What Is Inflation?
Inflation, in the most basic of its descriptions under the economic sciences, is the term used to describe an increase in prices. Consequently, it means that the currency has lost its purchasing power over a matter of time, and the rate with which this happens reflects in the aggregate pricing across the board for a country. Hence, an inflation rate is mainly depicted as a percentage showing the currency’s purchasing power that has changed over time.
Understanding Inflation
So while many may think measuring inflation is easy, keeping up with individual product pricing over time is beyond any human comprehension. After all, a modern human doesn’t just rely on basic necessities.
We have extending needs, wants, and desires, accumulating a vast and diverse pool of products and services that suffer price changes under economic inflation. Therefore, while inflation might seem vague, it is the best possible figure to determine the overall impact of the change in purchasing power.
Importance of Controlling Inflation
It is definitely one of the most commonly pursued ways of understanding inflation that people take by asking, “why is it important to keep inflation under control?” The answer, however, is fairly simple, and even enough once if you grasp the essence behind it. Controlled economic inflation means that the population has purchasing power and can accumulate wealth.
Consequently, it means that they can pay off their debt and have a financially stable standard of living. Thus, this presents an overall economic stimulus check, showcasing the country in question as economically balanced. A nation that is providing a good enough standard of living to its people. That’s why countries want to remain afloat over the issue of inflation.
Causes and Effects of Inflation – How Inflation Works
Many people think inflation is just the increase in prices of the daily goods and services we buy. Because that is the level of a regular consumer’s expenditure, that’s how far they think inflation goes.
Similarly, suppose the person is a regular real estate market investor. In that case, they’d associate inflation with a bigger market, such as real estate. Unless they are more knowledgeable, they best believe property owners and investors are the only ones to experience the price hike.
Safe to say, the reality of how inflation actually works is far different than what it may seem to a consumer limited by their spending capacity. Hence let’s take a look at the causes and effects of inflation that apply to all levels of inflation:
Causes of Inflation
Inflation is mainly portrayed as a country-wide or even a worldwide price hike. However, oftentimes, initially, inflation can be extremely individual and gradually spread to that decree. It happens to a single product and, by extension, carries on to become a nationwide problem. Hence, it is important to understand what breeds the very first flair of inflation for it to become such a widespread phenomenon.
- Printing and Releasing Money to the Public
This is the most blatant cause of inflation because the currency simply loses all of its purchasing power. Believe it or not, there are countries where you can use currency notes as toilet paper because they are in that much quantity but have no value whatsoever. It is like you willingly walk towards an economic downfall when the exact opposite is your end-term goal.
Similarly, when the government legally devalues the currency due to the ongoing economic tender of the country, it is like offering the moving cloth to a bull. You are bound to be struck by it one way or the other, no matter how hard you try to stay out of the way. In such scenarios, you can see that many countries have started accepting other currencies that are still powerful against their own. For example, the Turkish Lira is weakening, so they have started taking Euros.
- Lending Money by Purchasing Government Bonds
This is the easiest method for the federal reserves to create money. They loan money to people and businesses, bringing it into existence via the reserve account credit – in exchange for buying government bonds from the bank. This creates a secondary market to get money into the cycle when an already suffering economy is struggling under the inflation rate. In turn, money ends up having no purchasing power for the people who possess it.
Effects of Inflation
Inflation is not limited by the understanding or spending capacity of the people. It is a far-reaching economic factor that goes beyond our regular, everyday expenses and spreads across countries to envelop every part of the world due to interconnected trade. Hence, it shouldn’t come as a shock that the effects of inflation are far-reaching too and are dictated by how a nation was prepared to deal with them or not.
The demand-pull effect of inflation happens when there is an increased supply of money (in its broader terms) which in turn creates a massive demand surge for commodities, going beyond the production capacity of the industries. Hence, just as the demands keep increasing, so do the prices – creating an infinite inflation loop that becomes difficult to break.
The cost-push effect of inflation happens when there is a rise in commodity prices because of the production process it goes through. When there are unnecessary additions to the supply chain process of the production of a product, and it channels its way through the cost of everything, it consequently results in the price hike of all intermediate goods and services.
The built-in inflation effect is actually the worse outcome of inflation on the whole. It is basically the idea that people form this unhealthy expectation for the current inflation rate that it will continue over long into the future. This then shapes their ways of saving and spending accordingly, making it highly challenging to work against the tides and shape the economy for the better.
Pros and Cons of Inflation
Naturally when inflation is such a widespread economic phenomenon, it is bound to have certain pros and cons about the whole ordeal too. However, as inflation is highly subjective to how the people and the government of a country prepare for and respond to it, the pros and cons cannot be derived simply based on a single perspective. The following points do contribute to how inflation is experienced generally but categorizing them as pros and cons is subjective.
- Increased Assets Prices
- Encourage Spending Instead Saving
- Impose Cost to Economy
- Increased Prices
Bottom Line
We hope to have covered every base to explain inflation for dummies. It still might take a few rounds of research for someone to come to terms with how far-reaching inflation can be, how it is a worldwide phenomenon and isn’t limited to one’s spending capacity – but then again, considering the heavy use of the term nowadays, maybe even we don’t know what inflation is.
Read more: 27+ Crucial Financial Statistics (2022 Update)
