My grandfather passed away in 1971. My grandmother was 60. The will provided her with a monthly payment for the rest of her life, an amount that at the time would have been ample. However, what my grandfather never foresaw was what was about to happen in the world.
In the following two decades, inflation spiked from 2% or 3% in the 1960s to between 10% and 15%. The inflation spike was triggered by the oil price shock, followed by stagnant global economic growth and runaway inflation.
My grandmother’s provision did not include an inflation adjustment. By the time my grandmother passed away 25 years later, the payment did not even cover her room in a retirement home.
This was the economic backdrop when I started my studies in Economics in the nineties. When central banks were entrusted with strong mandates to fight inflation and given independence, even in emerging markets like South Africa, few seasoned economists believed they would be allowed to snuff out economic growth with high interest rates. As a fresh graduate, I was surprised that people doubted governments would follow through.
But central banks did. It became accepted practice, and strict monetary policies eventually introduced an era of disinflation. By the early 2000s, developed countries had become accustomed to inflation of around 2%. Even in South Africa, inflation moderated beyond most expectations, settling inside a 3% to 6% band for the next two decades.
Recently, the inflation target was lowered again, and we now believe that the Reserve Bank is serious about defending it. It feels safe to plan for low inflation.
However, we must learn from my grandmother’s story. Inflation can unexpectedly rise out of control and cause havoc.
And we may well be at such an inflexion point. The recent instability in oil prices, brought on by hostilities between the USA and Iran, may have been such a point. In addition, the US government is desperate for economic growth to win the next election. They’re desperate to keep interest rates low to fund the $40 trillion of government debt. They’re experimenting with unusual policies and chipping away at the central bank’s independence. The most influential government has taken their eye off the inflation ball, and it’s probably not safe to assume that inflation will stay at these levels.
Although these actions point to potentially higher inflation, other factors like lower population growth and technology-driven productivity improvements may well work against higher inflation.
We must just remember that inflation shocks have happened in the past and will happen again. I watched my grandmother pay the price of one wrong inflation assumption. It’s why I believe in flexibility and optionality in retirement planning: flexible investment options and inflation-linked strategies. We should never be too sure that the future will look like the past.
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Kind regards,
Sunél
