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Inflation Demystified

By: Cielito F. Habito, PhD
Price increases have sped up again in the last two months. The latest report, giving the inflation rate for February, put the rate at 3.3 percent on an annualized basis. This is significantly higher than the 0.9 percent posted in the same month last year, and higher than the previous month’s 2.7 percent. Is it high enough for us to begin worrying?
Inflation is defined as the sustained increase in the general price level; the inflation rate measures how fast overall prices are rising. A 3.3 percent annual inflation rate tells us that on average, what you were able to buy for P100 last year would now cost P103.30. As head of the National Economic and Development Authority in the 1990s, when part of my job was to announce the inflation figures every month, I often got peeved by radio commentators or columnists who would brand me a liar whenever I announced a drop in the inflation rate. The typical line was: “How can Mr. Habito claim that inflation is down when prices keep going up?” Apparently, it’s still not clear to many that a lower inflation rate never meant prices are going down. It means that prices are in fact still going up, but more slowly (i.e., at a lower rate) than before. If prices were in fact going down, the rate would be negative, and it would be called deflation. This is not exactly something to aspire for, as economists and businessmen actually fear deflation just about as much as they do high rates of inflation. Japan, for example, had experienced deflation for many years, and the Japanese were not at all happy about it; they found themselves actually wishing for inflation, to signify a stronger economy.
The problem with dropping prices is that it means there’s not enough demand for the economy’s goods and services at the given level of production, forcing producers to accept lower prices, and to cut down on production, on jobs, and eventually on people’s incomes and ability to buy their products. Left unchecked, it could turn into a downward spiral in the economy and a full-blown recession. So don’t pray for deflation, or negative inflation; pray, rather, that the inflation rate stays low, and positive.
Read the full article at http://opinion.inquirer.net/102613/inflation-demystified