Growing poorer ... inflation versus living cost
IF a household wakes up in the morning and heads to the local grocery store only to find out that the local currency is not stretching as far at the store, it is incorrect to say the household is merely imagining things.
With prices generally on the uptrend, one is likely to hear a lot about rising inflation and living cost. What do these terms really mean? How do they affect ones daily life?
The living cost view is often confused with inflation. Under normal circumstances, the living cost concept arises from the role of money as a medium of exchange. When a household says the cost of living has increased, it generally means that it is harder to maintain a given standard of living on a given income.
Simply put, the one dollar today is much smaller than let us say 10 years ago. What it means is that the household in today’s environment will end up being satisfied with fewer goods or services or save less or work harder to maintain the current living standard.
What is inflation all about? It can be best understood as a change in the value of unit of the local currency. When there is inflation, it simply tells us that the value of the unit of the local currency is smaller for all transactions.
Imagine it is situation where both the income of households and the prices of the goods and services increase by the same percentage.
In this scenario, while the value of the currency would have shrank due to inflation, in contrast it will be neither difficult nor easier to maintain the same real standard of living.
But this is a hypothetical situation. In most cases the rise in household income which tends to mirror the consumer price inflation is still lower than the living cost.
While both the living cost and inflation generally measure and compare prices of goods and services, yet they both describe different economic conditions and situation.
For instance, a household wanting to know more about the income level needs to determine the affordable average lifestyle in a given area, will be referring to living cost.
Meanwhile, if the household is seeking to find out how much prices are rising or falling over a period of time, it will be appropriate to look at the inflation levels.
Harmful in different ways
Meanwhile, inflation and the living cost are both harmful in different ways. An increase in the living cost will hurt household and make them poorer.
The harm from inflation is more subtle as it makes it harder to plan for the future and so it discourages savings and investment and also erode the real value of cash and other assets that have fixed nominal values.
Because the rate of inflation typically becomes more variable, it increases uncertainty and makes markets work less efficiently and slows economic growth.
In the meantime, the effects of inflation are the same for everyone, but changes in the living cost varies from place to place and from person to person. If inflation shrinks the unit of account by 5%, then the real values of anything will also fall by 5% . In contrast, the change in general prices of goods and services will affect people’s cost of living differently.
For instance, rise in the price of heating fuel will hurt those in cold regions more than those in warm regions. An increase in the price of meat does no harm to vegetarians. The living cost in New York does not necessarily keep pace with that in Detroit.
Bottom line
Households and economists find different patterns in the storm of price data each month. Consumers look for changes in the cost of living. Typical cost of living calculations take into account will be the prices for food, shelter, clothing, transportation, utilities, health care, education and entertainment. There is hardly any official cost of living metric provided in many countries including Malaysia.
Economists, instead, look for situations that are relevant to policy. Assuming there is a conflict in an oil-producing state which sends the price of gasoline higher, so what? There is little the central banks can do about it. At best, to calm the waters they hold the interest rates steady.
Meanwhile, an upward rise in inflation even by a few basis points per month or should inflation stay stubbornly sticky may allow the central bank to show that the time has come to begin a gradual tightening of policy.
To conclude, the consumer price inflation is measured based on changes in a set basket of consumer goods and services tends to get into a hot debate, especially on its reliability as a good indicator to reflect the real inflation level which is the purchasing power of money.
In the meantime, households will continue examining their monthly data which will determine their living cost. While the effects of each type of inflation are similar, the underlying causes are not necessarily the same.