Consumption bears the brunt of the impact - if prices are unpredictable, it becomes difficult to plan how much to spend, save or invest.

For national economies, high inflation and volatility can also lead to economic collapse under certain circumstances.

For example, in Zimbabwe from 2007 to 2009, prices soared by 80 billion percent in one month, banknotes were shaped like waste paper, and the economy was shut down.

What about high inflation?

The most important macro-control means is to adjust interest rates. The role of central banks in most countries is to formulate monetary policy, a set of regulatory tools to keep inflation low and stable, and interest rates are an important component of this toolbox.

Therefore, following the high inflation data, it is likely that the central bank will announce an interest rate hike and raise the benchmark interest rate.

The benchmark rate is the basis for all business interest rates, including interest on bank deposits, fees paid for loans and mortgages.

Why are prices rising now?

The main reason for this surge in inflation is the rise in global energy prices, especially natural gas prices, which have risen sharply over the past year. World Bank data show that crude oil prices rose 77% in January 2022 compared to December 2020.

With oil and gas prices soaring and gasoline hitting a new record, businesses are facing higher energy, gasoline and transport bills and some are passing the extra costs on to customers, with supermarket prices generally rising.

Some retailers in the UK expect prices could rise as much as 6% this year.

The World Bank blog post pointed out that the momentum of this round of inflation surge started in the United States and quickly spread to developed countries.

As of December 2021, 15 out of 34 developed countries have inflation above 5%. Such sudden and highly synchronized high inflation has not been seen in more than 20 years. Seventy-eight of the 109 emerging market economies have inflation above 5 percent, doubling the rate in 2020.

The main reasons for the surge in inflation vary from country to country, but a general trend in both developed and developing economies is that commodity prices have risen in line with global demand.

Another major common problem is the ravages of the global supply chain caused by the Covid-19 pandemic over the past two years. Shipping costs have skyrocketed. Another, more insidious problem is that the impact of the new crown epidemic on supply chains is more diverse and opaque, and thus brings more uncertainty.

Broken supply chains have forced central banks around the world to largely shoulder the burden of tackling inflation in their own countries. Standard policy responses, such as raising interest rates, may hinder economic recovery in some emerging markets, while exacerbating the possibility of debt crises in other countries. sex.