Understanding Inflation: How Does It Affect Your Pocket?

By: Emile Du Plessis, Behavioural Economist at Standard Bank

South Africans are increasingly paying more for goods and services due to rising inflation. Headline inflation is projected at 4.8% in 2022 and 4.4% in 2023, according to National Treasury. Rising energy and fuel prices are expected to be key sources of inflationary pressure in the year ahead.

But what is inflation? 

Inflation is the overall rise in the price of products and services in the economy. This, in turn, affects the purchasing power of your money. When the cost of manufacturing goods or the transportation of goods increases, chances are that the cost of the goods will also rise.

Inflation can be caused by an increase in input costs that affect the price of a single product or service. This could be anything from increases in the cost of fuel to raw materials and labour used in production processes.

The inflation rate for the country is measured by tracking changes in the price of a basket of goods, which reflects a fixed set of goods and services that households buy. The movements in price of this basket of goods are evaluated regularly.  

Supply and demand imbalances  

Another factor that impacts inflation is supply and demand. When the supply of goods or services is limited, but demand remains the same (or increases), the price of that product or service goes up. This is what economists describe as cost-push inflation.  

The demand for goods and services as well as the cost of producing those goods and services both affect their price. For example, as a result of COVID-19, supply chains have experienced significant disruption as logistics hubs and workshops, particularly in China, have had to close for periods of time due to virus outbreaks. At the same time, however, consumer demand has skyrocketed as economies and consumer spending have recovered. Without enough supply to meet demand due to logistics disruptions, prices for goods have been pushed higher, which has driven inflation rates up in many markets and economies around the world.

Understanding your individual inflation basket 

South African consumers can beat the current high inflation rate by understanding their individual inflation baskets and taking control of the unique expenses that are driving up their cost of living. An individual inflation basket represents the core goods and services that an individual usually spends their money on, compared to the official inflation basket, which represents the goods and services that the average South African spends their money on. So, everyone’s individual inflation basket is different, and the composition of your basket is driven by how you spend your money.  

South Africa’s official inflation rate does not necessarily apply to households across the country but varies markedly between different income groups. Consumers must understand where the increases are in their own inflation baskets to try and soften the impact inflation has on their standard of living.  

In South Africa, the poor and vulnerable are hit harder by inflation than consumers in the middle-income group. The lower income group’s inflation basket tends to be heavily skewed towards transport, food and education, and any significant price rise in those elements has a much bigger impact on poor households. Similarly, there is a big difference between the inflation baskets of the middle- and upper-income groups. The goods in their inflation baskets include food, medical costs, rent and some transport. 

Softening the impact of inflation on your budget  

Once consumers understand the composition of their unique inflation baskets, the best way to mitigate the rising costs is to reduce expenses and save money. For example, if the cost of telecommunication is a big inflation driver in your basket, the best course of action is to review your plans and contracts, shop around and find the best price for this service.

Consumers can also reduce their expenses and boost their savings by reducing their debt. Pay off your debt quicker and avoid taking on new debt. The sooner you remove your debt burdens, the better. It allows you to save more and places you in a better position to manage cost increases or any economic shocks.

Consumers must be mindful that there is a difference between good and bad debt. Bad debt typically comprises overspending on goods, services and experiences that are not a necessity to live life. Conversely, a home loan that builds personal and generational wealth represents good debt. If you are going to borrow money, do so prudently. Consider which needs the debt or loan is going to address and if the objective you are borrowing for is going to serve you in future.

Controlling costs 

Because consumers can’t control the input costs of goods and services, they must focus on cutting the costs they can control and find inventive ways to reduce spending in areas beyond their control. You don’t have control over the cost of fuel, for example, but you can control when and how you travel. Consumers who have not exercised financial discipline in the past may have to track what they spend in order to determine which costs they can control or influence.  

Considering your financial position  

It’s more important for South Africans whose income stream is static and only manages to keep pace with inflation to manage their inflation baskets than for those whose income outstrips inflation and can take on more risk in saving and investing.  

Understand your inflation basket and your income and expenses to reduce the inflationary pressures on your household and maintain a more comfortable standard of living.

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