Gift Kasika
The inflation-rate prevailing determines income distribution between sectors and the attractiveness of foreign investments in the country. Inflation is a product of a number of interacting forces and cannot be blamed on an individual factor.
Inflation measures the rate at which the price of a basket of goods and services increases over a year; it is a continuation of price increases, rather than a once-off increase.
The basket on which inflation is calculated represents a composition of goods and services consumed by a citizen. There are a variety of price indexes for different sectors; the most common is the consumer price index (CPI), which captures changes in the prices of an average consumer’s basket of goods consumed.
Inflation resulting from a change in a factor of production does not have monetary implications because suppliers can pass the costs to consumers. Monetary implications result once price increases spread to all sectors leading to an inflation spiral. The inflation spiral entails that everyone pays higher prices and will need extra income to maintain their spending.
Others may be able to obtain additional income, but it is not everyone who can – because, at any point, the total money stock is limited; what others gain as additional income is a loss to others. The only way the money stock can grow is by monetary injections and/or through dishoarding (putting money previously withheld back into circulation). Inflation has to be financed mainly from money injection since dishoarding is limited to a point where the stock of hoarded money ends.
Price increases require an increase in the money stock to maintain the transaction levels. In most cases, Inflation is a demand-pulled facilitated by increases in the money stock. Central banks don’t have direct power to control the inflation rate or the money stock in circulation but they can influence the inflation rate using a number of operational tools.
Causes of inflation
Inflation begins when people increase their demands for additional income in response to an increase in prices. It is determined by a number of factors interacting with each other, the most common ones are the changes in the prices of intermediate goods, which go directly into the production line.
An economy becomes inflation prone when it is constantly faced with increases in the prices of imported inputs. Large increases in the price of inputs of production are difficult to ignore; consumers cannot simply absorb them without raising demands for additional income. Producers and consumers raise their prices and wages to recover their losses.
An increase in oil price or a decrease in the exchange rate raises production costs which, in most cases, producers pass to consumers. If people increase their salary demand as a result, inflation as a process is set in motion.
When people have bargaining power for increasing their salaries without fear, they will pass on their cost increases to their employers and the inflation spiral is set in motion.
The exchange rate is the most important determinant of the inflation rate for two reasons, most locally consumed goods are imported and a proportion of local production consists of imported inputs. When the exchange rate falls, the price of imported inputs in Namibian dollars rises, and local manufacturers experience increases in the costs of production.
A country becomes inflation prone when the money stock is flexible (elastic), Businesses will have little fear in passing their production costs to customers since their sales volumes will not be affected provided people can get additional money from banks or their employers. When the money stock is less elastic, producers will not pass their production costs to consumers because of the fear of reduced sales.
Inflation targeting
To promote stability, prices of the most important inputs have to be stable and the exchange rate has to be more constant. If sectors continuously pass their inflation costs into high prices of goods, inflation cannot come down. Inflation can only be brought down if nominal profits, wages and taxes increase less than the inflation rate.
Government does not have the power to directly control the inflation rate but they have a number of tools to influence the attainment of a specific target
Price control
Price stability of important production inputs prevents further inflation. However, price controls are accompanied by unpleasant results. It reduces supply when the allowed price does not allow businesses to recover their costs. Black markets develop as a result and the goods become traded at high prices. Businesses with quality products are not allowed to charge a price that merits their efforts.
Raising the interest rate
The central bank increases the costs of bank credit that reduce the growth in demand for cash. A high-interest rate has an immediate and direct effect on the money stock when it raises debt payment and reduces the money stock leaving people with less money for spending.
High-interest rates negatively affect societies that depend on bank debt such as small businesses and homeowners on their mortgage bonds.
Reducing inflationary expectations
If the central bank can convince people to revise their inflation expectations downwards, people’s current actions will not accommodate inflation in the future.
Inflation is not good for economic growth and employment. In 1958 William Phillips demonstrated an inverse relationship between inflation and unemployment, however that relationship ends at a 5.5% inflation rate. Above that, inflation becomes a cost that requires deliberate efforts to reduce it to maintain macroeconomic stability.