Inflation is the devaluation in the purchasing power of a given currency over time. It is often represented by the increase in the average price of a basket of selected goods and services over a period expressed as a percentage. Inflation is simply the fall in the value of a currency and the increase in the price level of goods and services over a period.
Inflation could be positive as it causes a rise in the prices of tangible assets like property and land leading to higher profits for the sellers. However, the decline in purchasing power impacts the standard of living and economic growth. Furthermore, it reduces the value of cash held or savings. Ideally, an optimal level of inflation is often promoted to encourage spending instead of saving for economic growth. This means that people are encouraged to spend now instead of saving for later since the value of the currency is falling. It is pertinent that the inflation rate is kept at a balance.
Demand-pull inflation occurs when demand causes a rise in price level. This is when the demand for goods/services exceeds production. For instance, a popular designer creates only ten dresses and more than ten people demand for the dresses causing the price level of the dresses to rise.
Cost-push inflation occurs when cost of production causes an increase in the price level. This increase could be as a result of increase in the cost of raw materials, wages or distribution cost. The increase in cost of production is passed onto the consumer.
Built-in inflation is based on the expectation that prices would increase based on past events and as a result, workers demand for higher wages and salaries to afford the inflation which would in turn increase cost of production. This increase in cost of production will then cause an increase in price level.
INFLATION IN NIGERIA
Inflation rate is represented by (Initial CPI – Final CPI/ Initial CPI) * 100. CPI = Consumer Price Index
The table below shows the inflation rate in Nigeria from April 2020 to April 2021 expressed in percentages
|July 2020||August 2020||September 2020||October 2020||November 2020||December 2020||January 2021||February 2021||March 2021||April 2021|
|March 2021||April 2021|
|Clothing & footwear||13.25||12.9%|
|Miscellaneous goods & services||11.5%||11.4%|
|Housing & utilities||10.1%||10.1%|
Source: Trading Economics, 2021
CAUSES OF INFLATION
Supply of money: The government can formulate monetary policies that increase the supply of money in the market which in turn decreases the value of the currency. The government may also decide to print more money to increase the supply of money in circulation.
Foreign exchange rates: Fluctuations in foreign markets may cause general inflation
ADVANTAGES OF INFLATION
- Investors that invest in assets to hold for a long period of time prior to selling would benefit from inflation. For instance, investing in land that would appreciate over time.
- It encourages spending instead of saving to improve economic growth since purchasing power of money is declining over time.
- Borrowers benefit from inflation as their debt is adjusted to inflation which causes their outstanding debts to shrink over time.
- Inflation benefits exporting countries as it would be cheaper to export from countries with a decline in their currency.
DISADVANTAGES OF INFLATION
- Increase in cost of production could lead to the layoff of workers to keep up with the increase, thereby increasing unemployment
- It weakens the value of currency. This impacts international trading and increases transaction and translation costs.
- It discourages savings and holding assets denominated in the country’s currency as the value would decrease over time.
WEALTH OPTIMIZATION IN TIMES OF INFLATION
The United States Treasury issues Treasury Inflation Protected Securities (TIPS) that have an inflation adjusted component. They are free from default risk and adjust the value of investment with inflation. Other methods of wealth optimization in times of inflation include the following:
- It is often advised to hold stocks against inflation as stock prices include the impact of inflation. Also, dividend is paid based on stock volume and high dividends lead to high cash flows to maintain living standards and increase spending power when inflation is rising.
- Natural resources and commodities such as gold and oil are considered hedges against inflation.
- Focusing on short term bonds reduces exposure to future inflation. One can easily purchase a new one as the old one matures.
- Investing in high yield bonds that pass the due diligence tests as they would offer protection against future inflation.
- Real estate offers a hedge against inflation. Land appreciates and rental income rises over time.
TRADING ECONOMICS. (n.d.). Nigeria Inflation Rate | 1996–2021 Data | 2022–2023 Forecast | Calendar | Historical. Retrieved May 22, 2021, from https://tradingeconomics.com/nigeria/inflation-cpi
Perry, B. (2018, May 4). 7 Ways to Protect Yourself Against Inflation. Pure Financial Advisors, Inc. https://purefinancial.com/learning-center/blog/protect-against-inflation/
Dhand, A. (2021, April 29). Inflation: Definition, Types, Causes and Formula. Scripbox. https://scripbox.com/mf/inflation/
Fernando, J. (2021, May 12). Inflation. Investopedia. https://www.investopedia.com/terms/i/inflation.asp#:%7E:text=Inflation%20is%20the%20decline%20of,over%20some%20period%20of%20time.