Reality Check: Are We Spending More or Have The Prices Grown?
In this article, we focus on perceptions towards the prices of goods and services. The research consisted of an online survey conducted on our platform questia.ro which was active between April 24th and April 25th 2018. The survey covered 499 respondents, with a +/- 4% margin of error when reported to the Romanian online population.
The economic definition of inflation is that it is a sustained increase in the general price level of goods and services in an economy over a period of time (Wyplosz & Burda, 1997; Blanchard, 2000; Barro, 1997; Abel & Bernanke, 1995). When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money, a loss of real value in the medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time (Mankiw, 2002).
In order to better understand the prices of goods, one must truly understand how inflation works. Shortly, inflation measures the rate at which various prices for goods and services rises in a given time, which ultimately leads to a decreasing purchasing power of the currency. In an effort to keep the economy running, central banks aim to limit inflation and avoid deflation.
Investopedia explains how due to inflation, the purchasing power of a unit of currency falls. For example, if the inflation rate is 2%, then a pack of gum that costs 2 LEI in a given year will cost 2.02 LEI the next year. As long as goods and services require more money, over time, the value of that money will drop.
The main causes of Inflation as listed by Economics Help are:
- Demand-pull inflation – aggregate demand growing faster than aggregate supply (growth too rapid)
- Cost-push inflation – higher oil prices feeding through into higher costs
- Devaluation – increasing cost of imported goods, also boost to domestic demand
- Rising wages – higher wages increase firms costs and increase consumers’ disposable income to spend more
- Expectations of inflation – causes workers to demand wage increases and firms to push up prices
The consumer price index (CPI) measures inflation by tracking the prices of a series of core goods and services. To be more precise, this index measures the “real” value of earnings over time. An important specification about CPI is the fact that its components do not change in price at the same rates or move in the same direction. To give you an example of how this works, you can have a look at how the prices for education and housing have been increasing faster than the prices of certain goods and services, while the fuel prices have risen and fallen several times in the past 10 years.
Another way of understanding just how much inflation can affect the economy and political context is to take a look at the greatest historical cases of hyperinflation, listed by Nomad Capitalist:
- Greece, 1944: due to a dramatic drop in foreign trade thanks to World War II - after Axis powers invaded Greece, they forced it to support 400.000 Axis soldiers and offer them financial indemnity. As tax revenues were gone and Greece couldn’t pay its war bills, the country had to use its central bank to print the money it needed. The result led to a hyperinflation of 18%.
- Weimar Germany, 1923: after losing World War I, Germany was forced to repay huge war debts to the victors. However, Germany was forbidden to use its “Papiermark” currency to pay reparations because the currency’s value had already declined due to the heavy borrowing in order to pay war costs. Thus, Weimar Germany was forced to sell huge amounts of the mark for foreign currencies in order to pay its debts. The German government started selling marks at any price to get cash in the door, which eventually led to hyperinflation at about 29.500%.
- The former Republic of Yugoslavia, 1994: the fall of the Soviet Union had a great impact on Yugoslavia, decreasing its role in geopolitics and its failed communist system. Consequently, Yugoslavia broke up into several small countries along various ethnic lines. All of these new states were refusing to trade with each other, which worsened the local economies on all levels. The next hit came from the West who raised economic sanctions to all of these countries. By retaining communist policies, the newly-formed Federal Republic of Yugoslavia turned to overspending, over-borrowing and losing control of money creation. January 1994 records a record of 313 million percent inflation. Prices were doubling every 34 hours while the currency got to be revalued five times in two years
- Zimbabwe, 2008: due to Robert Mugabe’s “land reforms” (translated as private property confiscation), the Zimbabwe economy has fallen apart. It was desired to redistribute land from White Zimbabweans for political capital, but instead these „land reforms” crashed the economy and prompted capital. Also, supporting Congo’s civil wars didn’t help, either. During this period of hyperinflation, a loaf of bread ended up costing 35 million Zimbabwe dollars.
- Hungary, 1946: World War II left Hungary economically devastated. Supporting Germany fight in the was also let Hungary accumulate a ton of debt— a debt that was never repaid. After the war, Hungary was forced to repay reparations to the Soviets. As the Allies took control of its budget and reparations reached nearly half of all revenues, hyperinflation set in. At its peak, inflation reached a mind-boggling 13.6 quadrillion percent — per month and prices doubled every fifteen hours.
In more recent years, the financial crisis between 2008 – 2009 affected millions of people all around the world, also known as The Great Recession. It all started with the loss of wealth, generally, due to falling home values because there was an increased number of homeowners who suddenly couldn’t afford to pay for their mortgages. Even though the housing market today shows signs of recovery, the process itself was long and tedious. Another cause for the Great Recession was the drop within wage incomes. Many companies, back then, either reduced personnel or decreased the number of worked hours or benefits. All of these factors had a significant effect on global economies.
Today, the labor market hasn’t really returned to its levels prior to the Great Recession. According to Cash Money Life, home values are still down, since it takes longer for them to come back at least to a level of neutrality, proving that inflation has long-term effects on worldwide economies.
According to Eurostat, the highest annual rate for inflation was recorded in Romania (4.0%) in March 2018, followed by Estonia (2.9%), Slovakia and Lithuania (both 2.5%) while the lowest annual rates were registered in Cyprus (-0.4%), Greece (0.2%) and Denmark (0.4%).
People generally believe that prices are on an ascending trend with 94.8% of responders thinking prices of goods and services increased in the past 3 months. A small percentage (4.6%) think that prices have remained constant in the last 3 months while the number of users who said prices have fallen in the last 3 months is not statistically significant.
We then asked the ones who believed that the prices have increased in the last 3 months to name the products that were most affected by the price change. Most people (83.0%) think that basic foods (eggs, milk, bread, etc.) are the ones whose prices have increased the most in the past 3 months, as well as the price for services (63.6%) and tobacco (40.4%). Alcohol is thought to have increased its price but to a smaller degree (only 22.1% of responders believe this).
According to Eurostat, in March 2018, the highest contribution to the annual euro area inflation rate came from services (+0.67 percentage point), followed by food, alcohol & tobacco (+0.41 pp), energy (0.20 pp) and non-energy industrial goods (0.07 pp).
We then also asked the ones who said that prices have grown in the last 3 months to name the main causes for this increase. Almost three-quarters of responders (74.1%) believe that prices have grown in the last 3 months mainly due to the depreciation of LEU against EURO. Also, more than half of the responders (57.3%) said that the increase of the minimum wage is also a cause for the increasing prices of goods and services. Also, more than a quarter of responders believe that the increase in production costs, liberalization of the electricity market and the increasing in oil price are also viewed as important criteria for the CPI rise.
According to our responders, The Government is believed to be the institution that has to deal with reducing the inflation by most of them (63.6%). The National Bank of Romania, whose role is also „to design and implement the monetary policy” is thought to be the institution in charge of reducing the inflation only by 23.2% of responders.
Respondents generally agree that it is important to save money (59.3% totally agree, 36.0% slightly agree) and they are interested in different ways of saving (47.7% totally agree, 41.3% slightly agree). Also, most of them (66.4%) think that nowadays, a bank account is indispensable (30.7% totally agree, 35.7% slightly agree). It appears that the users have the tendency to save their money, with more than half of them agreeing that they do not spend their wage as soon as they earn it (39.0% slightly agree, 22.9% totally agree).
Also, our responders seem to like the traditional cash instead of cards, with 61.4% preferring cash and 38.6% choosing cards.
However, they have mixed feelings regarding spontaneous spending, with 55.4% agreeing that from time to time they like to spend impulsively while 44.6% disagree.
I will end this article with a quote from Warren Buffet who once said that “Price is what you pay. Value is what you get.”
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