Oran Hall | Why inflation is harmful

“The principal objectives of the bank shall be the maintenance of price stability and financial system stability with the primary objective being the maintenance of price stability.” This is the mandate of the Bank of Jamaica, BOJ, under the Bank of Jamaica (Amendment) Act, 2020.

The BOJ, then, is charged with controlling inflation, because of the harmful effects it can have on the residents of Jamaica and the national economy.

Price stability is a state in which the general level of prices in an economy remains stable over time, meaning there is no sustained increase or decrease in the general level of prices, the former being inflation and the latter deflation. The purchasing power of money remains relatively constant when the inflation rate is low and stable. Consumers and businesses, not having to concern themselves with rising or falling prices, are better able to make plans and to borrow and lend for extended periods with a good level of certainty.

On the other hand, inflation is the sustained and broad increase in the prices of goods and services over an extended period. In a healthy economy, though, a moderate and measured level of price increases is normal and desirable, so the alarm bells do not ring when this is the case.

There are two basic types of inflation: demand pull and cost push. Demand pull inflation refers to the increase in the level of prices due to the demand for goods and services being more than the supply. When the supply of money – money in circulation in the economy – grows, consumers are able to buy more. Prices rise if supply does not increase sufficient to match the demand.

The spending policy of the government can also enhance the spending power of consumers. For example, the heavy spend of the United States government on infrastructure is believed to have contributed to inflation in that country during the Biden presidency. Additionally, significant widescale increases of the remuneration of the employees of any government can also stimulate demand by putting more money into the hands of the public. Reducing the income tax income can also add to the capacity of consumers to increase demand by increasing their disposable income, and lowering the rate of consumption taxes makes goods cheaper.

Other factors which can cause demand to increase include population growth, increase in employment, increased consumer confidence, and increases in the level of remittances.

Sometimes the imbalance between demand and supply is due to insufficiency of supply and the interruption of the supply chain. It could simply be a case of local producers falling short, but supply can be negatively impacted by disruptions in the supply of goods. One example is the war in Ukraine which is a major supplier of grains to the global market; disrupting supplies can cause prices to increase on the world market and affect countries which do not buy directly from it. The disruption of petroleum supplies is another example.

Natural disasters often disrupt the supply of agricultural and other types of goods. For example, Hurricane Beryl contributed to the increase in the prices of agricultural goods locally due to its destruction of crops and the resulting shortages. Logistical challenges caused by the reduction of traffic through the Panama Canal have also created supply issues.

When their costs increase, businesses generally pass them on to the consumer to preserve their profits. Such costs include interest on borrowed capital, rent for land and buildings, salaries and wages for labour, the cost of utilities, higher taxes, and the cost of raw materials and other inputs. When these are imported, they add another dimension – the price of foreign exchange to pay the suppliers.

Exchange rate movements which result in the value of a country’s currency depreciating against that of its trading partners cause the price of imported goods to increase in local currency, thus driving up price levels. Increases in the prices of imported commodities, not only increase the country’s import bill, but the price of the goods which consumers buy, many of which we do not produce at all or in insufficient quantities.

Expectations may also contribute to increased prices. If people expect prices to increase, they may seek to protect themselves by demanding higher remuneration, which generally causes producers and businesses to increase prices to protect their profits.

The BOJ has a mandate to maintain price stability because of the negative effects inflation can have on people, businesses and the national economy. Inflation tends to cause the cost of living to increase, and may reduce the living standards of people. It threatens the profitability and competitiveness of businesses by increasing the cost of producing goods and services, and may harm the economy by hindering growth by creating uncertainty and discouraging investment, as well as by causing employment levels to stagnate or decline, and by making exports less competitive as their prices increase.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com