Inflation is a thief of joy because it silently erodes the purchasing power of your hard-earned money. We feel it burning our bank accounts to the ground whenever we go shopping now a days. Have you ever asked yourself why prices are constantly on the rise? It is important to understand inflation so that we can dissect how it can go up quickly and how we can fight it. That is the purpose of this post today. Let’s dive in and unravel the mysteries of inflation and explore its causes.
Inflation Defined
Inflation is the increase in the general price level of goods and services over a period. It represents the decline in purchasing power of a unit of currency, each unit of currency can buy fewer goods and services. It is usually measured with various price indices with the most common being the Consumer Price Index (CPI) or the Producer Price Index (PPI). These indices track the changes in the prices of a basket of goods and services consumed by households or produced by businesses, respectively.
Inflation can have a positive and negative effect on an economy. Moderate inflation is often viewed as a sign of a healthy economy because it indicates growing consumer demand and economic activity. Additionally, it can also encourage spending and investment as individuals and businesses anticipate higher future prices. High or rapid inflation is not viewed as positively as moderate inflation because it can have a detrimental effect on an economy. High or rapid inflation erodes purchasing power, reduces the value of savings, and creates economic uncertainty.
Inflation Causes
Although inflation is a complex economic topic and can be influenced by a variety of factors, we can highlight some of the more common influences to better understand how to fight off high inflation. First, there is an inflation known as demand-pull inflation, which essentially happens when demand in an economy exceeds the aggregate supply. This leads to an upward pressure on prices. This happens when there is a significant increase in consumer spending, government spending, or investment activity. For example, when a surge in consumer demand for housing results in demand-pull inflation in the real estate market, it can lead to higher prices for properties, construction materials, and other related services.
Another influence is what is known as cost-push inflation. Cost-push inflation happens with significant increases in production costs, such as wages, raw materials, or energy. When these input costs increase, businesses will more than likely pass that increase onto the consumers through higher prices, which causes inflation. Some concrete examples of this include high labor wages, oil price increases, or supply-chain disruptions. When there is a sudden increase in global oil prices, production costs for industries reliant on oil, such as agriculture, manufacturing, or transportation, see a significant increase in production costs. When businesses pass on these higher costs to consumers, it contributes to cost-push inflation.
Next, we have monetary inflation. This is basically the money supply in an economy. When the money supply grows faster than the growth rate of goods and services, we see a general increase in prices. Central banks can play a role in controlling this type of inflation through what is known as Monetary Policy. We will talk more about the relationship between the central bank of the United States known as the Federal Reserve tomorrow and how they can influence inflation. For now, know that The Fed tries to influence monetary inflation through the demand for money via controlling interest rates or quantitative easing, which we will talk more about these tomorrow.
Another factor that influences inflation is what is known as built-in inflation. This occurs when workers anticipate future price increases and negotiate higher wages to maintain their purchasing power. These higher wages then lead to higher production costs for businesses, which in turn result in price hikes to the consumer. Additionally, there is imported inflation. Imported inflation comes up when a country’s currency weakens against other currencies, which makes the costs of imports increase, which as you can imagine will increase the prices of the goods imported for the consumer. A country can experience significant import inflation when they are more reliant on imports for their economy. If a country has a good balance, this might not be a major player in the inflation game. Finally, consumer expectations also have an impact on inflation. As noted above with the built-in inflation, if people believe that inflation is going to be significantly high, they might adjust their behavior accordingly, which will influence inflation. For example, workers might demand higher wages so businesses might increase prices because they anticipate higher costs, which affects inflation. Note: it is not our belief that demanding higher wages is a bad thing. These are just examples of how things interact in a good and fair economy and how these interactions influence the overall prices of goods and services.
Final Thoughts, For Now
In conclusion, understanding inflation and its causes is crucial to navigate the economic landscape. We have explored the concept of inflation, which refers to the general increase in the price level of goods and services over time. Factors such as demand-pull inflation, cost-push inflation, monetary inflation, built-in inflation, imported inflation, and inflation expectations all play a role in shaping the level of inflation in an economy. It is important to recognize that inflation can have both positive and negative effects on an economy, and high or rapid inflation can be particularly detrimental. By gaining a deeper understanding of these influences, individuals and policymakers can work towards mitigating the negative effects of inflation and promoting stable economic growth.
Disclaimer: I am not a financial advisor. The content on knowxchange.com or “this site” are for educational purposes only and merely cite my own personal opinions and experiences. In order to make the best financial decision that suits your own needs, you must conduct your own research and seek the advice of a licensed financial advisor if necessary. Know and understand that all investments involve some form of risk. There is no guarantee that you will be successful in making, saving, or investing money. Additionally, there is no guarantee that you won’t experience any loss when investing. Please seek the advice of a financial professional and do your own research.