Oran Hall | The consumer and inflation

The effect of inflation on each household is unique because no two households are exactly alike, and households combine the goods and services they use in different ways.

The items in the ‘basket’ of goods and services used in calculating the consumer price index, or CPI, are placed into 13 broad expenditure divisions which are divided into smaller groups of related items called a group. The ‘basket’ includes 318 commodities and each commodity may be more than one item for which price data are collected, so no household likely uses all the items it includes.

In a general way, though, there are broad ways in which consumers respond to expectations of higher inflation, and its effects can be expected to be more telling on some types of households than others.

Some amount of inflation is to be expected in a healthy economy, and it affects the level and pattern of current spending, savings and investments. A major reason for this is that it affects the real value of money in that what a dollar can purchase tomorrow is less than what it can today.

It also affects the real return on interest-bearing instruments, such as savings accounts and fixed-rate bonds and debentures. It affects other investment instruments as well in that the interest and capital earned may not be able to buy tomorrow what they can today. In fact, the value of the capital itself also depreciates.

Faced with the expectation of higher prices and lower real returns on interest-earning instruments, some consumers opt to increase their current level of spending on consumer goods while reducing the level of their savings.

One type of consumer item that tends to get attention in such a situation is consumer durables. They are generally costly but have a relatively long life, thereby giving considerable long-term benefit.

It is thus attractive to purchase them when their prices are low, compared to expected future prices. It is also easier to accumulate and store them relative to non-durables, a situation made easier when credit is readily available and more affordable than in the future when lending rates may increase, considering that the authorities tend to use higher interest rates as a tool to tame inflation.

One additional advantage of borrowing is that as inflation increases, the real value of each dollar of principal repaid and each dollar of interest paid declines, effectively working against the lender and in favour of the borrower.

Higher interest rates are used to encourage savings as well as to temper demand, particularly demand likely to be funded by borrowing.

Rising prices create uncertainty and makes it difficult to plan for the future. Faced with such uncertainty, some consumers tend to revise downwards their real income expectations and lower their consumption to save more for the future.

One real risk the consumer faces is a fall in living standards, which comes about when higher prices lead to a higher cost of living and consumers are not able to buy goods and services at previous levels, due to their income not keeping pace with increases in living expenses.

For consumers with a mind set on maintaining their standard of living, earning more income to do so becomes an imperative.

From an investment point of view, a shift in strategy generally helps in countering inflation. To the extent investors are willing and able to take more risk, a shift from interest-bearing securities to instruments that appreciate in value, like equities, real estate and capital growth unit trusts and mutual funds, provide some protection for the portfolio.

With respect to interest-bearing securities, as interest rates increase, the initial approach could be to invest in short-term instruments then shifting to longer term instruments as interest rates peak.

The consumers most vulnerable are those on fixed incomes. Pensioners are a prime example, as not many have the benefit of pensions that are indexed. With proper guidance, though, it is not far-fetched to suggest a modest exposure to capital growth pooled funds like unit trusts in favourable market conditions with good professional guidance. A major advantage of these instruments is their liquidity.

Adjustments can be made to consumption. Where possible, efforts should be made to improve the use of utilities and switches can be made to substitutes for consumer items, if they cost less and the quality is good. Buying in bulk, perhaps by pooling with others, may help to get better prices. More deliberate shopping and taking advantage of opportunities to secure discounts can also help.

The inflation figure that the Statistical Institute publishes is that for the entire country. In a real sense, that is not the inflation figure for individual households, and the strategies one household uses to cope is not necessarily appropriate for another household.

- Oran A. Hall, author of ‘Understanding Investments’ and principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel. finviser.jm@gmail.com