Inflation and Your Money

Imagine going to a restaurant to buy a cup of coffee and being told that the price was $5,000. After ordering a second cup, you request a bill and see that the total cost for two cups of coffee was $14,000.

Upon enquiring about the obvious error you were told, “If you want to save money and you want two cups of coffee, you should order them both at the same time.”

You may How to Defend Your Company Against High Inflation think that this is just an amusing story. In fact, this was a real-life example of life in Germany after World War I recounted in Adam Smith’s Paper Money, which described the extreme effects of inflation on that country’s economy. defines inflation as a “sustained increase in the general level of prices for goods and services, which is measured as an annual percentage increase”. Simply put, inflation will cause you to spend more money on the goods and services you normally buy. Therefore, a fixed amount of money (such as your salary) will buy progressively less things as inflation increases.

The two key points to note about inflation are that:

1. The prices of goods and services are going up
2. The value of your money is going down

If you can envision a graph of these two effects of inflation, you will realise that the cost of living is going in one direction – up, while your spending power is going in the opposite way – down. No wonder so many of us feel distressed after a trip to the supermarket!

Jamaica’s inflation figures at the end of December 2008 showed a 16.8 per cent increase in prices over the previous year. This means on average, an item that cost $100 in December 2007 would cost $116.80 one year later. The Bank of Jamaica calculates the inflation rate by periodically tracking the changes in costs of a large basket of basic goods and services including bread, agricultural produce, clothing and electricity.

But what causes these costs to increase in the first place? Why can’t prices just stay constant over the years?

Experts who study money and economics agree that two main things will result in inflation:

1. When the demand for goods and services exceeds their supply, then prices will increase. This typically happens when there is too much money chasing too few goods.

2. When companies experience increased input costs such as salaries and raw materials, they will increase their prices to maintain their profit levels.