The short answer is, it’s complicated.
Inflation has been a hot topic in the news cycle for sometime now. As the Reserve Bank of Australia (RBA) has continued to increase interest rates – there have been 10 consecutive rises since May 2022 – inflation sits at a level that is altogether too high. In a statement three weeks ago, after the latest rate rise, the RBA governor Philip Lowe said:
“Inflation in Australia has passed its peak, but at 7% is still too high and it will be some time yet before it is back in the target range,” the RBA governor, Philip Lowe, said in a statement. “Given the importance of returning inflation to target within a reasonable timeframe, the board judged that a further increase in interest rates was warranted today.”
The effects of inflation impacts all corners of our life…
The cost of goods rise, so for example, the weekly supermarket shop is more expensive. If wages don’t rise in sync with rising inflation, an individual’s income is technically worth less – as their buying power declines. High inflation also stagnates economic growth. And in a continued state of high inflation, the job market gets affected. Think fewer job openings, redundancies, increasing unemployment, and a slower pace of hiring.
Today we’re looking at the impact of inflation: on the labour market, on the economy, on industry and on wages.
What Does Inflation Affect?
Everyone knows the simple impact of inflation: rising prices. But the certainty about inflation often ends there. When we say ‘rising prices’ we’re talking about a national average. However, inflation has differing impacts on business. Depending on the industry, the commercial health of a business, the productivity the workforce, and the nature of the supply chain, rising inflation does not discriminate evenly.
Inflation is a sustained rise in overall price levels. Moderate inflation is associated with economic growth, while high inflation can signal an overheated economy.Pimco
The affects of inflation are directly related to the concept of supply and demand. At a macro level, this means that if the supply of money in an economy is to high, compared to the amount of goods and services available for sale, prices will increase.
And these principles of supply and demand are central to the affects of inflation on business (and therefore on the population). Affects such as rising cost of raw materials, high interest rates and rising unemployment. It’s when these affects come into play, that business tend to raise their prices.
Inflation can also lead to other outcomes. For example, the broad affect of inflation is to soften overall demand in the economy because goods and services become more expensive, and the value of people’s incomes decline. But in times of rising inflation, demand for products (most often essential items) may suddenly spike as people expect prices to continue rising, and so they start to stock up. It’s a dynamic, and often a nasty catch-22.
Most often, the best way for business to manage rising inflation is to increase the cost efficiency and productivity of their business. But that’s not to say this is an easy feat, by any means.
How Inflation Affects Industry
The affects of inflation on industry are definitive and unavoidable. Here are the top 6 of these affects:
1. Disruption to the Supply Chain:
Inflation can lead to supply chain issues, as gas prices rise (as they have since the Russian invasion of the Ukraine). Business owners look to source their materials at the lowest possible price. These supply chain disruptions can lead to delays in production and potentially, revenue loss.
2. Raw Materials Shortage:
As business seeks to source materials at the lowest possible price, this can have the impact of creating shortages of raw materials. This scenario can also lead to delays in production and revenue loss.
3. Increase Cost of Inventory:
With an increase in the cost of raw materials, this can lead to higher costs of inventory. Understandably, this will lead to profit erosion and impact the bottom line.
4. Consumer Price Index (CPI):
When consumers pay more for goods and services, the rate of CPI increases. This then leads to rising costs, a decline in buying power for both businesses and consumers.
5. Wage Affects:
Inflation can have an impact on wages where workers seek pay increases to maintain their buying power. When business responds, profits are negatively impacted.
6. Rise in Interest Rates:
When inflation rises, the RBA tends to continue to increase interest rates. This leads to higher borrowing costs for business, and profitability decline.
How Does Inflation Affect the Economy
Inflation affects all aspects of the economy including business investment, employment rates, tax policy, interest rates and consumer spending.
Aside from the impacts on industry listed above, inflation can also lead to eroding the value of savings, it puts pressure on household budgets, and can particularly hurt people on low incomes.
Put simply, the economy can’t work as efficiently when inflation is high.
High inflation makes it harder for business to plan. And interestingly, consumers and workers look to protect themselves against further price increases.
The graph below, from the RBA, shows inflation has peaked in Australia. But they also caution that this monthly indicator can be somewhat volatile from month to month. As we entered 2023, inflation looked to be softening.
The Impact of Inflation on the Job Market and Wages
This is where inflation can hugely affect the population.
Inflation and the Jobs Market
The important thing to remember here is this: inflation can have both a positive and negative affect on the job market.
On the positive side, when the cost of goods and services increases, the demand for workers can increase to help supply them. The net affect is jobs growth.
Conversely, as wages rise to align with inflation, employers often find it hard to keep up with the increasing cost of labour. As we mentioned in the introduction, this can lead to redundancies, a hiring slowdown or freeze, and increased unemployment. Different sides of the same coin.
Inflation and Unemployment
In terms of employment, as inflation rises, it can lead to a decline in jobs growth, and more unemployed people. This is because organisations can’t keep up with the increase in the cost of goods and services, which leads to lower jobs creation.
Also, workers can sometimes experience a situation where their wages don’t increase in line with inflation rates. So when inflation increases, the value of worker’s earnings is lower: this results in the ‘cost of living’ pressures that is a reality for so many workers, today.
Inflation and Salaries
With the impact of inflation raising the cost of goods and services, some employers increase wages to keep up with the cost of living pressures. This means that workers can see real wage growth.
But when wages increase, the prices of consumer goods and services typically go up also. This then raises the actual inflation rate at the same time.
That being said, this isn’t always the case. Nominal wage growth often lags behind inflationary pressures.
Inflation and Hiring
When wages rise, employers may need to spend more on hiring and training costs. This can lead to a decline in hiring, or even hiring freezes. The knock-on effect here is a tightening labour market, as the cost of taking on more workers increases. Paying more for workers typically leads to fewer hires.
Inflation and Job Availability
Jobs availability can be affected both positively and negatively. It really depends on the industry and type of business.
So, if a business relies heavily on consumer demand, an increase in hiring may occur as business employs more people to meet this demand.
On the other hand, organisations relying on capital investment – such as manufacturing – will likely be adversely affected by inflation given investing will become more expensive over time.
The knock-on effect here is a decline in jobs growth, and jobs availability.
Inflation and Redundancies
As inflation rises, it most often leads to an increase in costs for employers. Some businesses in this scenario may need to make cuts to stay commercially viable. Large scale lay-offs adversely affect the employment rate as employers scale back operations and reduce headcount in an effort to keep up with the rising costs of goods and services.
A key factor to remember in these turbulent, inflationary times is this: if your company is reducing your workforce size, be mindful of the workers that remain, who will likely come under increasing pressure to achieve the same output, with fewer resources. Employees left to manage in this scenario can be spread very thin. So make adjustments to your performance expectations and organisational goals, to relieve the pressure these workers may be dealing with. Training your business leaders to be really good leaders will also help the experience of workers and have a positive impact on culture.