Inflation

Inflation is a sustained and significant increase in the general price level – Andre Roux

This definition implies that only when price increases are recorded for a wide range of goods and services, does inflation occur.

The general price level is measured by the ‘Consumer Price Index (CPI). To calculate the CPI, some 600 goods and services are included in a ‘basket’. The ‘weight’ of each is determined by surveys of household expenditure. The two items that weigh most are food and housing.

The Consequences Of Inflation

The table below shows how inflation has eroded the purchasing power of your money since 1970:

The second column of the table shows that the price of a basket of goods costing R 100 in 1970, was R 1705 in 1994. Put differently, the average price level in 1994 was 17 times higher than in 1970.

The third column in the table shows how the purchasing power of R 1 000 has declined over the mentioned two decades. In 1970 R 1 000 enabled you to buy 1 000 goodies, ten years later that same R 1 000 would buy 361 goodies; while in 1994 you could only buy 59 goodies with your hard-earned R 1 000.

From 1970-to 1994, South Africa’s inflation rate was very high, reaching the highest scale of 15% by 1988. The consequences of persistently high inflation are always negative for the economy:

First, and most obvious, is that inflation reduces your purchasing power. If disposable income rises by say 10% every year while inflation averages 15% per year, then your purchasing power actually declines by roughly 5% a year.

Inflation favours debtors at the expense of creditors. Let’s assume you entered into a hire-purchase agreement where you have to make 60 monthly payments of R 100 each to a supplier; with an annual inflation rate of 15%. In a year’s time, the actual purchasing power of your R 100 would have fallen to R 85, and by year 5 your R 100 will be worth R 50. In effect,, you are paying your debt with cheaper money. The seller is affected in the exact opposite way – the instalments he receives from you are declining because of inflation. In short, inflation redistributes wealth – taking away from creditors in favour of debtors.

Inflation is also detrimental to the exchange rate of the rand. If the cost of goods produced in SA rises by 15% per year, while the cost of producing the same goods in the USA rises by 5% per year, then it means that local goods become relatively more expensive. As a result, our revenue could decline because the international demand for our goods will drop as foreigners elect to buy the relatively cheaper American items. By the same token, South African importers will prefer to buy the goods produced in America rather than the relatively more expensive locally-produced ones. Now if imports rise and export falls, this will invariably lead to the depreciation of the Rand, which leads to higher inflation – a vicious cycle!

In conclusion: inflation can be a vicious cycle, and everything possible must be done to curb price rises. For consumers, this means avoiding, as far as possible, the use of credit to finance the purchase of goods, especially so-called luxury items

Click here to view a video that explains what inflation is.