Varukorg som åker upp på en röd pil för att illustrera inflation — Photo: Shutterstock

What is inflation? Economist Ola Olsson explains

Published

11 April 2023

at

The fact that inflation is currently high has probably not escaped anyone. When Statistics Sweden (SCB) reported the Swedish inflation figures for February, the media coverage was intense, and sometimes it is difficult to keep up. Ola Olsson, Professor in Economics, helps us better understand what inflation is and how it affects us.

What is inflation?
”Inflation is the percentage increase in the general price level over a year. An indirect effect of inflation is that a given amount of money loses purchasing power,” says Ola Olsson.

When the inflation figures for February 2023 were reported, we learned that inflation had risen by 9.4 percent in February. 9.4 percent compared to what? And what does it mean for people’s personal finances?
”It means that the general price level according to the Riksbank’s main measure CPIF has increased by 9.4 percent over the last 12 months. So a typical price has increased from 100 to 109.4 between February 2022 and February 2023.”

Which measure of inflation should individuals primarily keep an eye on to understand how their personal finances are affected?
”The Consumer Price Index, CPI. This measure includes all prices that affect households.”

What is the difference between the Consumer Price Index (CPI) and the Consumer Price Index with a fixed interest rate (CPIF), and why are two different CPI measures needed?
”CPIF excludes the effects on housing costs, which can be directly affected when interest rates rise. The purpose of a higher policy rate is to get people to save more and consume less so that demand decreases. Including the direct effects of policy rate hikes on housing costs in inflation would be misleading because such a development is necessary to reduce other price increases. The Riksbank prefers to use CPIF as its main measure of inflation, and when talking about the ’inflation target of 2 percent’, it means that CPIF should increase by 1 to 3 percent annually.”

A term that is appearing increasingly in news reports is ”core inflation”. When the inflation figures for February were reported, for example, it was reported that ”Core inflation rises sharply, from 8.7 percent to 9.3 percent”. What does it mean, and why is it important for individuals to keep an eye on core inflation?
”When talking about ’core inflation’ or ’underlying inflation’, certain prices are excluded, such as energy prices, which are largely set in the global market, or food prices, which can fluctuate rapidly. I don’t think it’s that important for the public to keep a close eye on core inflation. If you’re particularly interested in how certain prices are developing, you can, for example, focus on the price of electricity, which affects most people and which you can follow day by day. Or the price of diesel/petrol for those who drive. The prices of these goods have fallen quite a bit lately.”

Regardless of which type of inflation we are talking about, it is being felt by most Swedes right now. When do you think the inflation curves will start to level out?
”They have already started to level out and are likely to fall further during the spring and the rest of the year as general demand decreases.”

Inflation can lead to smarter consumers

The current inflation rates mean that everything has become on average 12 percent more expensive over the past year. At the same time, wages have increased much less on average, which means that many people have experienced a significant real wage reduction. It is likely that households will not have the same purchasing power as in 2021 for several years. But in the long run, this can bring some good.

”Although it’s tough for many, it also gives us the drive to live ’smarter’, for example, more energy-efficient and through our critical scrutiny of corporate pricing, we can contribute to improving competition in markets such as food and loans. A more cost-conscious behaviour such as this can strengthen households’ long-term economic conditions”, says Ola Olsson.

By: Ulrika Lundin

DIFFERENT MEASURES OF INFLATION

Consumer Price Index – CPI
An index that measures the average price development for private Swedish consumption, the actual prices that consumers pay. The measure is based on the so-called ”CPI basket” which includes a selection of goods and services such as food, clothing, housing, and culture.

Consumer Price Index with fixed interest rate – CPIF
CPIF is a complementary index measure that is not affected by changes in mortgage rates. In this measure, household mortgage rates are held constant. Otherwise, it includes the same goods and services as CPI.

Inflation target
The Riksbank wants inflation to be low and stable, and since the mid-1990s, Sweden has had an inflation target of 2 percent. The idea is that if households and companies have a benchmark for inflation, it guides economic expectations, which leads to a functioning price and wage formation.

Core inflation
A measure of inflation where certain goods and services are not included in the measure. It is often referred to as ”cleaned for xxx”. In Sweden, when we talk about core inflation, it means Consumer Price Index (CPI) minus energy prices, while when the US Federal Reserve talks about core inflation, they have cleaned for both energy and food prices.

Underlying inflation
Price Index, but without temporary effects and foreign impulses.

Hyperinflation
There is no exact definition of hyperinflation, but it refers to at least a 50 percent increase from the previous month. The most well-known example is Germany in the 1930s.

Demand-pull inflation
When demand for goods or a service is so high that the market cannot produce the demanded item, which pushes prices upward. Usually occurs in boom times when consumers have a lot of money.

Cost-push inflation
When it becomes more expensive to produce goods or a service, for example, because wages go up, and those who provide the goods or service raise the price.

Imported inflation
When the cost of goods imported to Sweden increases. It may apply to both foreign raw materials that Swedish companies need to manufacture their goods or goods that consumers use more directly. In both cases, Swedish companies’ costs increase, and they, therefore, raise their prices.

Expected inflation
When people expect prices to go up and, therefore, demand and get higher wages. When people then have more money in their wallets, they buy more, and it is likely that companies raise their prices to earn more. This leads to actual inflation.

Actual inflation/inflation
Goods and services become more expensive, which means that your money does not go as far. You need to earn more to be able to buy the same amount.

Area

Society and

economy