Hopeton Morrison, ContributorIT IS budget time again and one of the key debates has centred on the containment of inflation. Inflation is at the heart of the decision by the nurses and teachers to withdraw from the Jamaica Confederation of Trade Unions (JCTU) as both groups of professionals argue that prior year inflation has already wiped out any subsequent benefits that a 20 per cent wage increase under the Memorandum of Understanding (MoU) could deliver over the next two years.
The news is both good and bad. We are coming off three years of double-digit inflation for the calendar years 2003, 2004 and 2005. That is the bad news. The good news is that inflation for the last six months is being reported at a mere 1.6 per cent.
Inflation is a steady rise in the general level of prices. It is measured by the changing cost over a period of time of a 'market basket' of goods and services which any typical household would buy. Among the most common causes of inflation is that occurring when the supply of money rises faster than the supply of goods and services that are available for purchases. That accounts for the government often insisting that wage increases as a whole in the economy be capped (hence the MOU) so that there will not be too much money around to prompt further inflation.
When workers ask for and receive higher wages, this increases the cost of producing goods and services. The producers of goods and services will respond to this increase in the costs of labour by charging more for their products. Those men and women whose incomes do not rise with the increasing charges end up experiencing declining buying power. So rising inflation has a negative impact on personal savings and investments.
CONSUMER PRICE INDEX
The government measures inflation using the consumer price index (CPI). This is really a broad measure of prices or the cost of living for consumers in Jamaica and is published monthly by the Statistical Institute of Jamaica (STATIN) which tracks the prices of numerous goods and services that are sold across Jamaica. Indices of this type have a base time period from which comparisons are made. For example, if 1990-1992 represents the base period of 100 and the CPI is 176 in 2006, then the cost of living has risen by 76 per cent since the base period.
So how does inflation affect borrowing, savings and investments? Interest is the price of money and rates on loans climb during times of high inflation. The reason is that financial institutions want more for the money they lend because inflation reduces the value of the money to be paid back in the future leading to higher interest charges on loans.
All savers and investors are hurt. They are lending money to financial institutions in the form of their savings. Unless the interest rate on these savings, is higher than the inflation rate, they are losing money. So, for example, stashing away large sums of money in pass-book-type savings accounts earning seven or eight per cent is poor investing made even worse by the fact that you are paying withholding taxes of 25 per cent of your interest so your returns are closer to five or six per cent.
And investors in equities are not exempt from these losses as inflation also reduces the value of future corporate earnings.
LOW INFLATION
Contrast rising with low inflation. Low inflation not only increases the real returns on your investments but makes it easier to engage in long-term financial planning including such events as purchasing a home, planning for your child's education and retirement planning. Where prices are rising, however, it follows that your income must also rise to maintain 'purchasing power'. Please refer to the table below which shows how much of your dollar high inflation will wipe out time required for $1 to lose half of purchasing power.
Inflation rate
2% 5% 10% 15% 20%
Years
35 15 8 5 4
In a situation where inflation is 20 per cent, for example, you are losing half of the purchasing power of your money in four years as against 35 years with a two per cent inflation rate. So the rule of thumb is to always invest in a manner that hedges against (or minimises the effects of) inflation.
Hopeton Morrison is general manager of St. Thomas Cooperative Credit Union Ltd. and lecturer in the School of Business Administration at the University of Technology. Please send comments and questions to: hmorrison@stccu.com
