Introduction
Brexit is a shorthand term for Britain leaving the European Union (EU). The term resulted from a merger of two words: Britain and exit to become Brexit. Such a process was similar to the manner in which a possible Greek exit from the euro was labeled Grexit previously.
The United Kingdom held a referendum on Thursday 23 June, which was to decide whether the nation should leave or remain in the European Union. After the vote, the leave won by 52% against those who voted to stay by 48% (Wheeler & Hunt 2016). The poll turnout was 71.8%, with approximately 30 million people taking part (Wheeler &Hunt 2016). England supported leaving the Union by 53.4% as compared to those who wanted to remain by 46.6% (Wheeler &Hunt 2016). Wales also voted to leave the Union while Scotland and Northern Ireland supported remaining in the EU. One of the greatest effects of Brexit has been the increased rates of inflation, which will have a long-term implication on the economy of the United Kingdom. Major organizations, such as Easyjet and John Lewis have highlighted the fall in sterling, which has increased their costs. The present paper discusses the impact of the Brexit referendum vote on inflation and how this effect is likely to change in the future as well as the impact that inflation usually has on economic growth.
Inflation
Inflation in economic terms refers to an increase in money supply or price levels, which affects almost all nations at one point (Awogbemi &Taiwo2012, p. 35). Generally, when businesses and groups talk about inflation, it means an increase in prices as compared to some scale. When the rate of the money supply is increased within a given economy, a clear indicator of it is demonstrated by higher price levels. Since the Brexit vote, there has been downward pressure on the sterling, which has led to mounting pressure on the prices of most commodities. As a result of the referendum, the pound has continually staggered lower in value. It is now valued at 20% less against the dollar than it was before the Brexit vote (Plummer 2016). The natural laws of economics provide that such a trend will translate into a higher rate of inflation. Additionally, foreign organizations exporting goods and services to the UK will continue to charge equivalent amounts in their currencies, for instance, euros and dollars. However, they will rate more in sterling when the amounts are converted. The increased rates of inflation will affect not only finished goods, such as food, drinks, and clothing but also raw materials that are processed in Britain, such as car parts. Another product that is likely to increase in price is petrol since oil is valued in dollars. Therefore, an increased rate of inflation in Britain appears to be a predetermined conclusion. The major question is how much more and is this going to change moving forward.
In December 2016, the Consumer Prices Index, which is the government’s headline quantity of inflation rose to 1.6% (Jonathan 2017). It occurred much sooner as estimated by city analysts, and up from 1.2 % in November (Jonathan 2017). According to data from the Office for National Statistics, the percentage increase was a result of a sharp rise in the cost of air prices and monthly upsurges in food and petrol prices. The government affirmed that a combination of costlier imports and the increasing oil price might be influencing the food production prices and consumer prices for food products. In the same month of December, staples like vegetables, bread, sugar, chocolate, and sweets prices went up.
According to Mike Prestwood, the head of inflation at the Office of National Statistics (ONS), the prevailing rate of CPI is the highest to have been witnessed in a period of two years (Jonathan 2017). Moreover, the rates of housing for the landowners also increased by 1.8 % in November alone, rising the annual rate to 8 % (Jonathan 2017). The increased weakening rate of the pound continues to drive prices higher and the current CPI rate of 1.6 % besides the rising fuel, food, and air prices higher than expected (Jonathan 2017). It implies that a hard Brexit period is imminent since the sterling will fall even more. Moving forward, the British Prime Minister pulled the trigger on Article 50.
The action will further impact the inflation rate in the short- term. Certainly, some of the nation’s major retailers have already cautioned that they will be forced to pass the increased costs of importing goods externally to customers. The increasing food and mortgage inflation will also directly affect families. The inflation rate is predicted to rise by 3% this year, hence expected to reduce real earnings (Jonathan 2017). In the coming years, the nation will feel the overall economic impact of Brexit, especially increasing inflation rates driven by a sharp fall in the pound.
Impact of Inflation on Economic Growth
According to Kasidi and Mwakanemela(2013, p. 363), economic sustainability alongside price constancy, remains to be the fundamental goal of macroeconomic guidelines for most nations in the world. A focus given to price stability in the economies is aimed at sustaining economic growth besides strengthening the purchasing control of the domestic currency. The concern on whether or not inflation is detrimental to economic growth has lately been a subject of intense deliberation among policymakers in economics. Several investigations have projected a damaging relationship between inflation and economic growth. Precisely, the main concern is whether inflation is obligatory for economic growth or it is harmful to growth.
Fundamentally, the rate of economic growth in any nation is largely determined by the level of capital formation. Conversely, capital formation depends on savings and investment (Kasidi &Mwakanemela 2013, p. 384). Generally, the world’s economic growth and inflation rates have been inconsistent.
An increase in a nation’s CPI is an indication of inflation. The consumer price index among economies of the world is used as an index for earnings, salaries, contracted prices, and pensions among others, hence a significant economic indicator. Another significant economic indicator is the Gross Domestic Product, which has also been affected by the inflation rate. Therefore, it is considered a significant tool for determining the rate of inflation.
Inflation impacts economic growth in several ways. The first one is through investment. If the price of goods rises and the consumers have to recompense for the increased price, they are forced to dig deeper into their savings. Under this condition, the savings are depleted. Consequently, the economy lacks additional funds for further investments. Therefore, high inflation rates hamper economic growth since people or economies invest when they have strong savings and sufficient cash to meet their expenses.
Inflation also affects interest rates, which also impact economic growth. When the rate of inflation increases in any economy, it is apparent that the value of money falls. A low value for money triggers a decline in the purchasing power of people. Similarly, when the inflation rate increases, interest rates also rise. An increase in the two factors means that the cost of goods will also be affected, making people compensate extra money for the same commodities. Therefore, economic growth is also affected.
Additionally, inflation also affects exchange rates. As the rate of inflation increases, the economic value of the affected currency falls. Generally, exchange rates determine the value of money prevalent in different nations. A high rate of inflation also triggers severe instabilities in exchange rates. When the value of a currency falls as a result of high inflation, international trade, that is, export and import, are affected. When such significant business transactions across borders are affected due to the low value of money, the overall economic growth is negatively affected.
High inflation also affects employment. Generally, the economic growth of many nations is determined to a larger extent by employment. If the rate of inflation increases, the unemployment rate also rises and vice-versa. When a large population is unemployed, the economic growth of a nation is negatively affected(Vinayagathasan 2013).
Conclusion
The decision by the United Kingdom to leave the European Union has begun to impact the economic sector of the nation. Particularly, the value of the sterling has dropped, triggering a rise in the inflation rate. As the nation continues with the due process of leaving the union, it also has to bear with the impacts of the decision. Inflation is a greater determinant of economic growth. Therefore, the decision to leave the European Union will directly impact the economic growth of Britain. Therefore, the fiscal players in Britain need to put in place strategies to ensure that the economic impacts of Brexit do not severely affect the nation economically.
Reference List
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