Friday, February 09, 2007

Inflation & You

I decided to talk about inflation because there are a lot of numbers thrown about on a regular basis about it and people dont seem to be able to understand or interprete them.
Inflation simply refers to a rise in prices.

Why worry about inflation?
The first rule of investment is to protect your principal investment.Inflation silently eats away at this principal.To keep it at bay, your investments should earn more than the overall inflation

For example, in Kenya your investments must earn at least 13% per annum in dividends+interest+capital gains to maintain their monetary value.

If your investments aren't doing this on average(over one year or over 2-3 years) you are done(Wealth creation wise).

There are two main measures of inflation in an ecomomy:
1-Overall inflation-the rise in prices of all goods and services in the economy.

2-Underlying inflation(Core CPI in the USA)- rise in prices excluding food and energy/fuel costs.
Economists measure underlying inflation. the Monetary policies of most Central Banks target underlying inflation.For instance, in Kenya (Central bank of Kenya) CBK's aim is to keep underlying inflation within 5%

The Problem In real life your real cost of living(eating,sleeping and working)includes food and transport but when measuring inflation for their monetary targets economists leave out these items.
For instance,the Overall Annual Inflation is 13.94% and the Underlying Annual inflation is 3.88%.

How it affects you
Over the past couple of years Economists have been issuing statements saying that inflation is under control.However, the average Kenyan has been grappling with rises in food and transport costs.The economists are 'right' in their own way since, they are looking at underlying inflation which has been within the Monetary target for a while.

By the way,UK economists failed to predict the January 2007, rate rise by the Bank of England in a spectacular way.Read more here


coldtusker said...

Unfortunately, food & transport costs vary substantially across from season to season & among different socio-economic groups...

The fluctuating price of oil is part of the reason. Food production varies by season.

Nevertheless, the underlying inflation will capture the "permanent" effect of changes in food & transport as the price of other goods & services increase. The problem is the lag time...

We need to tame inflation... How?
- Increase competition e.g. telecoms. New players will force the cost down. After Telkom introduced RUIM, both Celtel & Safaricom have reduced prices.
- Rebuild infrastructure. This will decrease business costs e.g. transport of goods, less time wasted o journeys, faster processing of passengers thru JKIA, etc...

pesa tu said...

Yes,the time lag is part of the reason why rate cuts or rises take time to affect the economy.

We need to ivest more in infrastructure and less in the soft sectors like education.Since, the effects of education take more than 5 years to see BUT the effects of good infrastructureare within 12 months of project completion

mwasjd said...

I figure with Woodside packing up, chances of Kenya avoiding inflation due to oil prices are near nil. Which brings the question of govt control. If the govt controlled prices of food and fuel, does that help limit inflation? Or because we operate in a free market economy (globalization), such a move would act retrogressively to the economic growth, and prices would EVENTUALLY rise?

What about Zimbabwe's case, any ideas on what measures can be taken to reverse the 1000+% inflation?

MainaT said...

I think if you look at what it is that causes inflation (outside of oil prices), you will notice that its too much liquidity in terms of a lot of money chasing too few profitable/high return opportunities. So beyond doing the things you've mentioned above to create the environment for such opportunites to arise, the govt can use the normal monetary policies at its disposal i.e. interest rates.
Price controls are only useful if there is an actual shortage of the goods that cause the price rises. Otherwise they distort any market.

pesa tu said...

@Mwasjd:Price controls in a poor country like ours would lead to another GOLDENBERG.In fact, the Exchange control sytem is one of the causes.

ZIM-they need to devalue the currency ,remove price controls, issue a new currency and restore international monetary relations.Museveni did the same when he took over Uganda

pesa tu said...

@mainat: Yes,monetary policy is required But when u have 70s style stagflation extra is needed