Inflation: 7 facts and fictions you should be aware of - explainer

Interest rates are high and rising. 

“Federal Reserve interest rates are at historic highs,” US media report. And Israel’s Bank of Israel is following suit. The Central Bureau of Statistics announced that the Consumer Price Index rose 0.6% in October, raising the annual inflation rate to 5.1%. 

The real inflation-adjusted interest rate is still extremely low. This is because loans are paid back in deflated money, worth 5% less than when you borrowed it. Now, it is true that if your wages have not kept up with inflation, the higher rates you pay for your mortgage are very burdensome. But simply in terms of logic and accurate measurement, why do we not adjust interest rates for inflation, when everything else is?  When adjusted, the real interest rate is low or even negative today. 

Inflation in Israel is now at an annual rate of five percent.

To see why, let us analyze how inflation is measured. The cost-of-living index takes an average basket of goods and services that households buy, tracks the prices of each item included, and then calculates a price index based on the cost of the basket. Lately, that comes to 4.5% inflation year-on-year. In other words, the cost of the average consumer basket of goods has risen by 4.5%.

But nobody is “average.” Each of us consumes individually different baskets of goods and services. Hence, smart price-sensitive consumers find bargains, buy non-branded goods, buy in quantities, and avoid expensive luxuries. And never frequent pricey Tel Aviv restaurants. For them, inflation is low.

But our Tel Aviv foodies who dine at hugely expensive restaurants regularly – their inflation rate is astronomical. 

Each of us has unique fingerprints and equally unique rates of inflation. What is published is simply an average and may not reflect the individual’s pocketbook.

The cause of inflation is mainly rising costs and supply chain disruption.

Take, again, our Tel Aviv gourmets. How can restaurants get away with charging sky-high prices? It is demand and supply. They have clients willing to pay exorbitant prices. Why? After years of pandemic lockdowns, we have at last emerged from our rabbit holes and want to catch up and enjoy. Some of us have money because governments have been generous with emergency support payments. And we are far less price-sensitive than before because, well, we have gone without for years and are happy to have stuff, whatever it costs. 

In turn, restaurants and other businesses have had more than two lean years, barely scraping by, and many feel they can and will catch up by hiking prices, especially when they sense that price resistance, or “sticker shock,” is low or nonexistent. Stickers shock us far less these days than they once did.

I feel that this is the real underlying driver of inflation. Not supply disruption, etc., but rather price-insensitive buyers on the one hand, and businesses eager to recoup lost profits on the other. 

Evidence? Check out after-tax net income for banks and companies. Banks are raking in the money. They are charging higher money interest rates but paying us depositors what they did before – basically, nothing. Result: Billions in profits. 

Israel’s Discount Bank had net income of NIS 897 million in the first quarter of this year, up 72.5 % from fourth quarter 2021. And that is not atypical.

I call to the witness stand Coca-Cola (the global firm). Their third-quarter 2022 profit grew by 14% compared with last year. Not because they sold much more product. They simply boosted their prices by up to 12%. Check the price of a liter of Coke next time you buy one. 

And Big Oil? London-based Shell and Paris-based Total – European energy companies – reported a combined quarterly total of nearly $20 billion in profits, as oil and gas prices soar in the third quarter. I wonder, why not tax those excess, exorbitant earnings?

Soaring government debt is driving inflation and will be very hard to repay.

It is true that in most countries, government debt has soared, as governments borrowed money to pay for COVID-related emergency spending. In Israel, government debt as a percent of GDP rose from a historic low of 59% in 2017 to 72% in 2020, and 69% in 2021. That amounts to an added NIS 165 billion ($50 billion) yearly that has to be paid back by us taxpayers.

But wait! Remember – everything has to be adjusted for inflation. Governments will pay back their debt in deflated shekels, worth much less than when they borrowed them. Adjusted for inflation, that debt burden is far less burdensome. Indeed, some even claim that governments have an interest in maintaining inflation, to ease the task of paying back borrowed money. In any event, I believe the pandemic relief money was well spent, keeping businesses from bankruptcy and people from losing their jobs.

Housing prices, a driver of inflation, will continue to rise as they always have.

According to the financial weekly The Economist, “[housing] prices are falling in nine of the 18 countries monitored by Oxford Economics and are dropping fastest in the most overheated markets. In Canada and Sweden they have fallen by more than 8% since February; in New Zealand they have fallen by more than 12% since their peak last year.” 

Housing prices have begun sliding in America and Britain, too. Many other countries are heading in the same direction.

And Israel will join them – according to Zvi Stepak, founder of Meitav, a leading investment house. (See The Jerusalem Report, “Inequality: A Global Disease,” Sept. 5). 

He recently told the business daily Globes, “There is strong similarity between financial bubbles and real estate bubbles.…The confidence of builders that [housing] prices will keep rising reminds me of the similar confidence of investors in capital markets….Those who buy apartments today may be stuck with them in the future.” 

“There is strong similarity between financial bubbles and real estate bubbles.…The confidence of builders that [housing] prices will keep rising reminds me of the similar confidence of investors in capital markets….Those who buy apartments today may be stuck with them in the future.”Zvi Stepak

When, dear reader, you do your annual financial plan, think about a scenario in which housing prices in Israel stop rising and actually fall. What happens when house-rich people become instead house-poor? The Economist predicts a severe global mess. It is worth careful thought, lest we get an unpleasant surprise. 

At the same time, I know many smart people who insist that housing prices will never fall in Israel. But I say, never say never.

Inflation is unmitigated evil.

Blessing? Well, yes. With inflation come wage increases. 

The average wage in Israel rose by three percent between August 2021 and July 2022. Not quite enough to compensate for inflation; but, nonetheless, more money in our pockets encourages consumption, which drives growth and employment, even when that money buys less – or perhaps especially when that money buys less, and you need more of it to buy the same stuff. 

This is called inflation illusion – the feeling that we are better off when we have more paper money, even though we know it is worth less. A modest amount of inflation illusion can spur spending and growth.

The Israeli economy is in bad shape because of inflation.

The shekel, now at about 3.5 per dollar, has weakened from its rate in January (3.1 shekels) but is still stronger than its value at the onset of the pandemic in March 2020, 3.67 shekels. Nearly all global currencies have weakened, as the dollar grew stronger owing to higher US interest rates.

American economist Arthur Okun invented what he called the “misery index” – the sum of the rate of unemployment and the rate of inflation. Israel’s rate of unemployment in September was only 3.4%, down from 4.8% in October 2021. Hence, Israel’s misery index is now about 7.9%, in contrast with that of the US, which at present is 11.7%. We are a lot less miserable than our American friends.

And the stock market? The Tel Aviv TA125 index is now more than 50% higher than in March 2020, at the outbreak of COVID. 

This is not to understate chronic problems – inequality in income and wealth; widespread poverty; hungry children; danger signs of a looming hi-tech shedding of workers; instability in public policy; and lack of long-range strategic planning. But overall, Israel’s economy is doing remarkably well, considering we have had five national elections since April 2019. 

Instability in Britain? Not even close to that of Israel.

Elections, like Purim, have become an annual event. Yet, surprisingly, despite it, the economy ticks along – a tribute to the resilience of Israeli workers, managers and entrepreneurs. And, perhaps, the benign neglect of politicians, so busy running for office that they have no time to mess things up.  ■

The writer heads the Zvi Griliches Research Data Center at S. Neaman Institute, Technion and blogs at www.timnovate.wordpress.com.