Inflation falling, but prices rising!
View(s):
File picture of a vegetable market.
Last month, Sri Lanka’s inflation rate dropped to 6.3 per cent with a steady decline from its historical highest rate of 69.8 per cent reported last September. The country’s low-inflationary regime ended towards the end of 2021.Then, it reached double digit level after April 2022 and showed an increase to hyper-inflation levels in 2022. Accordingly, the annual average rate of inflation was reported as 46.4 per cent in 2022.
“They keep telling us that inflation is going down, but every week we find that prices are going up. What nonsense is this?”
I have heard this comment quite often. The comment is a result of confusion. If we don’t know or don’t consider the difference between the inflation rate and take price increases into account, then there is confusion.
Inflation talks, confusing
Under normal circumstances, the prices tend to rise rather than to fall. Therefore, the “average” price level of a country continues to rise, while that average price level reflects all the prices of a set of essential goods and services consumed by an average household. While the increase in the average price level is inflation, sometimes the rate of inflation rises indicating that the prices rise at a higher rate. Sometimes, the rate of inflation falls indicating that the prices rise at a lower rate. Prices are, anyway rising!
Another source of confusion is, sometimes our expectation about a decline in price level, which is called “deflation”. It is quite an unusual thing to happen, including “zero” price changes. If it happens rarely under different circumstances, it is not a sign of a healthy economic performance. A famous case study in the world is the Japanese long-term deflation which lasted for over 30 years.
Deflation is not only an unusual economic outcome, but also a “bad” economic outcome. Perhaps, it is worse than inflation! When prices fall, the public anticipate prices to fall further. Accordingly, the public tend to postpone their spending habits anticipating the benefit of falling prices.
When it happens on a large scale, it is the so-called aggregate demand that would keep falling. The result would be slowing down growth leading to lower incomes and inadequate job creation. That’s why the countries that are caught up in long-term deflationary situations struggle to accelerate their growth and are fond of having some inflation.
Therefore, some degree of inflation is fine. We should not worry about inflation as long as it is neither too little nor too much. The rate in between “too little and too much” is not determined by a magic number. By experience, we know that it must be about 1-2 per cent for a high-income country and 3-6 per cent for a developing country. Generally, the rates lower than this range is an indication of an economic stagnancy, while those higher than that is an over-heated economy.
Global inflation outlook
Global inflation outlook follows business cycles – economic booms and busts – as well as the policy responses to them particularly in more advanced or large countries in the world. During the crisis time with the COVID-19 pandemic, the world economy experienced significant contraction with subdued aggregate demand, resulting in lower inflationary trends everywhere in the world.
As the pandemic-led economic downturn deepened, the US, UK, Euro area experienced near-zero inflation. In fact, the lower inflation in many countries in the Euro Area and Scandinavian region also turned to be a deflation. They all accelerated their loose monetary policy stance by printing money and expanding credit growth in order to mitigate the health crisis impact on the economy and to prevent deflationary outcome.
Loose monetary policy stance in the world did not lead to inflation at least at the same time, unlike the popular belief. Economists know that prices respond after a time lag, in the first place, so that there is no reason to anticipate overnight inflation. In the second place, it was an economic crisis with economic stagnation and subdued aggregate demand so that there is enough room for “more money” without inflationary trends.
The situation started changing after a time lag that is since the mid-2022. Global inflationary trends turned back and started rising to its historical high levels. The pandemic subsided with the increased “herd-immunity” effect and the global vaccination programme, which gave a strong boost from “pent-up demand”.
And presumably, the money that was pumped started to overflow further boosting aggregate demand. Here comes inflation, as it was never before. There were downside forces such as the geopolitical tensions and the Russia-Ukraine conflict, working in the opposite direction too. But the inflationary impact of upside forces was stronger, resulting in overheating economies and demanding monetary policy reversals.
The world started raising policy rates – both advanced countries and most of the developing countries. Now the global inflationary trends too remain under control. As per IMF forecasts, the inflation rate of advanced countries, which 7.3 per cent in 2022 is set to decline to 4.7 per cent this year, and to 2.8 per cent next year with a slower economic growth. In developing countries which had 9.8 per cent inflation in 2022, it is forecasted to decline to 8.3 per cent this year and further down to 6.8 per cent next year.
Sri Lanka in the
global economy
Sri Lanka, being a partner to the global economic trends, shows its domestic inflationary trends also moving closely with those of the world.
However, there is a big difference and the difference is about the magnitudes of the inflation numbers, which are explained largely by the domestic factors. The country reported a massive rise in the rate of inflation in 2022, and then a gradual decline since the last quarter of the year reaching its moderate levels by mid-2023.
With a tight monetary policy stance, slow improvement in domestic supply, relaxed import controls, exchange rate appreciation are some of the important domestic policy factors that have helped the reduction in inflation. Generally, with a series of policy measures aimed at stabilising the economy, it is good to see that the crisis-ridden country has made a u-turn within a shorter period of time, unlike many other countries with similar experience.
However, it does not mean that the Sri Lankan economy would quickly recover and that the country is now out of the danger zone. Let me elaborate on the two points I made.
From an average person or a family, literally a recovery means restoring the pre-crisis living standards. If we go by the official statistics of inflation, during the year 2022 alone, people’s real income got wiped out at least by 50 per cent. If we take the fall in real income up to now – July 2023 – the loss of real income is even more! Since we are not anticipating any decline in “average” price level, for sure we will not gain the loss of our real income back through price reduction.
If it happens, it is only through the increase in our incomes, compensating for the adverse price effects. In other words, people’s income should rise faster than the inflation trends, past and present. As it depends on higher economic growth over a longer period of time, the recovery of the living standards to the country’s pre-crisis level takes many years to the future.
Stability with growth
While achieving higher economic growth and sustaining it over a longer period of time is fundamental to economic recovery, it is also fundamental to sustain the stability that we have tried achieving now. We have been trying to do a course correction with harsh austerity policies after a hard knock on the head. With all that, the policy aim should not be merely for achieving debt sustainability and credit worthiness.
Course correction should be accompanied by reforms too, aiming at achieving higher growth and sustaining it for many years. It is only then, that stability would be meaningful on the one hand and the people would be able to restore their real incomes that were lost against hyper-inflation.
(The writer is a former Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and
follow on Twitter @SirimalAshoka).
Hitad.lk has you covered with quality used or brand new cars for sale that are budget friendly yet reliable! Now is the time to sell your old ride for something more attractive to today's modern automotive market demands. Browse through our selection of affordable options now on Hitad.lk before deciding on what will work best for you!