Inflation

Inflation is an economic term for the rising prices of goods and services. It is the annual percentage increase of the cost of living as measured by the consumer price index (CPI). Consumer price indices are based on a representative basket of goods and services purchased by consumers in an economy. The formula is as follows:

High inflation is often a sign of macroeconomic imbalances. Venezuela's case is worth mentioning here. By 2014, the value of Venezuela's currency, the bolivar, and the Venezuelan economy's success were heavily reliant on oil exports. Oil accounted for more than 90% of the country's export revenue. These export revenues allowed the government to fund social projects aimed at combating poverty and inequality. Basically, the government's expenditure were off the charts.

The global price of oil fell further, and foreign demand for the bolivar to buy Venezuelan oil plummeted. Imported items became more expensive as the value of the currency decreased. Venezuela's economy collapsed and international investors began to look elsewhere, driving the bolivar's value even lower. In order to control the problem, the then-President chose to print more money. It increased the supply of currency, causing the currency's value to fall even further.  This cycle thus became the source of Venezuela’s hyperinflation. The inflation rate reached 863% in 2017, and 9586% in 2019.

In the case of Bangladesh, inflation has been significant due to the pandemic-induced supply chain crisis; rising food costs and trade instability resulting from the Russia-Ukraine conflict. Data shows that food inflation soared to 9.94 percent in August 2022 – the highest since April 2012. In 2023, inflation decreased to 8.78% in February before jumping to 9.33% in March.This rate is way above the wage growth of 7.06%, which can lead to a reduction in consumer spending and a decrease in economic activity. 

Types of inflation

• Demand-pull inflation describes how demand for goods and services can drive up their prices. If something is in short supply, you can generally get people to pay more for it.
• Cost-push inflation: When raw materials costs increase for businesses, the businesses in turn must raise their prices, regardless of demand. When the price of chicken goes up, for example, eventually restaurants will need to charge more for a chicken sandwich.
• Built-in inflation: If a company raises employees' salaries and then raises prices to maintain profit margins, this is built-in inflation.

Inflation and The Stock Market

The stock market prefers to see steady price increases of 1% to 3% annually, which is regarded as low- to moderate inflation. In this case, the currency’s value remains stable; there is a steady demand for goods and services, and prices are predictable. In fact, companies with high pricing power will outperform since they have the ability to defend their margins by passing the higher costs to their end market customers.

However, when inflation rises above this mark, sluggish consumer spending overtake the stock market and margins go down. This results in slower economic growth, which raises questions about a firm's sustainability.Bond yields rise quickly in response to rising inflation. As a result of this higher interest rate, fewer people participate in the stock market, which lowers stock market returns.

So, one must be able to assess the level of inflation and have the appropriate mix of equity and debt