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How Thinking There’s Inflation Leads to More Inflation

Greg de la Cruz works at NCR Corp's R&D center in the Philippines and is the author of two published titles on Amazon.

It's nearly impossible to not worry about rising prices when it's all over the news, and when everyone talks about it. Thinking there's inflation can lead to a self-fulfilling cycle that's devastating to both businesses and people.

It's nearly impossible to not worry about rising prices when it's all over the news, and when everyone talks about it. Thinking there's inflation can lead to a self-fulfilling cycle that's devastating to both businesses and people.

Is It Bad to Worry About Rising Prices?

Unless you’ve been living under a rock, you can’t avoid news breaking out on the prices of commodities that are about to go high. In our age of peak connectedness, stories travel fast. Whether or not the speed of transmitting news has contributed to spreading fake news and false alarms—that’s a topic for an entirely different article. Here, we’ll instead focus on how a constant barrage of messaging about inflation produces an adverse effect on inflation itself.

If there’s news about inflation everywhere, it’s no longer your fault that you’re worrying about it too much. It’s perfectly human to let a scarcity mindset take over, even if it’s not the most rational way to respond. Your self-preservation instincts kick in, and next thing you know, you’re in line at a gasoline station filling your car up to the brim and some more with empty gallons from your trunk—all in anticipation of higher gas prices.

When lockdowns were announced, long queues and empty shelves on supermarkets became a norm, and it was like that for a little while because the pandemic hit businesses and people in different ways such as staffing, supply chain issues, hoarding mentality, and other kinds of disruption.

Is worrying about inflation bad for inflation? The natural reaction for consumers when anticipating higher prices seems to be their wanting for higher compensation. And especially if you’re an employer in a sector directly delivering products or services to end-users, you’ll likely fall into a self-fulfilling cycle where—because prices are so high everywhere, your employees will demand higher wages, and these higher wages will in turn result into higher prices—a deadly cycle.

A Self-Fulfilling Prophecy

Some inflation is good, but high inflation is always bad—when price hikes outpace wage increases, there’s hardly enough time for ordinary people to keep up, and it’s particularly devastating to low-wage earners who themselves have little bargaining power.

As Christian Weller, a senior fellow and professor of public policy at the University of Massachusetts, pointed out in a 2021 Forbes article, “higher inflation—faster price increases—can become a self-fulfilling cycle if workers have sufficient sway to demand higher wages to offset higher prices.”

He adds: “In that scenario, workers receive wage increases that raise costs for businesses, which in turn increase prices again. This scenario assumes, though, that companies cannot or will not absorb higher labor costs by, example, temporarily reducing their profits to keep their customers.”

If left unchecked, businesses will run themselves to the ground or could end up in a stalemate with workers, who throughout the pandemic have become more empowered to choose their own employers and demand preferred working conditions. There are hardly any winners in a scenario like this, and this might exactly be the time when higher powers need to step in.

Government Price Control Measures

These higher powers—that being the government’s regulatory bodies such as the International Trade Administration for the United States and the Department of Trade and Industry for the Philippines—need to enact or implement measures to reduce the harm caused by rapidly increasing prices.

According to Tejvan Pettinger, there are five types of price controls done by the government:

  1. Maximum price – a ceiling to how much prices can be raised, such as rent.
  2. Minimum price – the “floor”, prices can’t be set lower than it. A not-so-obvious example of this is the minimum wage, the price floor an employer can pay to its employees.
  3. Buffer stocks – where governments keep prices within a certain brand.
  4. Limiting price increases – in privatized monopolies such as water, electricity, and gas, the government can limit how much prices can be increased.
  5. Direct price setting – prices of goods set by the government itself.

Pettinger further provided three reasons as to why these price controls are implemented, but the key reason when addressing inflation is obviously for it to stabilize prices. According to Will Kenton, government price controls can be both good or bad. Three of the advantages he pointed out are the following:

1. Helps consumers afford goods and services – “Price ceilings are established to prevent producers from price gouging. This is common in the housing/rental industry and in the drug/health sector.”

Price gouging: when retailers and other businesses take advantage of spikes in demand by charging exorbitant prices for necessities (Heather Morton, National Conference of State Legislatures).

2. Helps companies remain competitive and profitable – “Governments may also set price limits on goods and services if they feel that producers aren’t benefiting from how goods and services are priced in the free market.”

3. Prevents monopolies – “Companies are at an advantage and can dictate prices when demand is high…Governments can intervene and set price ceilings to prevent suppliers from continuing to raise prices, allow competitors to enter the market, and crush monopolies that exploit consumers.”

As to the opposers of price control measures, Kenton cited three disadvantages:

1. Leads to shortages – “When prices are too low enough for things like housing, there may not be enough supply, thereby increasing demand. For instance, landlords may let the condition of their properties deteriorate because they aren’t making.”

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2. May create excess demand or excess supply – “Government-imposed price controls can lead to the creation of excess demand in the case of price ceilings, or excess supply in the case of price floors.”

3. Results in losses for producers and a drop in quality of products and services – “When prices are too low, there’s a good chance that producer revenue drops. They may have to find a way to cut down on costs…As a result, R&D drops, while newer and more innovative products start appearing on the market.”

A Central Bank’s Mandate

When it comes to macroeconomic control of prices, there is none bigger than the central bank of the government. This is Federal Reserve for the United States, or the Bangko Sentral ng Pilipinas for the Philippines. While the central bank of any government has many roles to play, such as being the guardian of the country’s reserves whether in gold or foreign currencies or being the boss of all commercial banks and financial institutions, it has one function in particular in terms of the economy—to control inflation.

There are three pillars of central banking—price stability, financial stability, and an efficient payments and settlements system. In terms of price stability, we have the below example of what a central bank does, according to the Philippines’ central bank:

“The BSP’s main responsibility is to formulate and implement policy in the areas of money, banking and credit with the primary objective of preserving price stability. Price stability refers to a condition of low and stable inflation. By keeping prices stable, the BSP helps ensure strong and sustainable economic growth and better living standards.” (The Bangko Sentral ng Pilipinas website, bsp.gov.ph)

The BSP adopted an inflation targeting framework of monetary policy in 2002, which was focused on achieving a low and stable inflation. Its approach entails the announcement of an explicit inflation target that it promises to achieve over a given time period. To achieve this inflation target, it uses a “suite” of monetary policy instruments depending on its assessment of the outlook for inflation.

If it perceives inflation to exceed the target, it resorts to a contractionary monetary policy. If it perceives inflation forecast to be lower than the target or there is need to increase liquidity in the financial system, it resorts to expansionary monetary policy.

The terms contractionary and expansionary may sound fancy, but really, the dumbed down version of their measures is to either increase or decrease interest rates, or “borrowing rates” with commercial banks. If borrowing rates are low, businesses will be encouraged to take out loans; and when borrowing rates are high, businesses and people are less likely to borrow or re-finance existing debts.

The BSP also utilizes other policy tools at its disposal, such as increasing the reserve requirement, or the percentage of bank deposits that banks must set aside in deposits with the BSP which they cannot lend out.

Geopolitical Trade Wars

There are instances when central banks and federal reserves have no way to get ahead and are always playing catchup. This is precisely what happens when geopolitical trade wars occur. It’s hard not to mention the Venezuelan oil embargo when talking about geopolitical trade wars. The West—United States, the European Union, Canada, Panama, Mexico, and Switzerland—applied economic sanctions in response to the repression-filled administration of Hugo Chavez.

In August 2017, President Trump imposed sanctions by prohibiting the trading of Venezuelan bonds in the U.S. markets, a move which moderately affected the country’s petroleum industry. And on January 2019, sanctions were imposed on the Venezuelan government-owned oil-and-gas company PDVSA (Petroleos de Venezuela, S.A.) to pressure Nicolas Maduro to resign—freezing $7 billion of PDVSA’s US assets and preventing US firms from exporting naphtha to Venezuela.

The Venezuelan oil embargo caused gas prices to increase short-term, but is incomparable to the more recent Russian oil embargo.

Another example of a geopolitical trade war that has affected prices is the ongoing China-USA economic standoff. When Trump assumed the presidency, one of his main priorities was imposing tariffs on China and other international trade partners. His approach exacerbated the trade war, which negatively impacted the economies of both countries. Manufacturers in the United States experienced higher costs, and consumers dealt with higher prices. And in China, the rate of economic and industrial growth slowed. When the two largest economies of the world are in conflict, it’s easy to assume that the rest of the world’s economies will be impacted.

Geopolitical trade wars are not things that ordinary people—not even those running the central banks—can control. Central bank governors and members of the board can have some influence over presidents and prime ministers, but at the end of the day, it’s the conflict that controls the fate of the affected economies, and as a result, the rate at which prices increase.

The Need for Responsible Media Reporting

It’s difficult to take a break from worrying about inflation when the subject gets brought up too often by the media. In an age driven by clicks, likes, comments, shares, and views—media outlets are motivated to increase readership and viewership, both of which drive revenue.

Fear, anxiety, and worry are all convenient to capitalize on. This was obvious during the time leading up to the Covid-19 pandemic and for most of its peak havoc. Should media outlets be more responsible when it comes to informing the public of inflation?

As a personal example, a distant relative of mine shared news reports of consumer gasoline and diesel prices undergoing massive price hikes in the coming week due to the Ukrainian-Russian war. He shared a news post which was said to be authored by the social media account of the country’s largest oil producer. This post caused rash and irrational reactions among those around my circle—most of my acquaintances started hoarding gas, queues at gasoline stations began to form as if a super typhoon was coming.

A few days later, the social media account came out with another post slamming the news organization that promoted the viral post. It turned out that the report was unverified, and the news organization issued a public apology.

(My question is this: Did the oil company pay the news organization to stir the public into panicking, thereby artificially increasing its prices?)

What Good Consumers Do

In the face of high inflation, good consumers don’t panic. They also don’t promote the sharing of increasing prices of commodities, such as oil and gas, because doing so only spreads more fear and anxiety.

While you can give some credit to “over-sharers” for helping inform people of what’s about to happen, they should be more careful, and must keep in mind that it’s impossible to control the way people would react and take action.

Irresponsible and unethical media reporting is partly to blame, but irresponsible consumers shouldn’t get a pass. A responsible consumer “is conscious of his consumption habits and who chooses to have, even demands, a more positive impact on society and the environment from the producers of goods and services” (Acciona). This definition may be in the context of sustainability, but I believe it holds true for maintaining price stability as well.

If you really care about price stability, don’t spread fear—spread rationality.

© 2022 Greg de la Cruz

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