Dubai: Why does a cup of the humble chai at a shop cost Dh1 one day, and then Dh1.50 the next? And you’ve heard your parents always tell you about how cheap things were when they were kids.
What about house prices? Well it's true, prices for literally everything have risen dramatically over the decades.
It’s called inflation. It is something that affects you and me when we purchase food, petrol/fuel, clothing, etc. Here’s a quick explainer:
What is inflation?
It’s an oddity of our economic life: prices for things keep rising. Incomes and prices in the past were far different from what they are today. Economists refer to inflation as the general progressive increase in prices of goods and services in an economy.
Is it good or bad?
Inflation, when managed well, can be beneficial and is an integral part economic growth. There is a constant trade-off between economic growth and price levels to balance both to reach an optimal equilibrium.
Inflation and deflation are two phases of economic cycles. Prices have a functional relationship with overall level of demand in an economy, and vice versa. When an economy contracts, deflation or a general fall in prices occurs.
When it begins to expand, the prices, too, tend to rise. In short, general price levels in an economy moves in the same direction as economic expansion or contraction.
Ideally, we want at least a little bit of inflation. In fact, most economists say that an inflation rate of 2-3% is considered a good thing in order to promote investment and economic growth.
What's the pandemic's effect on purchasing power?
Purchasing power is the amount of stuff you can purchase with a unit of currency. As prices go up, the purchasing power of money goes down.
As COVID-19 emerged as a pandemic in early 2020, supply chains were hit, while shutdowns impacted output, resulting in massive job losses and salary cuts — leading to a contraction in “aggregate demand” (the total demand for goods and services within a particular market) — thus forcing prices to decline. As economies around the world recover from the pandemic-induced recession, prices too are going up.
Why are oil prices rising post-pandemic?
The recent spike in inflation worldwide can be largely attributed to the spike in crude oil prices, the surge in demand post-pandemic, and the inability of the manufacturing and services sectors to keep up with the demand.
As markets recover across the globe, partly because of liquidity infusions done by central banks to keep the economies afloat, the demand for goods and services has also gone up.
This has resulted in spike in demand for manufacturing, transportation and last-mile connectivity. The requirement for fuel and associated products as also risen. Generally speaking, demand is picking up because people have more money to spend.
Because fuel is more expensive, so any economy that relies on import of fuel, passed on to consumer. These two are the main factors.
Why did crude oil hit zero?
Crude prices had plunged during the pandemic because of negligible demand. In fact, US crude had hit negative territory in April 2020 amid a coronavirus-induced supply glut, ending the day at a stunning negative (-) $37.63/barrel as desperate traders paid to get rid of oil — producers literally had to pay buyers to take the barrels that they could not store due to the oversupply of oil.
Eventually, crude production was clamped to match demand, and prices stabilised. However, as demand has continued to rise after the pandemic, oil producers have not been able to meet the demand. OPEC+ countries have agreed to increase supply by 400,000 barrels per day in February, but it’s not enough. many oil-producing countries are struggling to meet their production targets. This has now caused crude prices to touch $90 a barrel.
Since crude prices are high, the cost of crude products is also high, and anything that needs fuel for transportation is automatically costing more. Bills have skyrocketed for countries that depend heavily on imports — whether its food, consumables, automobiles.
Heavy input costs is also playing a major role in keeping rates high. Since raw material prices have shot up and employment in manufacturing and services sectors is still not matching demand, goods are not being produced in desired numbers and are well short of demand. Add high transportation costs to the bill and you get an inflated price.
Who monitors inflation?
Inflation affects everyone — as we buy, food, petrol/fuel, clothing, services. One result: a fall in the “purchasing power” of money. Economists and governments closely track inflation. To keep close tabs of inflation, experts come up with price indexes — these are updated periodically to calculate the annual rate of inflation.
▶ It measures price movements using weighted average prices of fixed “basket" of consumer goods and services that are common in the consumption of majority of the population.
▶ These are the typical categories: Food and beverages; Housing; Apparel; Transportation, Medical care; Recreation (i.e. Netflix); Education & Communications; and Other (haircut).
Economists update these categories every 10 years or so to adjust for changes in spending.
What does it mean when CPI goes up?
The averages of the prices in the basket of these goods and services are compared over two periods to determine the direction of price levels in the economy.
If averages (expressed in per cent) over two period have risen, the economy is facing rising inflation and if the change (in per cent) is negative it is a case of deflation. To calculate CPI, multiply 100 to the fraction of the cost price of the current period and the base period.
An upward change in the CPI, this means there has been an increase in the average change in prices over time. This eventually leads to adjustments in the cost of living and income (presumably so that income is adjusted to meet a higher cost of living). This process is referred to as indexation.
What are the some of key factors driving inflation?
LABOUR: Labour is a factor. Too many people lost their jobs during the pandemic, many of them worked in manufacturing or services sectors. Once demand dropped during pandemic, these people were relieved of their duties as companies cut costs. Now the demand is back, but the suppliers haven’t been able to keep up with the hiring.
VEHICLE PRICES: Vehicle prices have a percentage in overall inflation index. There are vehicle supply chain issues, with the ongoing chip shortage is prime contributor. There’s too much demand now that economies are recovering, but not enough manufacturing capacity.
OIL PRICES: When it comes to increase in oil prices, anything that’s imported automatically starts to cost higher. These include food, consumables, automobiles, etc. Car prices have gone up, too, contributing to overall inflation.
What’s the so-called low-base effect?
"Low base effect” is a situation when inflation was low the previous year (i.e. because of strict COVID lockdowns). So demand was low even as governments pumped in liquidity to keep economies functioning.
A statistically significant role in high inflation is being played by the low base effect. Any gauge that measures economy is usually measured as a comparison with the year-ago period.
The “year ago-period” is one that saw lockdowns the world over, killing demand. Since there was negligible demand and the supply side was yet to feel the pinch of the pandemic, inflation was significantly lower. The market was flooded with goods. There were no buyers. Because of this low base figure, current inflation levels seem mathematically higher.
How does inflation affect the travel sector?
One sector that has been significantly hit is travel, becoming expensive year on year. Domestic and international travel had plunged during pandemic. Now they are in recovery phase. The supply – whether fuel costs or flight seats – is not favourable to match the demand. All aviation markets haven’t fully opened up yet.
Countries like India are still operating flights under the air-bubble agreements. This means the entire bilateral seat capacity between countries is not being utilised. Many airlines that have had to shed staff during the pandemic are yet to go back to their previous manpower levels.
Hiring hasn’t been as quick. So there are fewer employees and support services to handle a surging demand in the sector.
Will post-pandemic recovery affect inflation too?
During the pandemic, people went into saving mode, and accumulated cash reserves they otherwise wouldn’t in such a short period. Now that jobs are more secure and there’s less likelihood of job losses, people are keen to spend, causing a spike in demand.
Is deflation good or bad?
It’s the opposite of inflation. Deflation occurs when the inflation rate falls below 0% — which marks a decrease in the general price level of goods and services. While inflation reduces the value of currency over time, but sudden deflation increases it.
In general, deflation is a sign of a weakening economy. Economists fear deflation because falling prices lead to lower consumer spending — a major component of economic growth. Companies respond to falling prices by slowing down their production, which then leads to job cuts and pay cuts.
When are things likely to recover?
A general rise in consumer prices across many leading global economies are the result of both demand- and supply-side impact. Rising vaccination rates and opening up of economies have positively impacted consumption demand. Recovery will happen when key conditions are met:
(1) A balance between demand and supply across sectors, which will lead to stability.
(2) Faster hiring in key sectors such as manufacturing, services, aviation, shipping, etc – any sector that moves goods around. This will enable supply to match demand. Increasing manufacturing capacity, and a better supply chain will help even things up.
(3). At the same time, demand will have to be cut down a little. That’s what central banks are mulling. By increasing lending rates, the central banks will attempt to make money expensive and reduce demand. This will give the supply-side the time it needs to play catch-up.
The spread of Omicron at the start of Q1 2022 means growth likely slowed down a bit, but there are no signs of inflation easing.
What are reflationary measures?
When governments and central banks sense that an economy is facing a deflation or recession, they unleash a set of fiscal and monetary policy measures to “reflate” the economy.
During the pandemic, we saw this happening across the world. Fiscal policy measures generally focus on increasing government spending on infrastructure to create new jobs, welfare measures, tax rebates, subsidies and even direct cash transfers to people to boost general level of consumption and demand.
Easy- and low-cost credit has a positive correlation with consumption, demand and prices. Central banks across the world use monetary policy tools — such as interest rate cuts, bond buying and zero-cost funding to banks — to keep the banking system liquid enough to supply adequate levels of credit to businesses and consumers.
