Be mindful of inflation on your income

By Bernard Otabil

In fact, there should be no award if you are able to correctly identify that when your cost of living goes up and your income stays the same, you will have less to spend.

Indeed, it just follows that if you could spend one cedi on a loaf of bread today and the price even changes marginally, say a two per cent increase, you wouldn’t be able to afford the same size of bread at one cedi. You will need to pay more for it.

Now, even though l wouldn’t expect you to receive any special award for being able to identify, correctly, the impact of prices on your income, there is an indirect reward for you when you are able to establish that link between prices and your income.

And the reward is because those who have been able to establish the link correctly have often become prudent financial managers; they are able to create streams of income from investments and savings that are normally generating returns above the rate of inflation because they understand the negative impact of inflation on their income.

Let us now consider a very important concept as we try to make the most out of the income that we earn. Shall we? Great! To set it rolling, l would like to repeat a phrase l have often used in this column: There is a fortune that lies hidden in your income, no matter how much you earn.

And to uncover this fortune begins with your frantic efforts to understand how you could manage with the little that you earn, and still make some available for investments.

To understand this, you need to understand also that the income that you receive on a monthly or weekly basis has a ‘nominal’ and ‘real’ component.

When we talk of nominal income, it actually refers to that part of your salary that is paid out in cash. In other words, it is what some people describe as ‘take-home’ pay; the net figure is always the actual currency terms unadjusted for inflation.

As l have often explained in this column, inflation refers to the increase in the general price of goods and services over a period.

Technically, economists would use the Consumer Price Index or CPI as the indicative reference for expressing inflation. It is normally done by using changes in a ‘basket’ (collection of items) over a period.

For instance, when we say a 10 per cent inflation rate, it means that prices in the current period are about 10 per cent higher than that of the same period a year ago, or sometimes over a pre-defined time period.

When, say, there is a 10 per cent inflation rate, it means that your ‘take home’ pay in terms of its purchasing power could also be losing the same value. Ah, do you get it now? I guess so. Good.

Since we have introduced the subject of inflation here, l would also like to point out at this point that when you hear people talk about ‘low’ inflation or ‘single’ digit inflation, you shouldn’t think that prices of goods and services are not rising at all.

That is a wrong view to hold. In actual fact, what it means is that prices of goods and services are actually rising but then it is the rate of increase that is reducing.

Let me put it in context this way: Assuming that the rate of inflation in May was nine per cent, in June it was 12 per cent , then in July it was 14 per cent and 15 per cent in August, clearly, you could see that the prices of goods and services are rising, but if you look at the rate of increase between periods, whereas the differential between May and June is three per cent, between June and July is two per cent and between July and August is one per cent. The prices are increasing alright, but the rate of increase is reducing. This is a very simple way of understanding this concept.

It, therefore, does not follow that if inflation rate is dropping you should find the prices of goods and services necessarily falling too. It does not follow that way.

It is this movement in open market prices that affects your income over time.

When your income is inflation-adjusted, what you have is the real income. Using the examples above, once you have factored in the rate of inflation, say the increase in price by two per cent over GH¢1, the reduced number of items your income could purchase reflects the real income you have.

So, if your nominal income increased by 10 per cent from last year, your real income will remain the same if the prevailing inflation rate is also10 per cent.

If the inflation rate is five per cent, the real income rises by only five per cent because you need to deduct the effect of inflation.

Writer's Email: [email protected]
The Mirror/Ghana/graphic.com.gh