In the European Union (EU), the United States, and many other countries, inflation has reached its highest level in decades due to the impact of Covid-19, while the Ukraine conflict has increased food and energy costs. As such, the talk about inflation has become a very hot topic amongst policymakers across the globe.
What inflation means?
Why is inflation management one of the many important parts of making the economy healthy and long-lasting?
Why does a business need the support of the RSM financial team?
What inflation means?
The rate at which prices increase over a specific time period is known as inflation.
Inflation is typically defined as a broad measure, such as the
overall price increase or the cost of living in a
Inflationary pressures force the consumer to pay more for the same goods and services. Inflation, therefore, raises the cost of living over time. This behaviour may be helpful in terms of income inflation or asset inflation, such as in real estate or stocks if the assets were acquired before prices rise; however if the income does not keep pace with inflation, the purchasing power declines. When the inflation rate is high enough, the economy suffers.
Rising prices indicate a rapidly expanding economy. People purchase more than they need to avoid higher prices tomorrow, which increases demand for goods and services. Suppliers need assistance to keep up. Worryingly, neither can wages. As a result, most people need help to afford everyday goods and services.
Annual inflation in a healthy economy typically ranges from two percentage points (2%), which economists consider a signal of pricing stability. When inflation is within a reasonable range, it can positively impact demand and productivity, for example, when the economy is slowing and needs a boost. When inflation begins to outpace wage growth, it can be a sign that the economy is in trouble.
Inflation can be classified mainly into three types or causes:
When the economy's demand for goods and services exceeds its ability to produce them, demand–pull inflation occurs.
For instance, when demand for new cars recovered faster than expected from its sharp drop at the start of the COVID-19 pandemic, an intervening shortage in raw materials supply made it difficult for the automotive industry to keep up with this renewed demand. As a result of the subsequent shortage of new automobiles, prices for both new and used cars increased.
Once the price of input goods and services rises, the price of final goods and services rises. This kind of inflation is known as cost-push inflation.
During the pandemic, for instance, fundamental shifts in demand, purchasing patterns and cost to serve led to a sharp rise in commodity prices. Industrial businesses were forced to consider price increases that would be passed on to their end customers to offset inflation and minimise the impact on financial performance.
When employees demand higher wages to keep up with rising living costs, this results in built-in inflation, also known as a wage-price spiral.
A self-reinforcing cycle of wage and price increases follows as a result, with businesses raising their prices to offset their rising wage costs.
The past few years were marked by the coronavirus pandemic and disrupted supply chains which have contributed to the already near-record rise in consumer prices, further exacerbated by the Russian invasion. The war severely restricted Russia and Ukraine's supply of energy, wheat, and other goods.
If the war persists and the EU imposes a ban on its massive gas and oil imports from Russia, in addition to the already severe sanctions imposed on Moscow, the countries' exports appear to decrease even further.
Why is inflation management important?
In conclusion, the rate at which prices fluctuate can have an impact on a variety of aspects of the economy, including the purchasing power of individuals, the expansion of the economy, and the increase or decrease in interest costs associated with the national debt.
Change is inevitable and vital in the era of complexity and uncertainty we now live in.
Inflation management is just one of the many important parts of making the economy healthy and long-lasting. It is a difficult challenge that many governments worldwide will have to face in the forthcoming years, given the recent instabilities and their unknown effects. In this fast-paced environment, our financial team of professional advisors with years of experience here at RSM Cyprus can fully support your organisation and empower you to face your economic business challenges with confidence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.