Understanding the three phases of inflation key in crafting solutions

Flour on sale at a supermarket in Nairobi. [Boniface Okendo, Standard]

No topic in the realm of economics has dominated Kenya conversation more than that of inflation.

Both households and businesses have been subjected to price shocks in recent years in a way that has forced them to change fundamental ways of how they operate. While headline inflation has been on a steady decline over the past few months, it only marks the end of the first phase.

The country will need to grapple with solutions to handle the second and third round effects of inflation - which are beyond the scope of the Central Bank of Kenya and will require collective effort from the entire leadership of the nation. Failure to do so could plunge the republic into deeper socio-economic challenges with far-reaching consequences.

The three phases of inflation tend to unfold in clear and visible sequences. The first round was what was witnessed in 2022 with supply chains coming under significant stress owing to the Covid pandemic closures coupled with the Russia/Ukraine war.

Supply of critical commodities could not keep up with pent-up demand from countries that were reopening. Naturally, this led to a surge in inflation globally, most notably in the United States where it reached its highest level in 40 years. In Kenya, the consumer price index was marginally shy from hitting double digits.

The second-round effects of inflation started unfolding in 2023, mostly within the labour markets. Salaried employees and wage earners began to clamour for increased compensation to counter the eroding effects inflation was having on their purchasing power. There was remarkable diversity in how each country approached this delicate issue.

For example, Japan's largest trade union, Rengo, announced that workers at the country's biggest firms are set for the sharpest wage spike in more than three decades. Similarly, the United States has seen wages quickly adjust to inflation, particularly in sectors facing labour shortages.

In many sectors in Kenya, wages have failed to adjust sufficiently, leaving wage-earners in limbo and pushing them to adopt new lifestyles. In other sectors such as healthcare, medical interns are facing the prospects of having their negotiated salaries drastically reduce - a fact that has triggered a month-long strike, crippling Kenya's health sector.

The third-round effects of inflation largely depend on how the second-round effects are handled. In regions where wages harmoniously adjust with inflation, there is higher productivity and vibrant economic growth. An IT professional, for instance, who receives higher compensation for his services, is likely to invest in better technology which makes him more productive in his ability to deliver higher quality services. This is one of the reasons that the United States economy has maintained resilience.

Conversely, in countries where wage growth fails to keep up with inflation, there is a resultant decline in productivity and lower economic growth. In extreme cases, it can also compromise the safety and well-being of a nation.

Consider the case of a bus driver who operates in 8-hours shifts and earns a constant wage for his labour. If his wages are not adjusted to counter inflation, he is likely to look for additional work during his resting period so that he can earn extra income. The lack of sufficient rest will slowly lead to fatigue, which could easily end up in a fatal accident.

It is easy to see why the three phases of inflation need to be properly understood and collectively addressed to safeguard Kenya's economic stability and enhancement.

-The writer is Chief Economist at Mentoria Economics