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Taming the High Inflation Beast

- Sky high prices, and high inflation, are bad for economic growth
Dickson Igwe. Photo: Provided
By Dickson Igwe

Annual inflation is considered normal for a growing economy. High inflation is something else. High inflation will push the best planned economy over the proverbial precipice.

When high inflation rears a head, economists and policy makers make every effort to tame the beast. For example, the US economy is thankfully growing strongly once more. However, rising inflation has become a fear for US central bankers. Interest rates may rise in the coming months.

There is a planned reduction in the amount of cash in circulation by the Federal Reserve, to ensure the US economy does not overheat. An overheated economy is a precursor to rising inflation. High inflation is a factor in recession. The question is asked: is there justification for inflationary fears in the US this early 2015?

In recessionary economies such as Europe’s and Japan’s, inflation is not an issue. That is because demand is stagnant, or contracting. There is no pressure on prices to increase owing to increasing demand and consequent supply pressures. Alternately, when demand increases, there is pressure on prices to rise. But this is not always the case as will be revealed in a subsequent story. Bear in mind that inflation is possible during a recession. High inflation during a recession is caused by supply or production shortages normally, over and above an increase in consumer demand.

Thankfully, high inflation has not been a factor in the Virgin Islands economy. Here is why. High prices at the shop, gas pump, and elsewhere, and high inflation, are not the same thing. Yes, high prices in the Virgin Islands, when compared with the prices for products in the US next door, are a reality for residents.

High prices are not good for any economy, or the pockets and purses of consumers, as they limit consumer options, and depress retail sales. Modern consumers are very price sensitive. Today’s interconnected and science driven type economies make profiteering difficult. Why: Jack the consumer has many more options, than he had in previous years, to look elsewhere, for that prized tablet, smart phone or digital TV set.

There is an opportunity cost of having to do without another additional product, because of the high price and high premium on the product that Jack has purchased.

If Jack buys a water hose for 50 US Dollars when in fact a reasonable price would have been 25 based on manufacturing and distribution costs, and the seller’s profit or return, then the extra cash spent represents a high premium.

Jack the Consumers high premium paid for the hose represents cash that could have been spent on something else: funds that could have gone into the coffers of a second business or retail outlet, and all that spells for economic growth. Unreasonably high prices limit the circulation of cash in an economy. High prices are therefore self- defeating, ultimately.

Price competitive businesses will succeed, where businesses that seek to profiteer, will hit the wall, or simply fail to grow.

In fact if Jack is wise, he will hold on to his cash until he can find an option where he can purchase that hose for near the 25 dollar price: the true cost of the product. That is clearly what happens in the Virgin Islands, with all the opportunities travel and digital technology offer consumers this early 2015, to pursue alternatives. St Thomas shopping, and shopping on the internet, will always be attractions, until prices and options improve locally. 

Another opportunity cost of buying a product or service at an unreasonably high price is the savings that could have been made, such as money in a savings account, or even invested in a wealth fund. Banks use those savings for lending purposes. Savings are also invested in business stock and this helps business liquidity and capital growth. High prices therefore affect consumer choice in a negative way.

However, on their own, high prices are not the same thing as high inflation. There must be certain underlying factors that cause these prices to be high for them to be termed inflationary. Inflation behaves in a peculiar way, within a specific context.

High inflation has not been a matter of concern for Virgin Islanders over the years. There are good reasons for this. The country uses the US Dollar as legal tender. The country’s economy is therefore linked closely with that of the USA. The US has not had an inflation problem for decades.

Monetary policy in the Virgin Islands is indirectly controlled by the US Federal Reserve or the US Central Bank. Were inflation to impact the US, then the Virgin Islands would suffer the fallout immediately. But so would neighboring Caribbean islands. Someone stated once, ‘’ when the US sneezes the world catches pneumonia.’’

Now, high inflation is unrelenting, causing a wide range of prices to spiral upwards daily. The consumer soon notices the trend in their pocket. There is a fall in the general standard of living. The cost of living goes up noticeably. In other words when high inflation hits, Joe Public feels the pain. 

Upwardly spiraling prices are bad for any economy. The main reason is uncertainty. Consumers cut back on spending in an inflationary environment and lose faith in the currency. High inflation also affects business confidence making it difficult to plan for the future. Businesses too have to make purchases.

High inflation puts pressure on a business’s employees. In Europe, high inflation in the past has caused wage inflation. Wage inflation, the tendency for wages to rise with prices, puts further pressure on businesses to raise their prices to cover costs. Businesses become reluctant to employ workers. There is a consequent rise in unemployment. The end result is recession. 

And there is very little a tiny externally reliant s country such as the Virgin Islands could do to make a dent in a price spiral upwards, were high inflation to become a major problem; apart from Virgin Islanders and residents tightening their belts, and living in a frugal manner. Inflation in the Virgin Islands, because of the nature of the economic demographic, will always be an external factor, coming into the territory from the outside. 

Now, Virgin Islands prices have always been higher than prices in the US, its main trading partner, and neighbor. This owes to three things: shipping costs, various customs duties, and premiums retailers put on their prices before sale to local residents. 

When prices rise for various products in the US, clearly there is a chain reaction. The Virgin Islands customer swiftly sees the price of that product go up in his or her local supermarket or gas station.  There is a direct link between price rises in the US and prices in the Virgin Islands. 

The preceding activity is not inflation however. Inflation is a specific economic term and is defined in a manner that asserts that it is not simply the rise in the price of product a, b, or c. Inflation is the general rise in the prices of goods and services across the board within a certain geographic area over a period of time. 

There is a normal rise in prices annually. This is termed regular inflation or annual inflation. This type of inflation is considered normal when it stays within a certain range determined by mathematicians, statisticians, and economists. Regular inflation is even considered necessary and positive for economic growth. 

High inflation is something else altogether. High inflation is problematic for an economy, and the individual consumer, the most important player in an economy. High inflation ultimately sets the stage for recession.  As governments, policy makers, businesses, and consumers, struggle, in an attempt to contain the beast, there is a decline in both business and consumer confidence. Demand contracts, followed by a contraction in supply. The result is an economic slowdown.   

To be continued 

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