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Inflation is going to have a significant effect on business and individuals for the next few years.

As we started to exit the pandemic and business started to get going again, energy prices started to rise quite sharply – two years of depressed demand had led to decreased output and low stocks, and as this changed, the low availability caused prices to increase.

On top of this, governments around the world spent heavily during the pandemic: on vaccinations, on medical facilities and treatment, on business and other financial support. Of course, that money needs to come from somewhere and governments greatly increased their borrowings to cover it, which meant tax increases in various ways to try to start covering increased borrowing costs and reduce deficits slowly.

Then, in late February, Russia invaded Ukraine started and energy prices started rising even faster, along with the prices of wheat, maize (corn) and sunflower products which the two countries export in huge quantities. Add the resultant effect of higher transport and fertilizer prices and all foods will be impacted as will almost all other products.

Already, for example, inflation in the US is at levels last seen more than 40 years ago, so few CEOs will have experience with this.

Consequently, as central banks try to reduce this, they have started increasing interest rates to slow demand.

While it’s generally accepted that a little inflation (around 2%) is a good thing for an economy as it shows increasing demand for goods and services which drives higher employment, and increased output with resulting moderate price increases, inflation levels much higher than this are bad, as are inflation levels much lower.

Low inflation, of course, indicates low demand which depresses wages and growth and can lead to a stagnant economy.

High inflation, on the other hand leads to rapid increases in costs and, generally, a sharp decline in employment and output as demand shrinks quickly when consumers find themselves under pressure from increased costs (especially on debt such as car and mortgage payments – normally the biggest monthly cost for most people). Recession is the most frequent consequence.

For businesses, high inflation provides a number of challenges:

  • Rising input / running and borrowing costs
  • Declining customer demand due to spending curbs and/or more active price negotiations which reduce profitability
  • Morale waning through a combination of slower business and more financial pressures
  • Salary increase expectations

And this is why Margaret Thatcher said, “Inflation is the parent of unemployment and the unseen robber of those who have saved.”

High inflation invariably leads to growing rates of unemployment, while price increases deplete the buying power of savings (including pension funds). Remember the Rule of 72 when looking at what inflation can do to prices: a relatively modest 7% means prices doubling in just over 10 years (72 / 7).

In my next post, I’ll look at what businesses can do to mitigate, so far as possible, the effects of inflation – possibly one of the toughest challenges many CEOs will have faced.

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Learn more from some related posts:

You might also find this short article from NC State University helpful: Inflation is healthy for the economy – but too much can trigger a recession