Coming on the heels of our discussion on the strengthening of the US dollar where we concluded with the statement that life might become expensive, well the latest economic news hitting the buzz is inflation going up in the US, Eurozone area and globally and on this blog post we look at what it means to you?
Inflation is defined as an increase in the price level in an economy. For example, if you bought a box of mangoes for $100 in January 2020 and you now, in 2021, buy the box of mangoes at a price of $110, this means the price of mangoes has gone up by 10%, rather obvious right, but what does it mean to you? Well, it means that you need more money to buy the same quantity of mangoes which then translates to a reduction in your disposable income by $10. Assuming your income has not increased by that same $10 then you will have cut down on another area and as is common with us we will cut down on saving.
We can therefore define inflation or look at inflation in another way, as the reduction of your purchasing power or your ability to make purchases. When Inflation numbers are announced, you normally hear that the annual inflation rate for a given country is 2.9%. This number does not refer to one single good but a basket of goods. For example on an individual level you have a monthly basket of goods and services you procure, it could be you pay rent, buy rice, sugar, cooking oil, pay for a taxi to go to work, electricity, water etc. If all that costed you $1200 per month and now costs you $1500, that means your cost of living has increased by 25% or your price inflation is 25%. Note, however the prices of rice and electricity might have come down, but the prices of water, sugar, transport might have gone up higher than the decrease in the former two, therefore meaning your inflation has increased.
Therefore, when you read or hear that the annual inflation of your country has gone up it is a measure of a basket of weighted goods, weighted based on what constitutes the largest share of wallet for the country and in most countries, food takes number 1 spot.
What then is the effect of an increasing annual inflation in your country? We will use the US as an example as their inflation has far reaching impact out of their borders. When the US annual inflation increases, we expect the following natural outcomes, assuming no intervention by the US authorities:
- Reduction in the purchasing power of the Dollar
- Weakening of the US dollar
Effect number 1 would mean that the disposable income of the average US citizen would reduce as the purchasing power reduces as explained in the mango example above. A reduction of US citizens’ purchasing power has a huge impact on global demand as explained in the earlier blog US NON Farm Jobs and the main impact being a reduction in demand for commodities, you may click on the link and refresh.
Effect number 2 would mean that imports for countries paying using the US Dollar, will become cheaper and exports for countries whose currencies will strengthen against the dollar will become less competitive. This means imported goods in your supermarkets might become cheaper making locally produced goods less competitive and some SME’s might find themselves out of business. Oil being one of the major imports in most African countries, a weak dollar might give a slight reprieve on pump prices.
With these effects in mind, it is important to follow the inflation projections as they will determine what your purchasing power is, and consequently affect your consumption choices.