Clearing up misunderstandings of inflation
The Sunday Nation
Nairobi,
13 January 2013
First of all, let me apologise for not writing last week [6th January 2013]: I got carried away by the end of year festivities! But on that day, a report appeared in the business pages of this paper under the heading “Consumers yet to benefit from low inflation as prices still high”. While that heading captured the gist of the story very well it illustrates the two biggest misunderstandings of inflation in the public domain.
The first misunderstanding comes as an inversion of cause and effect: many people think that inflation causes the prices of goods to go up. This is totally wrong! The correct position is that the increase of prices causes inflation.
The percentage figures announced every month by the Kenya National Bureau of Statistics (KNBS) are calculated from a survey of prices of various goods in the market. For this reason, they are always quoted for the previous month: that is, in January 2013, for example, the inflation figure given (3.2 per cent) was for December 2012.
To reiterate that
point; the average prices of goods in December 2012 was 3.2 per cent
higher than in December 2011. Therefore, this inflation figure has
absolutely nothing to do with expected prices in January 2013; it is a
historical figure telling us about the past!
The second
misunderstanding is in the meaning of inflation. Many people think that
a drop in inflation means a drop in prices. This is wrong. To understand
why, we can compare it to speed.
Suppose a car is
travelling at 50km/h and then it reduces the speed to 10km/h. Does that
mean that the car has stopped moving? Of course not! It has only slowed
down but it’s still in motion.
It is the same with
inflation; it tells us how fast
the prices of goods are changing. When inflation is high, it means
prices are rising very fast and when it is low, they are still
increasing slowly, but at a slower rate. Thus it is wrong to expect
prices to drop when the inflation is low.
Indeed, the respondent (Rose Kerubo) in the “Consumers yet to benefit from low inflation as prices still high” story confirmed this when she said “Since last year, things have remained the same. I do not see any change. My shopping is approximately Sh10,000 per month, and this has been so since last year,”
Ms Kerubo’s statement means that, according to her observation, the inflation rate has been zero per cent “since last year”!
If the average prices of goods fall, the result would be a NEGATIVE inflation figure. This is known as deflation. Now while some specific products do go up and down depending on the season (especially agricultural commodities), most prices are increasing. For that reason, the average outcome is a positive inflation figure, albeit a small one, like the current 3.2 percent.
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