What Is Inflation And Why Should You Care?

Written by: Oluwatoyosi Adebusuyi

What is Inflation and Why Should You Care?

It was a hot afternoon, and Victoria had just received her paycheck. She had worked hard all month, but as she looked at the numbers on her bank statement, she realized that her money just didn’t seem to go as far as it used to. She wondered why her groceries cost more, why her gas tank seemed to empty faster, and why her rent kept increasing every year.

Have you ever gone to the store and noticed that the prices of everyday items, like a bag of spaghetti or a can of sardines, seem to be increasing every time you shop? Maybe you remember when a bag of spaghetti used to sell for N80, but now it’s N300 or more. Or perhaps you used to be able to buy a can of sardines for N100, but now it’s N500–600.

These fluctuations in prices can be attributed to a phenomenon known as inflation. Victoria had heard of the term “inflation” before, but she wasn’t quite sure what it meant. She had only heard about people often referring to it as the cause of the constant price hikes. This brings us to discuss inflation. In this article, we’ll explore why it’s important for you to understand what it means, how it works, the effect it can have on you and your business, and how you can manage and protect yourself against it.

What does inflation mean?

Inflation according to Investopedia can be defined as the general increase in the prices of goods and services over time, which affects the purchasing power of everyone, from the average consumer to large corporations and governments. What this means is that what your N50,000 could buy in 2020, it can’t buy in 2023. And so, your money has lost its value and your purchasing power has reduced. This is why you get a raise at work or record an increase in your income but it doesn’t really feel like you’re earning more because you’re spending more on the things that used to cost less. Most times, it’s not you being irresponsible with money, it’s just inflation.

Let’s take a look at how Nigeria’s inflation rate has evolved over the past ten years till date.

Here’s a representation of how these numbers have fluctuated over the years as documented by Macrotrends.

As displayed above, the only times where there was deflation; when the inflation rate reduces and prices generally fall in an economy was in 2014, 2018 and 2019 and since then, Nigeria’s inflation rate has continued to climb up. The next question on your mind would be WHY? Why has there been a continuous rise in inflation and what could be the causes?

What are the causes of Inflation?

Increase in Demand

A country’s inflation rate can go up when the demand for goods and services increases and there is no corresponding increase in supply; businesses may raise their prices to meet the growing demand. This can happen when people have more money to spend or when there is an increase in government spending or investment.

Imagine a popular toy that suddenly becomes a craze among children. As more kids want to buy that toy, the demand skyrockets. Retailers respond by increasing the price due to limited supply and high demand. This surge in demand and subsequent price hike illustrates how increased demand can contribute to inflation so it becomes a situation of “May the best man win” with the best man being the person with more money to spend.

Other causes of demand-pull inflation (another name for this type of inflation) include:

1. A strong economy. When the economy is doing really well and not many people are out of work, folks tend to earn more money and spend it too. This increase in spending causes a boost in overall demand for stuff in the whole economy.
2. Not enough supply. When people are earning more and spending more, companies try to make more things to keep up with the growing demand. But it can take some time for them to produce enough goods because there’s a lot of demand for the materials, parts, and workers they need.
3. Money supply going up quickly. The Central Bank of Nigeria, which is in charge of money, sometimes ends up printing too much of it, especially during tough economic times. When this happens, there’s suddenly a lot of money available, and people want to buy more things. It’s like a rush of demand for goods and services. But if businesses can’t produce enough to meet that demand, it causes demand-pull inflation.
4. Expecting prices to rise. People have an idea of how prices might go up in the future, and we call these “inflation expectations.” And guess what? Actual inflation often follows what people expect. So, if folks think prices will go up soon, they might start buying more things now to avoid paying higher prices later. This can create a problem because businesses may struggle to keep up with the sudden increase in demand, leading to demand-pull inflation.
5. Government decisions. When the government takes action during economic ups and downs, it can affect how much money people have to spend and where they decide to spend it. For example, if the government provides extra money during tough times or offers tax breaks for certain products, it can influence how much people can spend on stuff and where they choose to spend that extra money.
6. Foreign investment: You know, foreign investment happens when people from one country find it cheaper to buy stuff in another country because of the exchange rate. For example, if lots of people from Country A can easily afford to buy houses in Country B, that can create a situation where there’s more demand for houses in Country B. And when there’s high demand like that, it can lead to demand-pull inflation in the housing market of Country B.

When there is more money chasing the same amount of goods, it can drive prices up.

Cost-push inflation

Cost-push inflation happens when prices go up because it costs more to make things. Imagine this: when the cost of wages or salaries and raw materials goes up, it becomes more expensive for businesses to produce goods. And when it costs them more to make stuff, they often pass on those higher costs to us, the consumers, by raising prices. It’s like a chain reaction where the increased production costs lead to higher prices, and that’s what we call cost-push inflation.

A few leading causes that trigger cost-push inflation include:

1. Labour market: You know, when it comes to paying employees, things like salaries and healthcare costs are considered labour expenses. So, if labour unions negotiate higher wages or the government makes new rules that require employers to provide more benefits, those added expenses can cause prices to go up. It’s like a push from the cost side, and we call it cost-push inflation.
2. Capital: Every business needs money to operate, right? Sometimes, companies borrow money from investors or banks to keep things running smoothly. But here’s the thing: if investors become cautious and don’t provide as much funding, or if a business has to pay higher interest rates on the borrowed money, that can force the business to increase the prices of their products. It’s like a ripple effect where the increased costs of borrowing money can lead to higher prices.
3. Land expenses: Sometimes, natural disasters or other environmental events can cause problems. For example, if a flood damages a business’s property or if there’s a shortage of available land for construction, it can drive up the costs of renting or building spaces. And when businesses have to pay more for these land-related expenses, they often pass on those costs to customers through higher prices.
4. Entrepreneurship: Starting a new business or growing an existing one involves various costs. Think about things like buying raw materials, paying higher wages as the business expands, or even renting a bigger workspace. All these costs can add up and put pressure on businesses to increase the prices of their products. This, in turn, can contribute to inflation, as the overall prices in the economy go up.

Currency Devaluation

Currency devaluation happens when a country’s money becomes worthless compared to other country’s money. This means that when we exchange our currency for another country’s currency, we get less value in return.

Let’s take the Nigerian Naira as an example. Would you believe it if we told you that in 1980, 1 USD used to be 55 Kobo? Unfortunately, that’s not the case anymore as 1 USD now exchanges for N461.07 according to the CBN and this has caused a significant change in the strength of the Naira. The Naira has continued losing its value and falling in comparison to major currencies like the US Dollar, British Pound, and others. This means that when you exchange Naira for Dollars or Pounds, you get less of those foreign currencies in return.

This devaluation of the Naira makes it more expensive for Nigerians to buy goods and services from other countries. For example, if you wanted to buy something from the United States and the Naira is weak, you would need to spend more Naira to get the required amount of Dollars. This can have several effects. On one hand, it can make Nigerian products cheaper for people from other countries, which might encourage exports and help local businesses. On the other hand, it makes imported goods more expensive for Nigerians, as we need more Naira to purchase the same amount of foreign goods.

Currency devaluation can occur due to various reasons, such as economic factors, political instability, different interest rates, and an increase in the amount of money circulating within the country. These factors can all contribute to the weakening of the Naira against other currencies.

What causes currency devaluation?

As explained by Investopedia, when countries devalue their currency, it makes their exports cheaper, so other countries are more likely to buy them despite the risk of inflation.

One reason is to make their exports more competitive in the global market. When a country’s currency is devalued, it means that the value of its money decreases compared to other currencies. This makes their goods and services cheaper for people in other countries to buy. As a result, the demand for their exports increases, which can boost their economy and create jobs.

Another reason is to reduce trade imbalances. When a country’s currency is devalued, it makes imports more expensive for its citizens. This encourages people to buy locally produced goods instead, which can support domestic industries and reduce reliance on foreign imports. By promoting domestic consumption, the country aims to stimulate its own economy.

Further research by Nairametrics also reveals that the depreciation of the naira was heavily based on forces of demand and supply. Dumebi Udegbunam, a contributor to the article and Fixed Income trader at United Bank for Africa (UBA) mentioned that currently, the demand for dollars outweighs its supply, giving room for hoarders and speculators to take advantage, hence the sporadic increase to a 48-year high in the exchange rate at the parallel market. He continued,

“With the country being highly import-dependent, there aren’t enough dollars to match our growing demand. Let’s look at our capital importation figures. Our capital imports fell to $875.62 million in Q2 2021 from $1.91 billion in Q1–2021. In 2020, capital importation dropped by 59.65% from $23.9 billion to $9.68 billion (lowest in 4 years) showing a drop in dollar supply”.

However, it’s important to note that currency devaluation can indeed lead to inflation. When the value of a currency decreases, the prices of imported goods tend to rise. This can lead to higher costs for businesses and, in turn, higher prices for consumers. So, it’s a trade-off that countries must carefully consider, weighing the potential benefits of a weaker currency against the risk of inflation.

While devaluing a currency may be an attractive option, it can also have negative consequences. Increasing the price of imports protects domestic industries, but they may become less efficient without the pressure of competition.

In the end, the decision to devalue a currency is a complex one, taking into account various economic factors and the country’s specific circumstances. Governments must carefully manage the potential risks and implement measures to control inflation if it rises significantly.

In Nigeria, just like in other countries, the government has these things called monetary and fiscal policies to manage the economy. The CBN is responsible for handling the monetary policy, which focuses on controlling the supply of money in the country.

Monetary and Fiscal Policies

When there’s too much inflation in Nigeria and prices are going up, the CBN takes action to bring it down. They use contractionary monetary policy by increasing interest rates, making it more expensive to borrow money. In just one year, the CBN has raised the Monetary Policy Rate (MPR), which measures interest rates from 11.5% to 17.5 per cent to tame inflation. This helps reduce the amount of money circulating in the economy, which can help lower inflation. The CBN also sets reserve requirements for banks, which means they have to keep a certain percentage of their deposits as reserves. By adjusting these requirements, the CBN can influence the amount of money available for lending, which in turn affects inflation.

On the other hand, when the Nigerian economy is facing challenges or going through a downturn, the CBN implements an expansionary monetary policy. They lower interest rates to make it cheaper to borrow money, which encourages spending and investment. This stimulates economic growth and can help lift the economy out of a slump.

It’s important for the CBN to carefully manage the monetary policy to avoid imbalances that could lead to inflation. If they don’t strike the right balance, it can cause prices to rise too rapidly, making things more expensive for people.

The CBN’s monetary policy is just one part of the equation. Other government policies can also impact inflation. For example, when the government issues tax subsidies for products (i.e., solar panels), that can increase demand and result in demand-pull inflation. Regulations that increase costs for manufacturers could create cost-push inflation.

In summary, in Nigeria, the CBN plays a crucial role in managing the country’s monetary policy to control inflation. By adjusting interest rates and reserve requirements, they influence the supply of money in the economy. However, it’s important to consider other government policies as well, as they can also impact inflation. Finding the right balance in these policies is key to maintaining stable prices and a healthy economy.

Inflation Expectations

Economists also talk about something called unexpected changes in the economy, and how they can potentially cause inflation. It all comes down to the supply of money. Here’s the idea: when everyone expects inflation due to more money in the economy, the supply of goods and services has a chance to catch up with the increased demand. But if there’s a sudden influx of cash that takes everyone by surprise, the supply side can’t keep up, and that’s when inflation happens.

And you know what? People’s expectations of inflation can also play a role. Forbes adds that when companies and workers start worrying about inflation, their fears can lead them to expect higher inflation results. As a result, workers may ask for higher wages to offset the increased cost of living. But it’s a self-fulfilling prophecy: their fears can worsen the problem.

To afford higher wages for their workers, companies have to increase their prices. When companies think raw materials cost more, they will also hike their prices to maintain their profit margins. Combined, that means inflation expectations can cause inflation rates to rise.

Are there any benefits to inflation?

Economists once believed an inverse relationship existed between inflation and unemployment, and that rising unemployment could be fought with increased inflation. This relationship was defined in the famous Phillips curve.

While it’s true that inflation can create challenges for consumers and businesses alike, there are instances where it brings a glimmer of positivity to the table.

• Debt Relief: Inflation can be a friend to borrowers as it reduces the real value of debt over time. As prices rise, the fixed amount owed becomes relatively smaller, lightening the burden of repayment. This encourages borrowing and lending, which again increases spending on all levels. For example, if a debtor has $10,000 of debt during an inflationary period, that debt has less worth as time progresses. From a purchasing power standpoint, it’s more advantageous to slowly pay off this debt during highly inflationary periods due to the debt’s diminishing value.
• Economic Stimulus: Inflation can act as a stimulus for economic growth. When prices increase, consumers may be motivated to make purchases sooner rather than later, driving up demand and spurring business activity. When the economy is not running at capacity, meaning there is unused labour or resources, inflation theoretically helps increase production. More dollars translates to more spending, which equates to more aggregated demand. More demand, in turn, triggers more production to meet that demand.
• Increased Investment: Inflation can encourage investment in productive assets like stocks, real estate, or businesses as investors seek to protect their wealth from the disturbing effects of inflation by putting their money into assets that have the potential to appreciate in value.
• Income Growth: Inflation can lead to higher income, especially in periods of strong economic growth. As the cost of living rises, workers may negotiate for higher income to maintain their purchasing power, improving their standard of living. This usually enables companies to use their resources and labour efficiently. Inflation helps improve the economic growth of a country that’s experiencing a recession. With economic growth, countries usually experience a moderate inflation rate that typically leads to stability.

How does inflation affect you?

Ah, the impact of inflation on our everyday lives — it’s something we can’t ignore. It’s like a slow, silent thief gradually chipping away at the value of your hard-earned money. This is the reality of inflation, and it can have a profound impact on your financial well-being. But how exactly does inflation affect you?

1. Reduced purchasing power: When prices go up due to inflation, the value of our money decreases. It means we can buy fewer goods and services with the same amount of money. So, our purchasing power takes a hit, and we might not be able to afford things we used to. Consumers also lose purchasing power regardless of what the inflation rate is — whether it’s 2% or 4%. This just means that they lose it twice as fast at a higher rate. Compounding ensures that the overall price level increases more than twice as much over the long run if long-run inflation were to double.
2. Higher cost of living: Inflation can lead to an increase in the overall cost of living. The prices for everyday items like groceries, rent, utilities, and transportation can increase. This means we have to spend more on essential things, leaving less money for savings or other expenses. An inflation rate of 5% means that on average the typical household basket of goods (e.g. food, TVs) and services (haircut, restaurant meal) is 5% more expensive than the previous 12 months.
3. Inflation and your incomes: If you have a fixed income, like a pension or a salary that doesn’t increase with inflation, it can be tough. As prices rise, your income stays the same, making it harder to keep up with the higher costs. It can put a strain on your budget and financial stability.
4. For example, if we have an inflation rate of 5%, but average incomes are increasing by 8%, the real income will increase by +3%. Therefore, even though inflation has increased prices, the important thing is that we have more income to afford the higher cost of living.
5. Higher-income households have been more insulated from the effects of inflation, given that most own their homes with long-term, fixed-rate mortgages that are not affected by rate increases. Lower-income households have been much more exposed to inflation, given that they tend to be renters and spend a disproportionate share of their incomes on necessities including housing, utilities, food, and gasoline.
6. Impact on savings: As goods and services become more expensive, a gap can often occur as the rest of the economy levels out. If living costs rise but your income doesn’t, it becomes increasingly difficult to save. Additionally, it can erode the value of your savings over time. If the interest earned on your savings doesn’t keep up with inflation, the purchasing power of those savings decreases. It’s like your money is losing value while sitting in the bank.
7. Borrowing becomes costlier: When inflation rises, interest rates tend to go up too. If you need to borrow money for a mortgage, car loan, or any other borrowing, you may end up paying higher interest rates. This means more of your money goes towards interest payments, making borrowing more expensive. In March 2023, the CBN increased its benchmark lending rate to 18% in an aggressive push to contain the country’s inflation rate.
8. Uncertainty and planning challenges: Inflation creates uncertainty in the economy. It becomes harder to plan for the future because prices are constantly changing. It can make it challenging to budget, save, and make long-term financial decisions.

Steps for protection against inflation

Inflation can be such a challenge, and if you’re not careful you will always continue to feel you’re not doing or earning enough. Unfortunately, it’s not going anywhere anytime soon and you must learn to stay one step aside no matter what.

Here are five simple ways you can hedge against inflation and keep your finances on solid ground. From diversifying your investments to exploring high-yielding savings options, these strategies will help you stay one step ahead of rising prices.

• High-yield savings accounts: Keeping your money in a high-yield savings account can help counter the effects of inflation. These accounts typically offer higher interest rates than traditional savings accounts, allowing your savings to grow and maintain their purchasing power over time. Moni offers your savings an irresistible rate of 21% interest pa and you can save money daily, weekly, monthly and even withdraw your interest on a monthly basis. No other fintech offers up to this on a savings account, including traditional banks — with the highest being 4.2%.
• Invest in stocks: While the stock market may experience dips, historically, it’s delivered returns that have beat inflation. Over the past 95 years, the average stock market returns clocked 12.3% per year. By investing in a diversified portfolio of stocks, you can benefit from the growth of companies and their ability to raise prices in response to inflation.
• Real estate investments: Real estate traditionally does well during periods of higher inflation, as the value of a property can increase. This means your landlord can charge you more for rent, which in turn increases their income so it is on pace with the rising inflation. Property values and rental incomes have the potential to increase with inflation, helping to preserve your purchasing power.
• Commodities: Investing in commodities like gold, silver, or oil can provide a hedge against inflation. While gold doesn’t always protect against rising inflation in the short term, it tends to keep up over the long term (meaning decades). These assets often increase in value during inflationary periods as their prices rise along with the overall cost of goods and services.
• Diversify your portfolio: Spreading your investments across different asset classes can help mitigate the impact of inflation. By diversifying, you reduce the risk of having all your investments affected by inflation in the same way. Consider a mix of stocks, bonds, real estate, high-yield savings, and other assets to protect your wealth.

Remember, no investment strategy is without risk, and it’s essential to do your research and consult with a financial advisor before making any investment decisions. Each individual’s financial goals and risk tolerance may vary, so it’s important to find the approach that aligns best with your specific circumstances.

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