Economists broadly define inflation as the rising of price that causes the slow but a steady loss of purchasing power. This is reflected in a wide increase in prices of goods and services. Generally, it refers to a broad rise in the prices of goods and services in many countries, including Ethiopia. This occurs across the economy over time thereby diminishing the purchasing power of both consumers and producers.
It has been observed for years across different countries that long periods of inflation are caused mainly by a monetary policy. That is to say that when a central bank fixes the interest rate at a low level or increases the rate at which money grows too rapidly, then the rate of inflation rises. This is not limited to a rise in price for any single commodity or service. It refers to a rise in prices across product and service sectors and finally to an increase at a country level. Economists have repeatedly asserted that inflation affects the daily life of every citizen of a country. Business managers have to reckon with the effects and impacts of inflation on their profits while paying more attention to raw materials, labor and other factors of production.
However, for some economists, inflation is not to be considered bad. In a strong economy, yearly inflation is in the range of two percentage points. These economists consider this a sign of economic stability. If inflation is in this range, it may have positive effects. It may motivate and encourage spending thereby raising demand and productivity as the economy is sluggish and requires an increase.
However, if inflation starts to exceed the growth of wage, it may be an indicator of an economy that is under pressure. It is assumed that inflation may be falling in several markets, but there may still be uncertainty in the future. Without a rise in productivity, most economies may be facing major economic crises. With a fall in productivity, inflation becomes a risk to global and domestic economic growth. The real question is to what extent does economic policy influence inflation.
Experts assert that monetary policy has a crucial effect on inflation over time. A high rate of inflation may be caused by an increase in money supply. They pointed out that high cost of raw materials and labor as well as supply disruption caused by conflicts lead to inflation.
It is revealed that there are two causes of inflation in the short-run. The first is demand-pull inflation that occurs when the demand for goods and services is higher than the capacity of the economy to supply them. The second is cost-push inflation which is caused by the rising price of inputs needed for the production of goods and services. Inflation occurs where there are radical changes in demand and purchasing patterns across economic sectors.
To minimize impacts on financial performance, managers of industries are forced to raise consumer prices thereby contributing to inflation. To combat inflation, some governments used to raise interest rates to higher levels. But, how high is an interest or inflation rate? Statistics agencies tend to measure inflation first by deciding on the present value of a "basket of various goods and services" consumed by consumers. This is referred to as a price index. To measure the rate of inflation, the agency compares the value of the price index over a period with that of another.
Most countries have developed their own Consumer Price Index (CPI) for measuring the cost of goods that consumers purchase. The CPI may be broken down by region and is consolidated for a country, including Ethiopia, as a whole. It is balanced by data obtained through enterprise surveys conducted periodically. The information obtained has to be analyzed by the concerned agency and the planning office to reveal the effects of inflation on consumers and enterprises. The question is how inflation affects consumers and enterprise differently and in what manner.
It is suggested that inflation affects consumers directly, while enterprises may feel the effect indirectly. Economists think that consumers lose their purchasing power when the prices of consumer goods they purchase rise. These goods include food, clothing, housing, school fees, and utilities and other basic expenses. These expenses may lead to low household consumption and growing pessimism. Though consumers face the brunt of the rising cost of living, enterprises are not immune from inflation.
Faced with inflation, enterprises may lose their purchasing power thereby risking a decline in their margin of profit. This happens especially when costs of inputs, including raw materials used in production, increase. These may also include intermediate products such as steel and finished machinery. In response, enterprises usually raise the selling prices of their products or services. They have to do this to offset inflation by forcing consumers absorb the increase in price.
It is observed that the challenge for many enterprises is to maintain the right balance between raising prices to cover the increase in input cost. In so doing, they simultaneously ensure that they do not increase prices too high so that they suppress demand. If demand is suppressed by rising prices, the enterprises may find it difficult to attract consumers. Also, they may not reduce price below the cost of production as this would lead to total loss.
The burning issue is the capacity of enterprises to respond to high inflation. During the time of high inflation, enterprises typically purchase materials at high prices, which reduce their margin of profit. A strategy for enterprises to reduce losses and maintain profit margins is by increasing prices on consumers. Nevertheless, if price increases are not implemented carefully, enterprises, including Ethiopian firms, may damage customer relationships, leading to loss of sales.
Finally, decline in sales may erode the profits they are trying to maintain. However, when they conduct their businesses successfully, they would be able to recover the cost of inflation for a given product. This would strengthen their relationships with customers and may secure overall margin of profit. Economists have suggested several measures enterprises may take to adapt to inflation, without state interference, and these are adjusting, developing, accelerating, planning, and tracking. These are indicated below briefly.
In adapting to inflation, enterprises engage in adjusting discounting rates and maximizing non-price instruments. This may include expanding production schedules or increasing supplementary and delivery fees for quick and low-volume of orders. This measure is based on business practices in the markets of most countries, including Ethiopia. Also, developing the art and science of price change is used by enterprises instead of making an overall price change. This price change is a tailored action to account for inflation exposure.
It also considers customer willingness to pay and product qualities. Another measure is to accelerate decision making process related to inflation. Decision makers regarding inflation include dedicated officers in the agencies responsible for economic decisions that may act quickly and responsibly based on customer feedback. They may also plan for alternative options beyond pricing to reduce costs. They use value-chain to provide cost-reducing alternatives to price increases. The concerned agencies track execution of decisions by addressing revenue leakages.
Beyond pricing, a variety of commercial and technical measures may help enterprises to deal with price increases in an inflationary market. But, other sectors may need a more relevant response to pricing. Enterprise managers may help protect their firms against uncertainty during periods of high inflation. In uncertain environment, in which enterprises have a variety of stakeholders, managers should consider performance beyond short-term profitability. They should consider the business cycle with their stakeholders in mind.
Enterprise managers should have an inflation management plan just as National Banks do. Some of the important areas managers have to keep in mind are indicated here. They should alert the entire enterprise on the choice of products and services which are critical for responding to price volatility. They should also focus on the scarcity of products and higher costs of production and services.
Other items enterprise managers should consider carefully are supply chain, procurement, pricing and feedback. The most difficult task for managers may be how to convince investors to accept supply chain responses. Given geopolitical and economic realities in Ethiopia, supply chain may become a crucial objective for supply chain managers, including cost minimization.
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Regarding procurement, managers may raise the value-creating contributions of inputs. They have to consider the toughness of the current market environment. Managers have to recognize that purchase of inputs requires strategic suppliers for expanding beyond cost cutting to "value creation." These managers, facing tight labor market, should guide their enterprise by devising new approaches to seek talent with focus on attractive wages, salaries and working conditions. By forging new pricing relationships with customers, managers will test their role as successful entrepreneurs.
With fixing new prices, managers may have the chance to develop better relationships with customers. Managers strive to achieve a focus on strategic action. They will also manage the impacts of inflation through functional, disciplined, agile and quick response. The impact of inflation on the whole economy may cause service delivery costs to rise faster than the rate of inflation.
Experts also think that labor shortages will lead to high demand for their services. This drives up costs and consumer prices that generate higher inflation. This causes an extreme pricing range, which is known as deflation. Deflation happens when the general level of prices decline within an economy. This is reflected in the rise of the purchasing power of a currency. This is further driven by growth in productivity of goods and services. In other words, the abundance of marketable goods is expressed by a decrease in demand. It may also be reflected by a decline in the supply of money and credit.
Generally speaking, moderate deflation positively affects the purchasing power of consumers. In this situation, they may purchase more with less money. Nevertheless, deflation may be, according to economists, an indicator of a declining economy, causing recessions and depressions. Recession is a period of temporary decline during which trade and industrial activity are reduced, generally identified by a fall in gross domestic production (GDP) in two successive quarters.
Editor's Note: The views entertained in this article do not necessarily reflect the stance of The Ethiopian Herald
