Black Entrepreneur's Journal - Issue 3

By: Dr. Victor Oluwi

Director of Educational Research, Training, & Capacity Development, Canadian Imperial Advantage

The Impact of Inflation on Budgets

A macroeconomic problem, inflation is defined as a sustained rise in the general price level of goods and services over a period of time. Inflation erodes the purchasing power of consumers and results in diminished real value of money as a medium of exchange and a unit of account. While generally undesirable, a moderate inflation rate spurs economic activities and increases the growth rate in the short-term. The level of inflation is measured by the inflation rate, which refers to the annualized percentage change in the general price index or the consumer price index (CPI). Renowned economists such as Adam Smith ascribed inflation to factors that include (but not limited to) excessive growth of the money supply; demand-pull forces; cost-push forces; currency deval uation; rising wages and rents of factors of production; government policies and regulations.

Relationship Between Inflation and Budgets

The impacts of inflation on budgets (whether households or national economies) are similar – albeit with different magnitude and scope. Specifically, while a rise in the general price level of goods and services in an economy over a period reduces the value of money, it simultaneously creates uncertainty and unpredictability, which are necessary conditions for the budgeting activi ties and processes.

A microeconomic concept - budgets are estimates of revenues and expenses over a specified future period. It is a financial plan for a defined period and can enhance the success of financial undertakings. While effective for earmarking resources, budgets are also valuable tools for setting goals, measuring outcomes, and planning for contingencies. However, the systemic and economic distortions that inflation triggers makes it difficult to plan and implement budgets for present and future spending and that is the reason it is important to adjust the budgets over time considering the inflationary rate.

Impact of Inflation on Household Budgets

Increasing and sustained general price levels has a direct and mostly negative impact on households. Specif ically, inflation reduces the real wealth of households with fixed nominal incomes or returns on assets. Imme diate impacts might include reduction in real purchasing power, rising costs of living, lower currency valuation, increased interest rates, economic inequality, and wealth redistribution.

The adverse effects of inflationary trends impact households’ budgets in areas that include housing, transportation, and food. While a modest 2% general price increase might boost nations’ economies, Statistics Canada, however, reported that the Canadian inflation rate increased to 5.1% in 2022. Such a high inflation rate will exacerbate the high living conditions of Cana dian households. To manage budgets effectively and efficiently, households should plan and track monthly expenses; review relevant investment portfolios, longterm financial goals, and retirement plans.

Impact of Inflation on National Budgets

The effect of high inflation is multifaceted and portends a debilitating impact on national economies. While inflation prompts higher interest rates, it simultaneously boosts interests paid on the federal debts and in turn, increases annual deficits, which culminates in making the nation’s fiscal outlook worse. Furthermore, there exists a direct relationship between inflation and mandatory and discretionary spending by the government. Specifically, mandatory spending such as social security and health care costs will rise with inflation. Similarly, projections for discretionary spending will increase with inflation as future spending will supposedly be larger due to rising prices. Inflation also affects the national debts of nations. Here, a rise in interest rates following inflation will lead to increased net interest costs, which will, in turn, increase annual deficits and the amount of federal debt relative to a lower inflation scenario. It is, however, pertinent to note that such a structural mismatch between spending and revenue will propel an unsustainable fiscal trajectory for the country.