Inflation-does anyone know where it’s heading?

Photo by Frank Busch on Unsplash

The reason I ask this question is because of the discussions at the recent ECB forum on Central Banking where economists couldn’t agree on a “general theory of inflation”. So the top expert macroeconomists of the world couldn’t come to a consensus on what drives the theory behind inflation in the world today.

Makes us mere mortals feel ok about not knowing where it’s heading.

Students of economics will remember the Friedman monetary theory that defined inflation as a function of too much money chasing too few goods. I remember memorising that definition many eons ago and thinking that it was fairly straightforward. But actually that theory has certainly lost credibility as that is not the only reason for inflation spiking upwards.

The second theory that has a connection is the Phillips Curve. This concept states that inflation and unemployment have a stable and inverse relationship. What this means is that with economic growth comes inflation but as there will be more jobs there will be less unemployment and it will not have an adverse effect on the economy. However, currently we can see that this is not the case either.

And then as debated by Charles Goodhart who is a professor emeritus at LSE and a PhD from Harvard that a large cohort believed it is the “bootstrap theory of inflation” in play -where inflation depended on people’s expectation of future inflation. He explained that this theory is weak because people will predict their recent experience into the future without any basis for what may actually happen in the future. I’m no expert but I tend to agree with him as this theory seems to be far detached from reality. So I’m in his camp , no offence to the other experts.

The pandemic was a classic case of events as no one could accurately forecast the supply chain shocks that affected the whole world. And to make matters worse, a container ship got wedged in the Suez canal creating the world’s heaviest traffic jam, which cost them $15 billion a day till it got unstuck.

Professor Goodhart thinks there will be cyclical and trend increases in inflation. Central banks around the world will keep monetary policy flexible to push unemployment levels down. This means eventually cyclical inflation will rise.

He states that the world is on the brink of the next chapter in globalisation with major demographic changes. Working age populations will start declining in many countries. The bargaining power of trade unions will increase as there will be a shortage of labour and he doesn’t believe that this is a transitory phenomenon.

And the extraordinary surge in property prices will stoke the inflationary fire for many more years to come.

So how does all of this mumbo jumbo affect you?

1. Till we get a grip on how to live normally with Covid-19 there will be temporary spikes to inflation which will affect our monthly budgets. Cauliflowers costing upwards of $7 and fresh ginger costing $49 per kilo seem to be the norm in Sydney. Restrictions on toilet paper and seeing supermarket shelves empty on some days has become the norm. Fuel prices constantly yo-yo with no clear indication as to why it happened.
2. If you plan to purchase a home or an investment property in the near future, do perform a calculation on whether you can afford to make the loan repayments at your noted interest rate plus 2.00% so that you do not face an interest rate shock if interest rates rise in a couple of years time.
3. Upskill yourself so that you remain pertinent in your industry. If you work in an industry that is going to be wiped out due to technological advancements try and find a new field that you could dabble in. If your company is open to it try and learn what happens in other departments.
4. Save for a rainy day, I’m talking about at least 3–6 months of your monthly expenditure and don’t invest all your savings in Bitcoin.
5. If your current location is getting expensive try moving away from it. There are already labour shortages in many areas because of border closures. Do your research and make the move if you can.
6. Don’t take on any credit card debt. If you can’t afford to pay for it you don’t need it.

Inflation is a heavy topic and I have tried to give a simple explanation. But it is a key part of economic recovery and fuels the next business cycle.

Governments and central banks need to work in tandem to ensure we don’t go into hyperinflation- when prices rise more than 50% per month over a period of time or stagflation-when there is slow economic growth and relatively high unemployment.

We can work on the factors within our sphere of control and that can provide us a cushion against these shocks.