Inflation is the rate of increase in prices over a given period of time. As a result of inflation, the purchasing power (value) of money decreases over time. Inflation affects the prices of everything we buy.
What causes inflation?
The following are the factors that cause inflation:
1. Supply and demand. In economics, when the demand for a commodity exceeds its supply, the excess demand pushes the price up. The result is higher prices due to inflated demand and attraction. On the other hand, when factory prices rise, the cost of production also rises. This leads to an increase in the price level as well.
2. Government deficit. There are times when government spending increases beyond what taxes can fund. In order to solve this problem, the government resorts to deficit financing such as printing more money which in turn increases inflationary pressure.
3. Population growth. As the population grows, it increases the total market demand. Moreover, excessive demand leads to inflation.
4. Hoarding. There is always the possibility that at certain times factors of production are in short supply. This affects production. Since supply will be less than demand, opportunistic businessmen resort to hoarding to raise the price even more, thus increasing their profits.
5. Non-economic reasons. There are many non-economic factors that can cause inflation in an economy. Examples are war or hurricanes (floods) where crops are destroyed. In fact, this reduces the supply of agricultural products which leads to higher prices of our basic commodities. A good example of this is the pandemic in which the supply chain has been disrupted, leading to inflation even if the price of oil is at its lowest point.
As the world economically recovered from the effects of the pandemic, Russia invaded Ukraine and this man-made crisis plunged the world into yet another economic problem. Ukraine is a major exporter of foodstuffs and Russia is a major exporter of oil. Just imagine that Ukraine’s food production has been hampered and Western sanctions against Russia are in effect. The result is global inflation due to another supply chain being disrupted. I felt it strange that certain groups would blame our current leadership because the crisis we are going through now is due to a flawed decision by a single foreign leader. We cannot control external factors but we can control how we respond to this crisis. We are all affected by inflation, and even if we cannot avoid inflation, we can reduce its impact on us. Here are some things we can do:
1. Spend on needs only. By spending less, we can avoid wasting our money on inflation. We should only buy what we need. Also better is to shop around and look for those with a lower price (but of the same quality). Make it a point to budget to control our costs.
2. Avoid debt. As inflation rises, so do interest rates. Banks need to raise interest rates in order to keep up with or outpace inflation. With a high rate of inflation, this is the worst time to be in debt. Note that in the past when inflation was low, many businessmen resorted to loans because the cost of money was low and it made perfect sense for them to use other people’s money to make money.
3. Investment. Cash is not king. During inflation, holding a lot of cash is not an option because inflation eats away at its value. Save some for emergencies and invest the rest in tools that beat inflation. An example of this is the stock market. The stock market is down right now, but over an approximate long period of time, that investment can earn a much higher rate of interest in the stock market than it would in a savings account. Another one is bonds. Another place to put our money can be diversification. We can choose from corporate bonds issued by private and public companies, municipal bonds from local governments, or Treasury bonds by the government. Note that when the stock market goes down, the bond market can go up.
4. Investing in real estate investment funds. Real estate is a good hedge against inflation but only a few can afford it. Consider a real estate investment trust (REIT). REIT is a collection of properties that includes everything from office buildings, hospitals, shopping centers, and more. It’s a great investment if you want a more liquid real estate asset, and it may be a perfect fit for risk-averse investors.
In any crisis, there is always an opportunity. We just have to open our minds. Panic is not an option. Instead of the blame game, why don’t we do our own research and solutions. Just like Jackie Chan said in “The Karate Kid”: Focus!
Edmund Lau is a Registered Financial Planner for RFP Philippines. To learn more about personal financial planning, attend RFP 99 in January 2023. For inquiries, email email@example.com or send