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Inflation: what it is, how it is calculated and how we expect it to evolve.

By inflation we understand the sustained increase in prices over a period of time. But, in colloquial language, we understand inflation as an exaggerated increase in prices over an important period of time.

The calculation of inflation is, theoretically, easy to calculate. If a product was worth 100 at the beginning of the year and 101 at the end of the year, the price of the product has suffered an inflation of 1%. The problem with official statistics is that inflation is calculated by taking an average of inflation for a group of products. If, for example, 10% of citizen purchases are groceries, and the price of groceries rises 100%, only the groceries section will raise inflation in the country by 10% - and we are not including inflation of the rest of the purchases -.

One of the problems to correctly calculate inflation is what percentage (or “weight”) we give to each product. It is very difficult to calculate exactly what the citizens consume, and in what proportion; and the temptation to modify the percentage (or “weight”) of each product to place the least inflationary ones is evident. Giving more relevance to the prices of products that have lower inflation and less to those with higher inflation makes it possible to offer better statistics.

Which inflation is “correct”? As a general rule, in recent years it has been accepted that positive inflation ending below 2% is ideal.

An important detail of inflation, which is not usually explained, is that when we say that inflation falls, it does not imply that prices fall. For that, inflation should be negative. For example, if in one year inflation is 20%, what used to cost 100 will cost 120. If the next falls to 10%, the price will go from 120 to 132. What has < em>fallen is the rate at which the price rises, but the price continues to rise. For the price to fall, inflation must be negative; that is, once the product costs 120, if inflation is -10%, the product will cost 108. It is positive that inflation in a country goes from 20% to 10%, but that 10% is still excessive. And a negative inflation is not good either, since it usually indicates that there are economic problems.

How do we expect inflation to evolve in Spain in the coming months? Well, in a very positive way. The data published in June of last year - corresponding to May of last year - was +0.8%, and that of July - corresponding to June - was +1.9%. These two data will be replaced by those published in June and July of this year, which will be much lower, so inflation will fall dramatically. The problem will be the rest of the year, for two reasons: first, because the rest of the data from last year was good; and the second, because the VAT cut on basic food and other government aid intended to fight inflation will be withdrawn. And it is foreseeable that this will have the effect of raising inflation.

The most serious problem is what is called “core inflation”, which does not include fresh food and energy, which are the prices that tend to move the fastest. At the moment, in Spain it is at 6.1%. Although it has fallen a lot in the last month, it is the one that costs the most to bring down, and it is very important. At the moment, inflation is falling due to the drop in the price of energy - oil has fallen from 120 to 72 dollars in one year, and natural gas from 9.76 to 2.26, and those two price drops have made fall inflation -. But once the price of natural gas and oil stabilizes, we may have problems, since inflation will tend to approach the level of core inflation.

Nevertheless, the ECB considers that next year it will be able to start lowering rates, that is, it considers that inflation will be controlled by then. At the moment, regarding inflation, its record of hits is not very good in recent years.

The Holders&Brothers team.


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