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The Winners and Losers of Inflation

Inflation is rising rapidly but it’ll affect us all differently, says Informed Investor economist Ed McKnight. Find out if you’ll be better or worse off.

6 July 2022

Prices are rising faster in New Zealand than at any time since 1990.

Like most economic events, this will create winners and losers. Some will make money. Others will lose it.

Here’s a summary of the main winners and losers.

Winners – Borrowers

When inflation is high, money loses its value. You need more money to buy the same amount of stuff.

This devaluing of money applies both to savings and to debt. So, if you’ve borrowed money, inflation will cause the real value of that debt to decrease.

Inflation effectively transfers wealth away from savers and towards borrowers. Rising interest rates usually balance this out. The Reserve Bank typically increases the Official Cash Rate, which raises the interest rates that borrowers pay.

However, even with the Governor of the Reserve Bank acting against inflation, real interest rates are still negative.

A borrower might pay 4 per cent interest on their mortgage, but since inflation is 5.9 per cent, their inflation-adjusted interest rate is -1.9%.

That effectively means you are being paid to borrow money, in real terms.

Losers – Savers

Savers, on the other hand, are hammered by high inflation. That’s because their money has stayed the same, but everything has a higher price, so they can’t buy as much.

Retirees who have their money squirrelled away in low-risk, low-return funds are made poorer through inflation.

Their income and the value of their assets won’t have increased at the same rate as price increases. They are made worse off.

Say a retiree invested NZ$100,000 into a term deposit at 2 per cent. After a year, they would receive NZ$2,000 in interest.

A retiree living on the pension would then pay NZ$350 in tax, meaning their after-tax return was NZ$1,650. They then have NZ$101,650.

However, with inflation at 5.9 per cent, that NZ$101,650 is only worth NZ$95,987 after adjusting for inflation.

So, putting their money in a term deposit resulted in a loss of NZ$4,013, in real terms.

Winners – Some shareholders

The traditional thinking is that inflation hurts shareholder returns. However, the story is more complicated than that.

Whether a business (and its shareholders) wins or loses depends on whether they can pass on the rising costs that the business faces to their customers.

If a company operates in a market with low competition and loyal customers, it can pass on cost increases. This helps maintain profit margins.

Similarly, if interest rates rise rapidly in response to inflation, companies with low debt will be able to ride out the inflation storm better than debt-laden companies.

Losers – Some shareholders

On the other hand, let’s say a company’s suppliers are increasing their prices. If that company can’t then pass on those cost increases to their consumers, profit margins will suffer. This lowers returns to shareholders.

Companies that can’t pass on cost increases tend to operate in markets where customers are fickle and can switch products easily.

For instance, if wages rise, it’s easy for mobile phone providers to pass on this cost to consumers. It takes effort for a customer to switch their mobile phone provider, and there are few options.

Whereas if the price of cocoa beans increases, chocolate manufacturers will face higher costs. However, it’s harder to pass on this cost to consumers since it’s easy for customers to pop a cheaper block in their supermarket trolley.

Winners – Some Workers

The labour market is tight. Unemployment just hit a record low of 3.2 per cent and NZIER’s Quarterly Survey of Business Opinion shows that a net 73 per cent of businesses can’t find the skilled workers they want.

There are many job opportunities but few workers to fill them. And wages are increasing in response. According to Statistics NZ, wage rates (for all workers) went up 4.2 per cent from a year earlier.

Skilled workers will face higher living costs, but they can negotiate higher pay to combat rising prices.

Losers – Beneficiaries

Inflation makes beneficiaries worse off for two reasons.

Firstly, their incomes are lower, so they spend a high proportion of their income. As prices rise, there is less room for them to absorb extra costs. This causes financial stress.

Secondly, increases in benefits lag behind inflation. Some workers can negotiate pay quickly, but a beneficiary’s income increases only once a year, on 1 April.

This happens through the Annual General Adjustment, where the government adjusts benefits for inflation or the average wage increase. However, this increase only comes into effect after costs have already gone up.

When inflation is high, and prices increase quickly, people receiving benefits will have to cut back more than workers.

Will Inflation Help or Harm You?

My key point here is that inflation is like any other economic event. Some people will benefit; others will be hurt but can cope, and some will struggle altogether.

Inflation does not have an equal impact on everyone. Whether you should be worried about it or not depends on which of these categories you fall within.

Informed Investor's content comes from sources that Informed Investor magazine considers accurate, but we do not guarantee its accuracy. Charts in Informed Investor are visually indicative, not exact. The content of Informed Investor is intended as general information only, and you use it at your own risk.

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