Inflation Guide: How to maintain your purchasing power

Inflation indicates that the average prices of goods and services increase for some time to erode consumer purchasing power. Simply put, if a loaf of bread cost you $5 a year ago, but now the price has increased by 10% to $5.5, then it’s a sign of declining the currency's purchasing power. In other words, fiat money has dropped in value.

Inflation isn’t always bad as the moderate one is associated with economic growth, while high inflation also signals an overheated economy and it affects all aspects of the economy ranging from consumer spending, business investment, and employment rates to government policy and beyond. 

There are different indicators to measure inflation in different cities and countries based on the selected set of goods and services, which include everyday items (such as food and petrol), durable goods (such as washing machines and computers ), and services (such as rented housing and insurance). 

In Hong Kong, we usually use Consumer Price Index (CPI) to keep track of the price changes in the city. For the U.S., she also uses the same methodology but also uses the Personal Consumption Expenditures Price Index (PCE) to assess a wider range of expenditures. 

On a side note, when people talk about inflation, they also associate another term, stagflation, but it’s always bad when stagflation occurs since it’s a combination of three negatives: slower economic growth, higher unemployment, and higher prices.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of goods and services, including transportation, food, medical care, etc, each of which was calculated by the price changes based on their relative weight in the whole basket before being included in the list of goods and services. The prices in consideration are the retail prices of each item, which are the same as the purchase prices for individual consumers.

CPI is one of the most frequently used statistics to identify inflation or deflation in an economy and the results are associated with the cost of living. 

In Hong Kong, the Census and Statistics Department publishes the CPI reports on a monthly basis, and the Bureau of Labor Statistics (BLS) of America takes the same approach, but the latter is more powerful since the data will greatly affect the global market. If an economy grows rapidly with increasing demand and rising prices, an upward price spiral, aka “runaway inflation” or “hyperinflation,” can occur. Hence, the U.S. Federal Reserve normally implements monetary policies including moderate long-term interest rates, price stability, and maximum employment to fight inflation.

Central banks around the world have hiked interest rates to beat inflation. The U.S. Federal Reserve has been by far the most important actor in a series of aggressive monetary policies. 

In Sep, the Fed raised benchmark interest rates by 0.75 percentage point to a range of 3% to 3.25%, the highest since 2008, and it was also the fifth increase in the last six months. But, what does that mean? 

As the interest rate is the cost of debt for the borrower, and the rate of return for the lender,  so when the interest rate goes up, it means the borrower will repay more and it's possible that the lender can't receive money at the maturity date and bad debts will be increased. 

Also, when the cost of borrowing goes up, consumers will become more conservative and they intend to save instead of spending. As for companies, they will also slow their investments. Hence, the decrease in demand may slow down inflation, but also hold back economic growth.