Inflation: Is it Good, Bad or Ugly?

Black and White are interesting colours. In few occasion wearing a Black shows the sad situation while for some cases like in marriage or business meetings this is called the formal. Black is associated with Black Magic a negative thing but black long hairs are symbolised as beauty. Similarly white is colour of peace and sorrow for some religions while for some it is for the celebrations (i.e. marriage).

What does it means?

Well as I understand most of the things have two sides and different people look at it through different perspectives. For some it is a sign of happiness for some it may be a symbol of sad and bad things.

Inflation also has two sides, while few countries especially the growing/developing nations are fighting hard to reduce/control it, while on the other side there are countries form developed nations like Japan who are struggling to increase it. Interesting but true.

What actually the inflation is?

As a dictionary meaning Inflation means continuous rise in the prices at a broad level.

In the economic terms it is called as: too much of money chasing too few goods and services.

How Inflation Moves?

When the gap between demand for goods and supply of money is too high, it causes prices to rise at a breath-taking pace. While a low to moderate gap results in a steady but minimal rise in the prices.

So when Inflation can be called as Good?

When the Prices of goods and services in an economy rise moderately and linear way it will be considered as desired.

But why should the rise in prices can be good?

When inflation rise moderately, Companies invest more in their businesses to increase their production to meet the ‘higher’ demand for goods/services. Therefore, more manpower is needed which pushes wages upwards. Money invested in production capacities fetches higher returns, which in turn accelerates the shareholders’ returns as well. This way economy creates more employment opportunities and also increases the wealth of shareholders as well as improves the tax revenue for government. A kind of win-win situation for all the stakeholders.

How high inflation impacts?

Some time there is lot of money/liquidity in the economy which results into such s strong demand that despite investing massively in production capacities, corporations usually fail to meet the demand. This spikes the prices of goods and services resulting them to become almost unaffordable.

This in turn reduces the discretionary income of the majority of households resulting into buying lesser goods. Then Companies suddenly realise that they went overboard with production during the boom time and soon start realising their overheads are unsustainable. This results into layoffs of employees. As people lose jobs, demand for goods and services falls again, followed by the price reductions which someday jumpstarts the economic upswing again.

So, how much inflation is good?

There is no fix formula for it. It depends on that country’s economic growth as well as the rate of inflation elsewhere in the world.  As said earlier, usually, developing nations witness sharp swings in inflation and cost of capital due to lower income and scarcity of capital and other resources.

As the country becomes developed economies the inflation goes down and stabilizes. This is because Economic prosperity reduces price volatility especially the essential items as they are the items which are important but will have some limited demands. (A person will not start eating more if he becomes wealthy).

What is life style inflation?

There is one standard inflation figure which is published by the government agencies. But is it really the inflation number for every person in that economy. The answer is NO.

Every person is unique and has different life style and accordingly the consumption is also different for different persons.

For example a Non-vegetarian person will be more impacted by the prices of fish and meats whereas the vegetarian person may not have any impact.

Twenty years back we use to have one TV in a home now we need in every room. One landline telephone was not just serving the family but the whole area and now every family member needs to have mobile phone in fact many of us carry two-three phones. So the cost of phone lines might have reduced but due to higher consumption our bills have not. One year school fees in a good convent school today would be equal to the amount of total fees paid from Nursery to College thirty years back. Similarly in every aspect of our life our aspirations have gone up and hence the headline numbers have very limited relevance and every person has to analyse his/her own inflation based on their own life style and aspirations.

How it impacts our investments?

So while deciding our future financial goal we need to consider our actual requirements and what kind of inflation it has historically. For example the education fees/ medical expenses rise much more than the headline inflation numbers. Further it could be worse, if inflation spikes up for any reason at a time when our goal is up for the fulfilment. Therefore, make a point to be conservative about the estimation of return on your portfolio and be cautious about the estimate of inflation.

To reach our financial goals and beat the inflation we need to ensure that we are investing in those assets which have capability to beat the inflation Equities and Equity based Mutual funds are those which can give us higher than inflation numbers over a longer period of time.

To Conclude

Inflation is a number based on various economic and social factors, and every individual has a different inflation number based on his own life style and expenses. We cannot say inflation good or bad on its own but other factors make it a boon or a bane. To face high inflation we need to have a proper financial plan in place.