The Process Of Inflation

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How Does Inflation Work?
How Does Inflation Work?

If you have been wondering why inflation has reduced and things are still expensive. 

A few days ago, the National Bureau of Statistics (NBS) released inflation numbers for the month of October. Inflation declined from 16.63% in September to 15.99% in October.

Inflation is measured at the rate at which the price of goods and services increases over time.

it can be measured by comparing one month to the previous month or comparing inflation in a particular month of the year to the corresponding period last year (this is known as year-on-year).

Think of inflation as a speeding car. If a car slows down, it still keeps moving but at a slower pace.

That the inflation rate slows down does not mean prices will drop (although they could drop, but in some cases they do not). It means price increases just become slower.

Another point you need to know is that inflation is measured using the price of a basket of goods. The inflation number for the entire basket is known as headline inflation (in this case, 15.99%).

However, you can take each component and examine the inflation rate individually.

Food inflation, for instance, is at a much higher rate than headline inflation. Food inflation for the month of October was 18.34%. It dropped by 1.23% from 19.57% in September. Within the food basket, some items could rise, and some items could fall.

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So why the fuss about inflation? The higher your inflation rate, the faster the rate at which a currency’s purchasing power is eroded.

The 10-year average inflation rate in Nigeria is 12%. That means that in four years and a few months the naira loses 50% of its purchasing power.

The high inflation rate also makes earning above inflation returns a tough battle. If the average inflation rate is 12%, then a decent return would be a bit higher than that. There are not many investment options that offer that consistently.

That also partly explains why diversifying to dollar assets is an investment option some consider. The 10-year average US inflation rate of 2% means that the purchasing power of the dollar erodes at a much lower pace.

(Inflation has pushed hard this year, even in the US, too. Headline US inflation for the month of October was 6.2%).

 

Author:  Oluwatosin Olaseinde: