Miodrag Šajatović: Everything You Need to Know About Inflation (For Starters)

Many parties and independent lists, along with their candidates for mayors, city mayors, and county heads, won the recently concluded local elections by promising voters more transparent and fairer public procurement and investment tenders. However, they will face a challenge they did not anticipate – inflation, that self-inflating rise in prices.

The global rise in the prices of raw materials and inputs this year is so high that unfortunate entrepreneurs who signed contracts for public investments linked to EU co-financed agglomerations last year must choose between bankruptcy due to adherence to agreed prices and penalties for contract cancellation. A recent example of this was discussed at our ‘Lider invest’. The Rijeka company Vargon withdrew from three agglomeration projects due to the enormous rise in raw material prices for the production of plastic supply and drainage pipes.

Where is the anchor?

So, how to write a public tender for EU projects in a time of awakening inflation? Long ago, in the early 90s, during the time when hyperinflation (about 30 percent price increase every month) ravaged Croatia, there was an anchor. You would agree on prices in German marks, and that was it. Here, there was inflation; in Germany, there was none. The mark was stable.

Now the situation is significantly different. Globalization has occurred, supply chains have become global, and so have the disruptions, ignited by the corona pandemic. Consequently, inflation. Today, there is no exchange rate anchor that would somewhat protect the contracting parties. A contract in euros is just as uncertain as one in kunas.

If it turns out that the global awakening of inflation is not a transient phenomenon (until global supply chains for semiconductors and similar strategic products are established), it would be wise for younger entrepreneurs, managers, ministers, agency heads… to check if they have someone in their team who was active in 1993. Someone who ‘earned their doctorate’ on inflation and hyperinflation from 1980, when inflation erupted in Yugoslavia, until 1993, when the government of Nikica Valentić activated the anti-inflation program. That mentoring knowledge could become very useful.

Inflation is an extremely unpleasant, multilayered phenomenon. It is synonymous with instabilities of many kinds. Therefore, it is still possible to find in political speeches the message that the goal of politics is to maintain price stability. Even the main task of the central bank is to preserve price stability. This has been done for a quarter of a century, among other things, by tying the exchange rate of the kuna to what was once the DM (for the younger ones: the German mark), and today to the euro.

Inflation Expectations

It is important to understand inflation expectations. In conditions of inflation, consumers decide to purchase earlier, assuming that they will have less purchasing power for the same amount in the future. This positively affects consumption in the short term. In conditions of actually negative interest rates on savings, this could encourage those who have savings to use them for the purchase of durable goods.

However, in the long term, inflation reduces consumption among a broader layer of consumers. Primarily those who live on pensions or salaries. As prices rise, unions begin to demand indexation. This is, simplified, the adjustment of pension or salary growth to the rate of inflation. But even when they succeed in that demand, real pensions and salaries fall. Namely, one must wait for statistics to publish how much prices have risen in the previous month, and then salaries are raised by that much in the next month. Which, due to the delay in adjustment, have meanwhile been reduced in real terms. Incidentally, in times of crisis, when salaries or pensions need to be reduced, politicians love inflation. It is a silent form of taxation. If you reduce the salaries of the state apparatus by ten percent, there would be a rebellion. If you reduce them by that much through inflation – you have achieved your goal, and your hands are clean as an employer.

Over time, unions and the opposition become aware, and alongside salary indexation, they begin to demand price control. Compliant politicians in power, at some moment of nervousness, try what was called price freezing. This, of course, causes the collapse of part of the producers, and on the other hand, shortages. And the black market, where prices are, of course, even higher.

In inflation, savvy traders did well. You acquire goods at one price, factor in inflation, add inflation expectations, and the result can be quite satisfactory.

The education could be expanded into another five columns, but perhaps it is fair not to take away the jobs of the generation of directors and economists who have recently retired (or are about to). They could become sought after as mentors (consultants) who have advice from the last century on how to survive inflation and, God forbid, hyperinflation in business and private life. 

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