Inflation: do we want it or not?
Inflation in Ireland is reaching 2%, the highest it’s been in 10 years, but not much compared to the 20% inflation we hit in 1981. How will our household budgets be affected? Do we want more or less inflation?
The European Central Bank made a radical shift in its inflation policy this year, moving from a policy to cap inflation in the eurozone at a maximum of 2%, to a policy of targeting an inflation rate of 2%. This means 2% should be the new average inflation rate with higher and lower rates accepted. Part of the reason for this policy shift was an acceptance that austerity during the financial crises 12 years ago did not work. Governments should have spent more to end the financial crisis, and that’s exactly what they did in the next crisis to hit us, the covid pandemic.
So aside from ECB policy, why are we seeing inflation now? There are a few reasons. Firstly, Governments are printing money to pay for all the costs associated with covid. Secondly, global supply chains got messed up during the pandemic. Factories closed and are hard to restart. Workers were laid off and found new jobs. Projects of all types got slowed down or shut down. Chinese manufacturing slowed, shipping capacity was reduced, construction stopped. All this slowing down means less of everything is available and prices go up, also known as inflation. Thirdly, the demand for stuff did not decrease. Many consumers had money because of covid payments and could spend, maybe not on holidays but on home improvements instead. Businesses and Governments are being forced to digitise meaning spending on semiconductors and IT. More demand and less supply mean prices go up.
On the face of it, inflation might seem like a bad thing, who wants prices to go up? But there are some silver linings. Firstly, wage increases are likely to match or exceed inflation rates. Workers are in short supply in many sectors after the pandemic and employers are increasing wages to attract people back to work. Secondly, inflation has the effect of reducing the value of money, it erodes the value of cash savings, but on the other hand it also erodes the value of debt. So, if you have a big mortgage, inflation will over time reduce the burden of your debt relative to your wages.
Runaway inflation like what some developing economies are experiencing now, or what Germany experienced before the War, is a long way off. Such hyperinflation destroys lives and livelihoods as no one knows the value of anything anymore and businesses and the economy grind to a halt. Household purchases must all be made on the day that wages land because tomorrow everything will be more expensive. Waiting a week could mean your last wage packet will have half the buying power of what it had a week ago.
Inflation affects households and household bills immensely, but we have not had to worry about it for almost a generation. Should we be worried again?
What do you think? Are you concerned increasing inflation might lead to runaway hyperinflation? Or do you think we are at the right level of inflation now? Should our Government print more money or exercise fiscal caution? Leave your thoughts below.