Allan Lewis, Contributor
Without proper pension provisions, more Jamaicans will live out their old age destitute. - NORMAN GRINDLEY/DEPUTY CHIEF PHOTOGRAPHER
NOTWITHSTANDING ITS recent relative stability, the Jamaican currency has been continuously debased during the past twenty years. As John Maynard Keynes suggested in 'The Economic Consequences of the Peace', all stakeholders including members of pension plans should be extremely concerned about actions that affect the relative value of the currency: the effects of inflation, regardless of the cause, are dire!
According to Keynes, "Lenin was right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
The measurement, causes, effects and cures of inflation are complex and confounding. Even if the change in the consumer price index is used excluding volatile food and energy prices (referred to as core inflation), different measures can result when monthly, quarterly or other periods are considered. Furthermore, although inflation is considered a monetary phenomenon, the rigidity of nominal prices and wages has real and complicating effects. Finally, notwithstanding the costs of reducing inflation, there is a "clear consensus that even moderate levels of inflation damage real growth and that low inflation must, therefore, be the
primary objective of monetary policy." The notion that a "little inflation" is good for long term economic growth is a canard.
INFLATION
Pensioners and other persons earning fixed incomes readily appreciate the effect of inflation, as benefits are generally not indexed for inflation after retirement. Thus, increases in prices often reduce the former worker's real benefits in the years subsequent to the end of his/her employment.
Elaborating, in the five years ended June 2005, those on fixed incomes who did not receive increases would have experienced a 40 per cent decline in their ability to purchase good, and services in Jamaica. More dramatically, someone who commenced receiving a fixed income in June 1995 would have had their purchasing power decline by almost two-thirds by the end of June 2005. Jamaica's inflation experience since 1995 is in stark contrast to that of our major trading partners: single digit inflation is an inadequate standard while some of our major trading partners have experienced average annual rates of inflation of less than 3%.
There are other ways in which inflation causes deleterious effects. Members of defined benefit pension plans often receive benefits related to the average of the last several (e.g. 3 or 5) years' salary rates of the employee. Increases in the inflation rate matched by equal increases in salary will reduce the ratio of benefits (based on average salary) to the salary received in the final year of service. For example, in an environment of 10% inflation, and if benefits are based on an average of salary in the last five years of service, the pension payable at retirement will be approximately 87% of the pension payable in an environment of 2.5% annual inflation (other things being equal).
Inflation has other effects that are not uniquely detrimental to pensioners and other persons who receive fixed incomes. "Shoe leather" costs (people reduce their cash holdings and take more trips to the bank taking time away from productive activities); "Menu" costs (economic agents have to regularly adjust prices which again takes time away from performing productive activities); increased variability of prices (uncertainty as consumers find it difficult to appreciate the appropriate relative prices of various goods and services); and unintended changes in the tax liability of firms (inflation causes an increase in nominal income which is then taxed more heavily) are all associated with increased confusion and inconvenience.
Inflation is also associated with markets becoming less efficient and often results in incorrect resource allocation However, perhaps the greatest cost of unanticipated or incorrectly anticipated inflation is the redistribution of wealth between net monetary creditors (more often than not the less fortunate and those on fixed incomes) and debtors in ways which may not be socially acceptable. All stakeholders in Jamaica's political economy and particularly pension plan members should be particularly concerned with the potential costs of inflation in Jamaica.
Disclaimer. This article was prepared by Allan Lewis who is the Managing Director of Prime Asset Management Limited ("Prime"). Prime provides pension fund administration and investment management and advisory services. The information contained in this article has been obtained from sources that Prime believed to be accurate and reliable. Prime does not purport to be giving any specific advice, legal or financial, and readers are encouraged to seek advice on any specific issues raised in this article. Prime does not deal in or make a market in any securities mentioned in this article. Please do not hesitate to contact the author at allanl@primepensions.com with comments and questions.
