Oran A. Hall | Why prices increase when the inflation rate falls
News that the inflation rate has decreased when consumers are experiencing increases in the prices of goods and services tend to cause confusion in the minds of a significant portion of the population. This is so because they are not clear about what the decline in the rate of inflation means.
First, let us look at a few definitions. Inflation is the sustained increase in the general level of the prices of goods and services used by consumers, or private households. The rate of inflation is the percentage change in the average price level of a fixed set of goods and services (“basket”) in an economy over a given period.
The consumer price index (CPI) is a major index used to measure inflation by applying the following formula: CPI in the current period less the CPI in the previous period divided by the CPI in previous period, multiplied by 100.
It measures the changes in the average price of a representative “basket” of goods and services the typical household uses – food, clothing, transportation, housing, education, for example.
A household may be one person or a group of people living together who pool their resources for food and other necessities.
When the rate of inflation declines, it does not mean that prices have decreased. Rather, it is that they have increased but not to the same degree as they did in a previous period. This is called disinflation. For example, we speak of disinflation if the inflation rate was five per cent in 2021 and four per cent in 2022.
The decline in the general level of prices is described as deflation, which is the opposite of inflation.
In the case of deflation, the rate of inflation would be, for example, -two per cent in 2022. The public is often confused because of the mistaken belief that lower inflation means lower prices – which cause deflation.
According to the Statistical Institute of Jamaica (STATIN), the point-to-point headline inflation rate at October 2023, was 5.10 per cent, compared to 5.90per cent at September and 11.80 per cent at April 2022.
Point-to-point inflation is a measure of the change in prices of goods and services used by consumers over a given period of time, usually 12 months. In effect, the CPI at one point, say October 31, 2023, is compared with the CPI at the corresponding point, October 31, the previous year, 2022. STATIN’s figures are telling us that the rate of inflation is falling.
Headline inflation refers to all aspects of an economy that experience price changes. It is not adjusted to remove highly volatile items like energy and food. This is in contrast to core inflation, which excludes the more volatile items.
Headline inflation is usually quoted on an annualised basis. Thus, a five per cent annualised rate means that if inflation grows at the monthly rate of five per cent up to the current time and continues to do so for the rest of the year, the annual rate should be five per cent.
There are some other measures of the inflation rate. There is the monthly rate, such as the 0.80 per cent in Statin’s October report, for example. In the same report, the year-to-date rate of 5.30 per cent refers to the period from January to October, and the fiscal year-to-date rate refers to the period from the beginning of the fiscal year, April 1, to October.
It is worth observing that not all categories of goods and services experience the same level of price changes. Although the overall point-to-point change was 5.10 per cent in October, the category food and non-alcoholic beverages increased by 8.30 per cent, restaurant and accommodation services grew by 13.10 per cent, and housing, water, electricity, gas and other fuels declined by 3.50 per cent.
We have become used to focusing on the increases in the rate of inflation, so let us stop to see some of the benefits of lower rates of inflation. Businesses like lower rates of inflation because it makes it easier to plan with stabler prices. They can also be more confident of sustainable long-term growth.
Governments can also plan with more certainty for the long term, and have greater control over costs. Central banks can also design and implement effective monetary policy measures that will cause less shock to the economy, and economists are able to make growth forecasts with a greater level of certainty.
Lower levels of inflation facilitate lower interest rates. This helps businesses to secure cheaper loan funds for working capital and for their long-term growth and development.
Although any level of inflation causes the purchasing power of consumers to decline, lower inflation rates cause the deterioration to be at a slower pace. Consumers can also benefit from lower lending rates to acquire meaningful assets and be better able to plan for the long term.
As for the effects on investments, lower interest rates lead to lower returns on interest-bearing securities, bonds and debentures, for example. The rate of interest on savings instruments may also fall.
On the other hand, stock prices often increase to take advantage of opportunities for higher returns as some investors move out of interest-bearing instruments.
Businesses, consumers and governments can reap benefits when the rate of inflation declines, and the general level of prices does not have to decline for such benefits to be derived.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. E-mail: finviser.jm@gmail.com