Inflation is an economic term that refers to an environment of generally rising prices of goods and services within a particular economy. To name a stark example, prices for many consumer goods are double that of 20 years ago. But how much do we really know about it. Moolr took a look at inflation.
Inflation is a quantitative measure of the rate at which the average price specifically selected group of goods and services in an economy increases over a period of time. If it decreases, that is called deflation. However, the general trend in economies is upwards. Often expressed as a percentage, inflation also indicates a decrease in the spending power of a country’s currency. The most commonly used inflation indexes are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
As logic suggests, the more prices rise, the less your money buys you. It can thus effect your standard of living negatively.
There are four main types of inflation, categorised by their speed. They are creeping, walking, galloping and hyperinflation. There are specific types of asset inflation and also wage inflation. Some experts say demand-pull and cost-push inflation are two more types, but they are causes of inflation.
Inflation can benefit either the lender or the borrower, depending on the circumstances. If wages increase with inflation, and if the borrower already owed money before the inflation occurred, the inflation benefits the borrower. Hyperinflation is a clear sign of an economy and a country spiralling out of control. You may have seen it happen to certain countries across history.
Rising prices are the root of inflation, though this can be attributed to different factors. In the context of causes, inflation is classified into three types: Demand-Pull inflation, Cost-Push inflation, and Built-In inflation.
Demand-pull inflation happens when the overall demand for goods and services in an economy increases more rapidly than the economy’s production capacity.
Cost-pull inflation is the consequence of the increase in the prices of production process inputs. A rise in wages in the labour force would be a prime example of this.
Built-in inflation is the third cause. As goods and services go up in price, labour expects and demands more costs/wages to maintain their cost of living. This causes a spiral that raises inflation.
Despite what has been said above, inflation does not have to be bad news. Sometimes it can be good for the economy. Mild inflation is not an occurrence to worry governments. Most people in the UK expect mild inflation, so its effects are not too negative. People are thus not put off spending their money because of it. They know prices will continue to rise so do not delay purchases. Consumer spending drives economic growth. The Federal Reserve favours a 2% core inflation rate as a healthy situation for the economy.
What’s more, people with tangible assets, like property or stocked commodities, may welcome some inflation as that raises the value of their assets.
To combat unhealthy inflation, a country’s appropriate monetary authority, such as a central bank (a prime example being The Bank Of England) then takes measures they feel necessary to keep inflation within permissible limit. Their ultimate aim is to keep the economy running as smoothly as possible. Their key tool is to set interest rates.