Inflation Rates Hit Record Highs and Lows

September 18, 2009

The inflation rate on consumer prices for the 12-month span from September of 2007 through August of 2008 reached 15.4 percent, the highest rate in more than 10 years. This year, during a similar 12-month stretch, the rate of inflation dropped to 5.71 percent, the lowest rate recorded in more than 10 years.

 

The dramatic swing in the inflation rate is representative of the economic fluctuations in Costa Rica during the past year.

 

Traditionally, a country’s rate of inflation reflects a country’s economic prowess, stability and dependence on foreign raw materials, gasoline and oil.

 

From Highs to Lows

 

The soaring highs of the inflation rate in 2008 was the result of a mixture of both positive and negative economic circumstances.

 

On the positive side, the 13.9 percent inflation rate in 2008 meant prices were up, reflecting increased consumer spending. This, in turn, meant that more money was being pumped into the economy. On the other hand, because the increased inflation rate was driven in large measure by higher oil prices, much of the money generated by the elevated costs went toward the purchase of gasoline produced abroad. Such is the lot of countries that are dependent on foreign oil and petroleum products.

 

“Gasoline and raw materials are the primary drivers of the inflation rate and consumer prices,” said Jose Luís Arce, economic coordinator of Economic and Financial Advisors S.A (CEFSA). “For countries that depend on foreign oil and raw materials, their rates of inflation usually fluctuate as gasoline prices change.”

 

But 2008’s high inflation rate was not driven solely by gasoline and transportation costs, according to the National Statistics and Census Institute (INEC), which calculates the inflation rate each month. Throughout the first 11 months of the year, before the foundations of the world economy were shaken by the financial crisis, Costa Rican expenditures were high and the economy experienced healthy growth.

 

“Typically, in the past, a dynamic Costa Rican economy has been accompanied by elevated rates of inflation,” said Eric Vargas, strategy director at the consulting firm Aldesa. “Thus, the decrease in the inflation rate this year is a reflection of the downward effects of the economy.”

 

In 2009, the inflation rate plummeted. The inflation rate from January to August of 2009 was 2.81 percent, the lowest inflation for the first half of a year in Costa Rican history.

 

The low inflation rate this year also has positive and negative causes and impacts. The good news for consumers, of course, is that prices are reasonably fixed and they show little increase. The downside for the overall economy, however, is that the reason prices have remained unadjusted is because of diminished demand.

 

“It is not only important to look at the (inflation rate), but also the context of what is going on in all the economy,” Vargas said. “For example, if the economy were growing at a normal pace, the low inflation rate would be a very positive thing; it would indicate that (economic output) is keeping up with the increase in prices. However, in the present situation, when the economy is in recession, the lowered inflation rate is an indication of the low level of economic activity. Though it seems the lowered inflation rate is a good result, in reality it means the economy isn’t growing.”

 

In that regard, Costa Rica’s inflation rate, like the rates of most other Central American nations, differs from the rates of more developed economies. For example, the United States rate of inflation hovers around 3 percent, and, when the inflation rate shows small increases, it is usually perceived as positive and means the economic output of the country is closely aligned with consumer demand.

 

In Costa Rica, this is not the case. The slump in the Costa Rican inflation rate this year, including an increase of only 0.65 percent for the month of August, is an indication that consumer demand is low. This means prices remain fixed. In August, of the 12 sectors INEC charts to gauge inflation, only the transportation sector showed growth of more than 1 percent.

 

Other goods and services – such as food, alcohol, clothing, living expenses and other goods and services – reported minimal price increases.

 

“Price is adjusted by demand,” said Milton Castillo, a statistician at INEC. “When price adjustment is very small, it means consumer demand is very low.”

 

High Inflation Is a Constant in C.R.

 

Over the past 10 years, the Costa Rican inflation rate has averaged about an 11 percent increase each year. In general, this has been a positive circumstance, meaning the economy has continued to grow and that consumers, in general, have been able to afford the hike in prices.

 

However, as more U.S. dollars enter the Costa Rican economy and pump up reserves at the Central Bank (BCCR), the exchange rate of the colón continues to rise. The continued increase in the exchange rate, which has grown annually at a rate of 27 colóns per year over the past 10 years, also drives inflation.

 

“The BCCR is trying to defend the exchange rate against continued upward pressure,” said Vargas. “To avoid this, it has to sell dollars. When dollars are sold, it puts colóns back in the economy. If there are more colóns in the economy, it slows the pressure of inflation, because colóns carry less value than dollars.”

 

A drawback to the continued price elevation is the wariness of foreign businesses to enter negotiations withCosta Rica.

 

According to the Global Competitiveness report released by the World Economic Study last week, inflation was considered the fourth most “problematic factor for doing business” in Costa Rica. Of the 133 countries ranked in the report, the inflation rate of Costa Rica was ranked 110th.

 

“Inflation rate is considered an indicator of internal stability,” said Arce. “It is a representation of the strength of consumers. Countries that enjoy lower inflation rates usually have a better macroeconomic system.”

 

Despite both the positive and negative elements of a high inflation rate, economists predict that the inflation rate will again rise in 2010 to previous high levels.

 

It appears that, despite the aberration year of 2009, high inflation rates in Costa Rica, given its dependence on foreign oil and the U.S., are here to stay.

 

 

 

 

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