According to Will Kenton, an expert on the economy and investing laws and regulations, an
economy is a large set of inter-related production, consumption, and exchange activities that aid in determining how scarce resources are allocated. The production, consumption, and distribution of goods and services are used to fulfill the needs of those living and operating within the economy, which is also referred to as an economic system. A recent unpredicted phenomenon that had a huge impact on the global economy is the widespread of COVID-19. This pandemic has resulted in global public health, economic, and financial market crises. With the sudden appearance of Covid-19, the economy faced a crisis as the sudden demand increased in certain sectors, while an unpredicted drop occurred in other ones. In many countries, the spread of Covid has led to substantial income reductions, the rise in unemployment, as well as disruptions of transportation, manufacturing, and service industries. All that being said, the economy was indeed deeply affected on a global level. Lisa Smith, a freelance writer with a passion for financial journalism, contributing to popular media outlets like Investopedia and Bloomberg BNA, states that Inflation increased 6.2% from a year ago in October, marking the largest percentage increase in 31 years, which was introduced by the U.S. Labor Department reported on Nov. 10, 2021.
Understanding Inflation
Understanding inflation and its causes is an important aspect of understanding how COVID-19 and the economy are related. Inflation is a measure of the rate of increasing prices of goods and services in an economy as defined by Investopedia. And if inflation occurs, the prices of basic necessities such as food increase, thus affecting society negatively. Lisa Smith says that climbing prices are bad news for consumers, as it takes an ever-increasing amount of money to purchase the same basket of goods and services year after year. This concept is known as purchasing power.
Central banks, a nation’s monetary authority, work to keep inflation within bounds that allow the economy to grow and prevent the rate of inflation from exceeding a certain level. However, a certain level of inflation is mandatory as it promotes spending and national economic growth. Moreover, the most common inflation measurement tools are reported monthly by the Bureau of Labor Statistics (BLS), the two main tools are Consumer Price Index (CPI) and Producer Price Index (PPI).
- Consumer price indexes (CPI) calculate the weighted average price. A consumer pays for standardized groups of goods, and finished products.
- The Producer Price Index (PPI) measures price levels at the wholesale level for domestic producers. In addition to measuring the goods at any stage along the production and output line.
Moving on, there are two reasons why inflation happens; demand-pull and cost-push. The main cause of price increase is demand-pull inflation, in which consumers pull prices up by consuming a lot of goods and services. Meaning, if sellers raise the prices; products would still be sold out. While in cost-push conditions, prices are being raised by supply costs, and that usually happens when there is a shortage of supply and enough demand to allow the producer to raise prices.
What drives inflation?
Demand-Pull Inflation
The main cause of rising prices is demand-pull inflation, as mentioned before when consumer demand for goods and services increases rapidly, that supply does not keep up, and producers are unable to make enough to meet consumer demands or they might not have enough time to build the manufacturing needed to boost supply, then inflation occurs. Moreover, another reason is the over-expansion of the money supply. When the money supply expands, it lowers the dollar’s value. When the dollar’s value drops compared to foreign currencies, import prices increase. Consequently, the overall price level rises. Furthermore, a government can create inflation by printing more money.
Cost-Push Inflation
According to Congressional Research Service (2020), the second cause of inflation is cost-push inflation. And this only happens when there is a shortage of supply coupled with enough demand to allow the producer to raise prices. Cost-push inflation can occur as a consequence due to natural disasters, a company’s ability to create monopoly government regulation and taxation, and when a country lowers its currency’s exchange rates.
COVID-19 and Inflation
Craig Kirsner, President of Stuart Estate Planning Wealth Advisors in Coconut Creek, Florida, stated that they are experiencing this sudden surge in inflation for two main reasons. First, due to Covid, no one has spent money for the past year and a half. People are spending and traveling now that the economy is open again, and there is a strong demand. Because our system isn’t designed to handle so tremendous demand, we will see inflation in the short run. Second, low borrowing rates, which have been at zero since March 2020, have boosted demand for housing, which is facing a big backlog, while also contributing to inflation concerns. Infinitely, what is happening now is a result of a single event that exposed both economic weaknesses and created a vicious inflationary cycle.
Consumers Spending’s during Covid-19
In a recent study published in the National Bureau of Economic Research, Alberto Cavallo, Edgerley Family Associate Professor at Harvard Business School, investigated the impact of changes in expenditure patterns because of the 2020 Coronavirus pandemic on inflation measures in his paper proceeding; “Inflation with Covid consumption baskets”. Cavallo used data collected on debit and credit card transactions from January 2019 to May 2020 from the Opportunity Insights Tracker (a mechanism that measures the daily change in U.S. consumption patterns), moreover, real-time expenditure estimates were combined with official inflation measures that had not been adjusted for the season. Various countries were included in this study.
In January and February 2020, Cavallo discovered that the official CPI from the BLS and his
computed COVID-19 CPI were nearly equal in the United States. However, the COVID-19 inflation estimate was greater than the official CPI in March of that year which is the commencement of the pandemic’s initial outbreak in the United States, despite that, both are showing deflation. As the pandemic spread, the gap between the two inflation rates widened. Between March and April, the official CPI fell 0.69 percent, while the COVID-19 CPI only fell 0.09 percent as a result of vastly differing price movements developed across items, and the price difference proceeded simultaneously with shifting weights. Causing certain nations to experience greater COVID-19 inflation.
The founding of this study shows that the majority of the differences between official and
COVID-19 inflation measurements were observed in food and fuel expenditures. The author says “During the coronavirus pandemic, the cost of living increased faster than the cost of living of the official CPI. The results showed that low-income households spent more on food than on transportation, which exacerbated the difference in the inflation measures during the beginning of the pandemic. Cavallo suggests that low-income households had higher rates of COVID-19 inflation (1.12 percent in May 2020) during the pandemic when compared with higher-income households (only 0.57 percent).”
Does inflation benefit anyone?
Unlike consumers, investors can benefit from inflation if they invest in inflation-affected markets. Meaning as a result of an increase in demand, some companies profit from inflation by raising their prices. Energy companies, for instance, might see their stock prices rise when energy prices are rising. Also, homes can be sold for higher prices if the economy is doing well and demand is high.
Furthermore, inflation can allow businesses to set their own prices and increase their profit margins. A rising profit margin indicates that companies’ prices are rising faster than the cost of production. Besides, companies can intentionally withhold supplies from the market, thus allowing prices to increase.
However, companies are also adversely affected by inflation when production costs increase. Companies are in danger if they cannot pass on higher costs to consumers through higher prices. For instance, if foreign competition remains unaffected by rising production costs, their prices should not rise. Subsequently, US companies may have to eat up higher production costs. Or else, foreign companies run the risk of losing consumers to other companies. To sum up, Tejvan Pettinger, an Economics teacher (A-Level students) at Greenes College and formerly with Cherwell College, Oxford, says that inflation will benefit those with large debts who, with rising prices, find it easier to pay back their debts, and on the other hand inflation will hurt those who keep cash savings and workers with fixed wages. Attached below is a figure of the dollar value and its power.
Inflation and Dollar Value
“The impact inflation has on the time value of money is that it decreases the value of a dollar over time. The time value of money is a concept that describes how the money available to you today is worth more than the same amount of money at a future date.” Says Evan Tarver, an author, editor, and copywriter with a rich and diverse history in finance and technology.
Meaning if you don’t put your cash in an equity asset, a debt instrument, or an interest-bearing bank account right now, the worth of the money you own will decrease. For example, if you have $100 in your pocket today, the value of that money will be lower in a year if kept in your pocket. If inflation kept on increasing, then the prices of goods and supplies will keep increasing. For instance, if bread costs $2 today, it’s likely that the same bread will cost double a year from now. This effectively reduces money’s purchasing power during that time span, as the same goods will cost twice as much in the near future. Another example is what’s happening to the Turkish lira currently, “The currency has declined more than 30 percent this year after investors lost faith in the authorities’ ability to manage the economy in the face of inflation that accelerated to almost 20 percent in October.” said Tommy Stubbington, Financial Times markets reporter. That being said, the prices in Turkey and Cyprus are vastly increasing in a short period of time. However, in order to benefit from inflation, and avoid the decrease of money worth, you can invest the money you have today at a rate that is equivalent to or higher than inflation.
References:
- Tommy Stubbington(2021), Turkish lira sinks to new low as investors warn of ‘vicious cycle’, https://www.ft.com/content/
- Pettinger, T., Solanki, N. A. V. D. E. E. P. S., Smith, J., & Hana. (2021, October 8). Who are the winners and losers from inflation? Economics Help. Retrieved November 20, 2021, from https://www.economicshelp.org/blog/145181/inflation/who-are-the-winners-and-losers-from-inflation/#:~:text=Inflation
- KIMBERLY AMADE (2021), What Are the Causes of Inflation?, The Balance, https://www.thebalance.com/causes-of-inflation-3-real-reasons-for-rising-prices
- THE INVESTOPEDIA TEAM( 2021), What Causes Inflation and Who Profits From It?, Investopedia, https://www.investopedia.com/ask/answers/111314/what-causes-inflation-and-does-anyone-gain-it.asp
- Team, T. I. (2021, November 11). What causes inflation and who profits from it? Investopedia. Retrieved November 20, 2021, from https://www.investopedia.com/ask/answers/111314/what-causes-inflation-and-does-anyone-gain-it.asp.
- The long-run effects of pandemics on inflation. VOX, CEPR Policy Portal. (n.d.). Retrieved November 20, 2021, from https://voxeu.org/article/long-run-effects-pandemics-inflation.
- S. Bureau of Labor Statistics. (2021, April 1). Consumer inflation during the COVID-19 pandemic: Monthly Labor Review. U.S. Bureau of Labor Statistics. Retrieved November 20, 2021, from https://www.bls.gov/opub/mlr/2021/beyond-bls/consumer-inflation-during-the-covid-19-pandemic.htm.
- Tarver, E. (n.d.). Evan Tarver. Investopedia. Retrieved December 2, 2021, from https://www.investopedia.com/contributors
- Kenton, W. (2021, December 1). Exploring how an economy works and the various types of economies. Investopedia. Retrieved December 2, 2021, from https://www.investopedia.com/terms/e/economy.asp.
- Smith, L. (2021, November 11). How to profit from inflation. Investopedia. Retrieved December 2, 2021, from https://www.investopedia.com/articles/investing/080813/how-profit-inflation.asp.
