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The Link Between Poverty and Inflation

Poverty and Inflation
Inflation refers to an increase in the prices of goods and services. Poverty and inflation have a close relationship in that a country with high inflation is likely to have high poverty rates as well. An inflation rate measures how much the prices of goods and services change over a year. Many countries struggle with high inflation rates. Most countries have experienced high inflation at some point in history. The U.S., for example, has maintained an inflation rate of around 0%-3% for over a decade. During World War I, however, the U.S. reached an inflation rate of nearly 20%. Today, some countries have negative inflation rates while others have inflation rates over 100%.

Highest Inflation Rates in the World

As of August 2020, the 10 highest inflation rates in the world ranked as follows:

  1. Venezuela – 2,030%
  2. Zimbabwe – 747%
  3. Lebanon – 388%
  4. Syria – 275%
  5. Sudan – 127%
  6. Iran – 99%
  7. Argentina – 66%
  8. Libya – 47%
  9. Brazil – 40%
  10. Turkmenistan – 35%

*There are varying estimates between experts, as inflation can be difficult to measure at higher rates.

Consequences of High Inflation

Dr. Prince Ellis, a professor of economics at the University of Cincinnati, spoke with The Borgen Project about the relationship between poverty and inflation. He explained that Zimbabwe and Venezuela have some of the highest inflation rates in the world. “These are two extremes,” he notes. “The price of goods and services can increase almost about 200% a day.” He used the example of a gallon of milk. If the milk is $2 one day, the very next day, the same gallon could be $6.

Dr. Ellis shared his own experience with inflation in Ghana, where he grew up. “I remember my mom had a store, like a convenience store at my house… And we used to sell general convenience items – bread, rice and milk and stuff like that… We are changing prices each week… She goes to the wholesaler… They change the price [of the goods] like price goes up by 20%. We have to also change it by 20%.” Unsurprisingly, this upsets consumers. Consumers may go to the market expecting an item to cost the same as it did last week. Of course, this is not the case, and they may find themselves suddenly unable to afford the item.

Causes of Inflation

Economists use the term aggregate demand to describe the total amount of demand in an economy. Sometimes the aggregate demand in a country increases too quickly for the country’s production. Because there is so much demand for goods and a scarcity of goods, prices increase. This type of inflation is called demand-pull inflation. Demand-pull inflation is often the result of central banks rapidly increasing the money supply.

Another type of inflation is cost-push inflation. This type of inflation comes from a decrease in aggregate supply. The term aggregate supply describes the total amount of goods or services that people are selling in an economy. When the cost of inputs (resources a producer uses to create the final product they sell) or wages increase rapidly, cost-push inflation may occur. This type of inflation was occurring in Dr. Ellis’s anecdote about his mom’s store. Dr. Ellis said that this type of inflation is common in developing countries because “they rely too much on international markets.” In fact, countries overseas import most of the resources developing countries use for production. If a spike in the prices of international goods occurs, a developing country that relies on the goods will experience a severe drop in aggregate supply.

How Inflation Contributes to Poverty

Poverty and inflation have a connection due to the fact that money has value, and its value can grow or diminish. Poverty is a lack of financial resources, leading to an inability to afford basic needs. In other words, as the cost of basic needs increases, the amount of financial resources necessary to afford those needs also increases. Dr. Ellis described this concept as “purchasing power.” He explained how increasing costs lead to decreasing purchasing power. If a person’s income level does not increase at as high a rate as the inflation increases, they will become poorer.

Poverty and Inflation Inequality

One of the issues regarding poverty and inflation is that high inflation has a disproportionately large negative effect on those struggling with poverty. Inflation inequality describes the disparities between the effects inflation has on middle and upper-class people and lower-class people. There are multiple reasons why inflation affects people with lower incomes more than those with higher incomes. One of the main reasons has to do with the types of jobs these two types of people have. Lower-income people often don’t have much opportunity to negotiate their wages. When prices rise, wages for these individuals tend to stay stagnant for a while. Consequently, their purchasing power plummets. Higher-income people, on the other hand, tend to have jobs with inflation-adjusted benefits. When inflation occurs, these benefits limit the decrease in the individuals’ purchasing powers. This disparity is why during inflationary periods, income gaps widen.

Lessening the Effects of Inflation

There are two important ways entities can decrease the negative effects of inflation.

  1. Using another country’s currency – In countries with extremely high inflation rates, the currency practically loses all value. “What happened to Zimbabwe, for instance, is that the currency is now useless. Now, they are using what the U.S. currency is,” Dr. Ellis explained. Using a foreign currency is a temporary fix. Since different countries have different economic systems and ways that they operate, this method fails to be effective long term.
  2. Inflation-adjusted payments – Dr. Ellis also pointed out that sometimes government payments, like Social Security, undergo adjustment for inflation. Many employers also adjust wages based on inflation. These policies do not decrease inflation, but they increase the amount of money people have, increasing their purchasing power.

Permanent solutions to high inflation require drastic changes to fiscal and monetary policy. Political instability, dependence on foreign nations and unpopular side effects are some of the many reasons countries struggle to curb inflation. However, nations can recover from hyperinflation. One of the most well-known examples of this is Germany after World War I. For 16 months, Germany’s prices quadrupled every month. Now, Germany maintains a yearly inflation rate of just under 2%.

– Jillian Reese
Photo: Flickr