x Abu Dhabi, UAESaturday 20 January 2018

Why cheese costs more

Put simply, inflation is an increase in the price of things people buy.

Put simply, inflation is an increase in the price of things people buy. The inflation bug concerns economists and average citizens alike, mainly because it raises the cost of living. During a period of inflation, your rent goes up, along with the price of goods and services ranging from a wedge of Camembert to a massage at your local health club. That means the money you make doesn't go as far as it used to. If wages don't keep pace with inflation, a society's standard of living - a measure of the buying power of peoples' earnings - can decline.

Governments fight inflation in numerous ways. They can put caps on prices of staple goods, as the UAE did this year after inflation soared into the double digits. They can even subsidise goods and services, passing on only a portion of real costs to consumers. Yet the most powerful counterinflationary tool out there involves putting a curb on the amount of money circulating in the economy. If there is less money chasing the same amount of goods and services, the logic goes, prices won't be able to go up too much.

Central banks turn down the taps on the money supply by raising base interest rates. These rates control the cost at which banks can borrow from the central bank, which has the authority to print new money. When interest rates go down, banks will borrow more, which can lead to more money in the economy and higher inflation. When interest rates go up, banks borrow less money, which can help put a damper on inflation. For this reason, inflation is one of the key factors considered when the European Central Bank, the US Federal Reserve and other central banks make rate cuts or hikes.

Many economists believe that inflation has eased somewhat in the GCC this autumn, thanks largely to a decline in global commodity prices that had driven a rapid rise in the price of imported goods. The UAE and most of the other Gulf countries rely heavily on imported goods, especially food. But inflation remains a concern. Most of the Gulf countries have been reporting inflation in the double digits all year, and continue to do so. The UAE's most recent figure was 11.1 per cent for 2007. Year-on-year inflation in Saudi Arabia and Kuwait is hovering around 11 per cent, too, according to recent government reports.

Yet GCC countries are handicapped in their battle against inflation because all of them, with the exception of Kuwait, have their currencies pegged to the US dollar. Those pegs mean that when the US Federal Reserve changes interest rates Gulf countries must do so in concert. Unfortunately, the Fed has rapidly reduced rates in an effort to breathe life into the ailing US economy in recent months, even though a counterinflationary hike might have been more appropriate for our region. afitch@thenational.ae