Danuše Nerudová, a former president of the Mendel University and a candidate in the Czech presidential election 2023 made a rookie mistake on Twitter. Let’s have a look.
“People are going to be 20% poorer this year because of inflation.” (source)
Inflation may be close to 20%, but that doesn’t mean the real value of people’s cash balances will fall by 20%. How is that possible? Let’s look at an example.
Nerudová had 10 000 election leaflets printed last year for CZK 10,000. That’s one leaflet for 1 CZK. If she wanted to print leaflets this year after a 20% inflation, and she had a budget of exactly 10,000 CZK, how many would she print? It is not 20% less, i.e. 8,000 leaflets, but it is 16.67% less, i.e. 8,333 leaflets. Why? Because the price of goods goes up by 20%, not that the income goes down by 20%.
Here’s the calculation:
Price of one leaflet before inflation 1 CZK
Price of one leaflet after inflation 1.20 CZK
Budget 10,000 CZK
Number of printed leaflets 8,333
How much has the purchasing power decreased? −16.67 %
To better understand this, try to imagine that with 100% inflation, our banknotes will not lose 100% of their real value, which could be inferred from Nerudová’s tweet, but “only” 50%. See the calculation:
Price of one leaflet before inflation 1.00 CZK
Price of one leaflet after inflation 2.00 CZK
Budget 10,000 CZK
Number of printed leaflets 5,000
How much has the purchasing power decreased? −50.00 %
For the loss in real value to be 20%, the inflation rate would have to be 25%. It is possible that Danuše Nerudová assumes there will be such a rate, but she should say so if that is the case.
The economics professor should also not use the misleading wording “we will become poorer”, since only cash balances held in wallets, pillow cases, or zero-interest checking accounts lose their full value due to inflation. Other assets we hold (such as real estate or cars) are unaffected by inflation, and in the long run even nominal wages will catch up with inflation.
Thus, the real impoverishment is far less than the loss in real value of the 1,000 CZK banknote in our wallet, even if we calculate it correctly.
Moreover, the solutions to combat inflation that Danuše Nerudová proposes are not good ones. A price cap on energy can lead to nothing but shortages. Financially incentivizing households and industry to reduce energy consumption is useless in a world of market prices. Price has, among other things, an informational function, i.e. a rising price informs the consumer to consume less of a good (in this case energy).
In the eyes of some politicians, kurzarbeit seems to be a cure-all. However, it is not clear how it is supposed to help households with inflation.