Tight rope walk of Inflation and Growth

Inflation and Growth

The land of dreams is getting expensive month by month, week by week and day by day. This takes us to a time frame four decades back.

What is being expensive?…….. In financial terms it is called as inflation to go more technical it is known as CPI (Consumer Price Index). More the CPI faster is the rate of inflation.

Inflation – a rise in the general price of goods and services of common or daily use.

So, what are these goods and services? The authorities construct a basket of goods and services required by an average household and tracks the change of prices on monthly basis. A tentative basket can look something like below.

The Bureau of Labor Statistics (BLS) monthly collects the prices of some 94,000 items from a selected sample of goods and services to assemble its representative basket. The numbers are then adjusted to ensure price changes don’t reflect improvements in product quality, and weighted in proportion with consumer spending patterns derived from a separate survey of about 36,000 consumers in a given year.

The prices of goods and services are gathered mostly from visits by BLS data collectors to some 23,000 retail and service outlets in 75 urban areas.

As we say that inflation in June 2022 is 8.6%. it means that if a paycheck says 5,000 $ for May 2022 received in June 2022 which is say equivalent to that was received in June 2021 the real value of money is 4,570 $. So 470$ of hard earned money is just vanished in air!!!!!!!

How does these numbers impact me, my family, my job, my business, my investments, and my future

Johnny Harris

Let us dive into this and try to understand the situation, causes, measures taken, and the developments expected.

Inflation is not always bad, it is a must for the economy to sustain and grow, however there is a threshold and the economy has long passed it for now.

Too much of anything is BAD. A continuously increasing inflation is a clear indicator of eroding value of money and assets. Not only existing assets but people at large will stop purchasing goods as

  1. They  are expensive
  2. The value of money or assets held is going down

Overall it becomes difficult for the industry to sustain in such an environment where people are delaying purchases and at the same time the cost of the raw material is increasing. The dual side pressure leads to lower margins for the businesses which are not from the extremely essential segment. In turn putting pressures on employment or pay hikes. Hence it becomes a complete pressure situations from income (where there are challenges to grow) and expenses (which are rising at a faster rate).

It is said and believed that food inflation is far higher than the overall numbers projected by CPI. A quick view on the basic food prices will give us an idea of the seriousness –

ProductPrice Avg. (May 2022)Increment ($) (Since May 2021)Percentage change
Orange Juice (60 oz.)3.71+0.225.9%
Eggs (dozen)3.38+0.9628.4%
Chicken Brest (lb)3.87+0.7419.1%
Fresh Beef (lb)6.02+0.7312.1%
Bacon (16 oz)6.20+0.8012.9%
Bread (Loaf)2.96+0.289.45%

And this is not just USA the entire world is facing the inflationary pressure at this point. It is independent of the state of economies, it can be a one of under-developed, developing or developed economies.

But, why did this situation arise and did we anticipate it coming?

Factors that were a fuel to the rising inflation can be many, some of the primary ones are –

  • Heavy stimulus packages (the $1.9 trillion American Rescue Plan Act of 2021)– this was done to boost the economy during pandemic.
  • Disrupted supplies and supply chains due to pandemic lockdowns and raw material availability.
  • Rising demand post opening of lock-down
  • Geo-political tensions and war between Russia and Ukrain leading to higher commodity pricing

According to David Wessel, the director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, The Obama administration’s stimulus package to respond to the 2008 recession was $787 billion; the pandemic stimulus packages, between the Trump and the Biden administrations, reach around $5 trillion!!!

Looking deeply into it we will be able to understand that this inflation has more than one major reasons and every politically influenced group will have their reasons to give different weightages to it. However we will be taking a bird’s eye view to analyze the situation.

A sigh of relief is that, this is not that happens regularly, these numbers are comparable to 1981, almost 40 years from now and skyrocketing. So, what were the measures taken 40 years ago, exactly the same ones we are witnessing right now.

The primary measure to control inflation is to suck out money out of the system. SIMPLE, no money in the market will automatically bring prices down. It is simple, but not easy and quick.  The authority which is in charge of doing this hawkish task is FOMC (Fedral Open Market Committee).

Paul Adolph Volcker Jr. served as the 12th chair of the Federal Reserve from 1979 to 1987. During his tenure as chairman, Volcker was widely credited with having ended the high levels of inflation seen in the United States throughout the 1970s and early 1980s. The question now is, IS THE VOLKER MOMENT BACK?

The answer is Yes and No – THIS IS A CONCERN, even bigger than 1981 because we are barely out of a global pandemic and now into the geopolitical turmoil of Russia – Ukrain crisis. Hence, it is a tight rope walk for the 16th chair of the Federal Reserve, Mr.  Jerome Powell.

June 1981, when inflation was at a level of 9.55% (not far from existing 8.6%) the interest rates were hiked to 19.10% as compared to 9.47% in Jun 19.80, in a span of merely 12 months the interest rate were hiked by 9.6%. a similar hike. As compared to earlier days FED seems to have taken delayed steps  of rate hikes due to a recovering economy from the pandemic. On 22nd Jun 2022 FED announced a 0.75% hike as compared to 0.5% already discussed. And was called as unprecedented and not a step which will be easily repeated unless forced further by the staggering inflation.

The rope walk is tight because, as the interest rates rise the development is deprived out of its basic fuel that is easy and economic availability of capital. Hence to control one demon (the inflation) the country might have to temporarily compromise on economic growth. And that is the risk of RECESSION.

And after all these efforts inflation is not an animal that can be tamed overnight of in a fortnight. It is here to stay for a while, reducing liquidity is far more slow process than pumping in funds and increasing liquidity.

Moreover, raising interest rates doesn’t fix the supply chain. Until we get that resolved, we’re not going to be able to fully solve inflation completely.

Let us think for the best and prepare for either a small slow down or a full blown recession.

Kanad Deshmukh

The markets have always discounted all the factors and bounced back from every slow down.  At times all we need is a little more patience to pass through the tunnel. However, knowing that we are entering a phase can help us be prepared in our very own manner.

CNBC

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