Introduction
Inflation is an unavoidable phenomenon in economic life that directly affects household purchasing power, business competitiveness and the balance of public finances. Whether moderate or rampant, it influences consumption, savings and investment choices.
Understanding inflation means, above all, knowing how it is calculated, using precise indices that reflect changes in the prices of goods and services. But beyond its measurement, inflation has profound effects on the economy : it can stimulate or slow growth, reduce real income, or even weigh on social stability.
Faced with these impacts, the State implements various policies and instruments to limit its excesses and protect both citizens and the national economy.
I- How to calculate inflation
Inflation is calculated by evaluating a wide range of goods and services, determine their prices, and monitor them.
Prices from one period to another, specifying the base year, which is the reference and represents the index.100%.
The equation for calculating the economic inflation rate is as follows :
Consumer Price Index (CPI)
Economists often use the Consumer Price Index (CPI) as a measure of inflation. Although other indices exist, CPI is the easiest to apply and the closest to reality.
To calculate this indicator, you must first :
- Determining the consumer basket, which is the basket that includes the most important goods consumed by the citizen, for example (milk, flour, clothes, humpbacked horse, transportation, etc.), then the prices of these goods that make up the consumer basket are collected during the year;
- Determine the base year, i.e. the reference year, which is the year against which we compare the prices of other years.
On this basis, if we consider that :
Price level in reference year = 100
Price level in the current year = 120
II- Effects inflation
1- The effect of inflation on income
Before discussing the impact of inflation on income, it is necessary to mention the types of income, which can be summarized in four categories :
- Fixed cash income earners : This category includes property owners and those with old rental contracts. Their incomes are deteriorating due to the increasing rate of inflation.
- People with semi-fixed cash incomes : For example, this concerns the employee category. With rising inflation rates, the government is forced to increase employee salaries. However, the rate of wage increase is generally less than the rate of price increases, which leads to a decrease in its real income.
- People with fixed real incomes : This category includes private sector workers whose wages are linked to inflation. With any increase in prices, wages rise at the same level as the increase in prices, which enables this category to maintain the stability of its real income.
- Real income earners : It includes the owners of the liberal professions and merchants. For example, when the prices of goods increase by a percentage of 10%The merchant is not satisfied with including the price of the commodity to increase10%Rather, it doubles the percentage to %20 which increases his profit margin and thus increases his real income.
Generally, those with fixed incomes are the most affected by inflation, while businessmen and traders, i.e. those with incomes arising from profits, benefit from debt, and their income may increase at a greater rate than the rise in prices.
2- The impact of inflation on debt
Generally, the debtor benefits from the increase in inflation, while the creditor is negatively affected by this increase.
3- The impact of inflation on the balance of payments
Rising prices reduce the competitiveness of domestic goods in international markets, negatively impacting export volume. Declining export volume generates a trade deficit and, consequently, a balance of payments deficit.
4- The impact of inflation on economic growth
There are two different approaches to assessing the impact of inflation on economic growth. The first assumes that inflation contributes to accelerating economic growth.
This is because rising prices push individuals to compete in demand for goods and services, fearing further price increases in the future. This increased demand provides an incentive for investors to increase production capacity, which contributes to increased growth and reduced unemployment.
The second argument assumes that inflation leads to a decline in economic growth. This is because rising prices lead to a decline in demand for goods and services, which leads to a decline in investment and consequently to an increase in unemployment, leading to an economic recession.
5- The impact of inflation on the distribution of wealth in society
As inflation rises, wealth in society shifts from those with fixed incomes to those with variable incomes. One form of this shift is that those with fixed incomes are forced to sell their assets to those with variable incomes in order to counter the effects of inflation.
6- The effect of inflation on savings
As prices rise, consumers are forced to allocate a larger proportion of their income to consumption to maintain their standard of living, which negatively impacts their ability to save.
On the other hand, inflation results in a weakening of individuals’ confidence in the currency, which weakens the incentive to save, as the currency loses one of its properties : its status as a store of value
7- The impact of inflation on investment
High inflation leads to a decline in demand, which in turn leads to a decline in investment in productive sectors. Conversely, savings are directed towards purchasing gold and real estate to prevent their value from being eroded by the depreciation of the currency due to inflation.
III – Inflation results
1-Economic aspect
- Devaluation of the currency through a decrease in the purchasing power of money;
- Decrease in savings and increase in consumption;
- Limited investments and low production;
- Changing consumption patterns and impacting economic growth.
2- Social aspect
- Decrease in purchasing power, especially for those with fixed incomes, because the rate of price increases is much greater than the rate of income increases, so they are unable to cover it;
- High unemployment rate;
- High poverty rates;
- The emergence of social unrest and the threat to social peace;
- A change in the distribution of national income in a random manner that has no connection to the principles of social justice or productive efficiency.
IV- State means to limit inflation
To mitigate the worsening inflation crisis, the state is adopting a contractionary policy by taking a set of measures that can be implemented through two different mechanisms : fiscal policy and monetary policy.
1- fiscal policy
A mechanism in the hands of the government through which the government aims to control :
A- spending
a- consumer spending
This concerns, for example, rents for government buildings, purchase of government office supplies, purchase of fuel for the government vehicle fleet, etc.
b- investment spending
It includes constructing new roads, building schools and hospitals, and purchasing equipment.
c- Transfers
We specifically mention financial assistance, social care and social security.
B- Resources
It is related to the imposed taxes and includes :
– Income tax;
– Sales tax;
– Corporate profits tax;
– Customs duties.
Contractionary fiscal policy measures include :
- Reducing government spending rates by adopting an austerity policy aimed at reducing government demand;
- Increasing the size of taxes and raising their level in order to reduce the purchasing power of the citizen and thus reduce its consumption;
- Price controls and wage freezes to reduce demand.
2- Monetary policy
A mechanism controlled by the central bank, the purpose of which is to monitor the issuance of money, particularly by controlling the main interest rate.
Contractionary monetary policy measures include :
- Raising the key interest rate to encourage savings and absorb excess money supply;
- Raising the rediscount rate. Note that the rediscount rate is the rate charged by the central bank for rediscounting commercial papers from commercial banks, such as bills of exchange, bearer bonds, and promissory notes;
- Raising the legal reserve ratio, i.e. increasing the mandatory reserve ratio for commercial banks deposited with the Central Bank;
- Open market policy : The central bank sells the securities it owns, which are mainly stocks and bonds. The purpose of offering these securities for sale is to withdraw part of the liquidity and reduce its volume in order to weaken the banks’ financial capacity;
- Quality control of prices : It is intended to control the amount of money and the size of prices in sectors and certain areas in a way that serves economic and social objectives.
And the types of control over the prices :
– Discrimination in loan repayment terms, such as granting small business owners facilities such as granting them long terms and periods of time to repay their debts;
– Discrimination in loan quotas, such as requiring that 20% of the bank’s loans be directed to development projects in remote areas.
Conclusion
Inflation is more than just a price change : it’s a key indicator that reflects the health of an economy. Calculating it using various indices allows us to measure its magnitude and anticipate its repercussions.
Its effects, sometimes beneficial but often restrictive, affect households, businesses, and public finances alike. Aware of these challenges, the State deploys monetary, budgetary, and structural policies to contain inflation and preserve economic stability.