The risks of inflation

Inflation has become the big economic issue, not only in the Philippines, but all over the world. The Bangko Sentral ng Pilipinas has just announced that the current inflation rate of 4.2. percent  to 4.3 percent is not going to be a problem for the Philippine economy. In other parts of the world, inflation has become an increasingly worrisome issue. A recent Reuters report highlighted this economic issue.

“ The inflation bogeyman has reared its ugly head and sent US stock investors racing for the hills in recent days.

Next week, coming off one of the most volatile stretches in years, two important readings on US inflation could help determine whether the stock market begins to settle or if another bout of volatility is in store. The jump in wage inflation pushed yields on the benchmark 10-year US Treasury note closer to the 3.0 percent mark last seen four years ago, denting the attractiveness of equities and unnerving investors fearful inflation will force the US Federal Reserve to raise short term interest rates at a faster pace than is currently priced on the markets.”

Since the Philippine stock market prices are closely linked to the New York stock market prices, the inflation scare leading to stock market declines is now a major global issue. In the book The Rise and Fall of Nations: Forces of Change in the Post Crisis World, Ruchir Sharma devoted a whole chapter to inflation. Here is one of the things he said.

“ High inflation is always a bad sign and low inflation is often a good sign. In general, an economy is in a sweet sport when inflation is low and GDP growth is high, especially when growth has recently started to take off – because the absence of inflationary pressure may suggest  it is the beginning of a long run. If GDP growth is picking up but inflation is rising with it, the boom can’t last long because at some point – sooner rather than later – the central bank will have to respond by raising interest rates in order to  dampen demand and subdue inflation. This increase in borrowing costs may also choke off growth. The worst case, however, is high inflation with low or falling growth, because in these conditions the central bank will have to raise rates in order to control inflation, effectively putting the brakes on an economy already at risk of stalling. This can lead to stagflation, an extended period of low growth and high inflation.

The question to keep in mind: Is inflation high or low? And one way you can tell whether consumer price inflation is high or low is by comparing the rate in one country to the recent average for its peer group. As of 2015, the recent average for emerging economies is about six percent and the average for developed countries is about two percent.”

If we accept Sharma’s assumption, the Philippines should therefore try to keep its inflation rate between two percent and six percent or approximately four percent which is the current inflation rate in this country. 

Inflation is the rate at which prices increase. The common thinking is that in a young or emerging economy which is growing fast, people will have more money to spend and with more money going after the available goods for sale, prices will inevitably go up. Inflation can, therefore, be caused by high demand for goods and low unemployment. It can also be caused by consumer euphoria or excessive government spending.

Inflation can also be caused by sudden decrease in the supply of good like a shortage in staple food  like rice. The increase in prices of food is one of the major causes for political instability that may lead to violent revolutions especially by the poor. Inflation can also be caused by “negative supply shocks” like a sudden increase in oil prices.

Sharma, in his book adds another major cause: “In practice, however, a young economy is most vulnerable to demand drive inflation [i.e. inflation caused by high demand for goods and low unemployment] when it has invested too little in its supply networks. The supply networks include everything from power plants and factories to warehouses and the communication and transportation systems that connect them to consumers. If these supply channels fall short of meeting demand, consumer prices start rising.

A high rate of inflation is a cancer that kills growth, attacking the living organism of the economy, through several channels. Inflation discourages savings because it erodes the value of money sitting in the bank or bonds, in turn shrinking the pool of money available to invest. Eventually, high inflation will force the central bank to take action by increasing the price of money through higher interest rates, which will make it more expensive for businesses to expand and for consumers to buy homes and cars, as a result the growth boom will stall. When inflation is very high – say in the double digits – it also tends to be volatile, dropping suddenly or accelerating into hyperinflation, adding new hurdles to growth in the economy. In an environment where prices are prone to wild swings, businesses find it difficult to get financing for their projects and also can’t be  confident of the likely returns on their investments...The economy then becomes permanently inflation prone.”

The general rule is that low consumer price inflation leads to steady economic growth. Any period of high growth may be doomed if it is accompanied by rapidly rising inflation. Aside from extremely high income inequality, it would seem that inflation is another economic issue that the world’s economic managers must resolve. 

Creative writing classes for kids/teens and adults

Young Writers’ Hangout on February 24, March 3 & 17, April 7, 14, 21 & 28 (1:30 pm-3 pm; independent sessions); Fiction Writing for Adults with Sarge Lacuesta on March 10 (1:30 pm-4:30 pm) at Fully Booked BGC. For details and registration contact 0945-2273216 or [email protected].

* * *

Email: [email protected]