Inflation Gyration

Federal Reserve Chairman Ben Bernanke Photo source: Reuters

As policy makers and pundits continue to debate — in the wake of Federal Reserve Chairman Ben Bernanke’s historic news conference on Wednesday — whether or not the economy is really suffering from inflation, a more practical question has arisen: What should managers do?

For those enterprises facing higher costs for raw materials, the pain can be severe. Meanwhile, at companies showing record earnings as prices rise (think oil and steel), managers can easily fall into the trap of looking past the fundamentals of the business.

Peter Drucker, for his part, was deeply interested in the macroeconomic implications of inflation, and he wrestled with whether inflation or unemployment was the lesser evil.

[EXPAND More]But Drucker was also focused on how to deal with the beast of inflation at the micro level. The “illusion” of “record profits” spurred by high inflation “leads to the wrong actions, the wrong decisions, the wrong analysis of the business,” he warned in Managing in Turbulent Times. “It leads to gross mismanagement.

“All this is known to most executives,” Drucker added. “Yet few so far have even tried to correct the misinformation inflation creates. We know what to do, and it is not very difficult. We need to adjust sales, prices, inventory, receivables, fixed assets and their depreciation, and earnings to inflation — not with total precision but within a reasonable range of probability. Until this is done, even the most knowledgeable executive will remain the victim of the illusions inflation creates.

“He may know that the figures he gets are grossly misleading, but as long as these are the figures he has in front of him, he will act on them rather than on his own better knowledge. And he will act foolishly, wrongly, irresponsibly.”

What about you? Are you seeing any effects of inflation in your business — and, if so, how are you managing them?