Inflation

Inflation is when the prices of goods and services keep increasing over a certain period. It results in a decline in the purchasing power of customers. It aims to gauge the effect of increasing prices on the economy in a financial year.

A low rate increases or rather balances the employment rate. Also, the rate of investment growth rises and, thus, the gross domestic product increase. However, it can invite deflation (or recession) in the economy without the necessary precautions deflation (or recession).

• Inflation is when a country's economy sees an increase in the prices of products and services due to a decline in purchasing power. David Hume first proposed the concept in the 18th century.
• Inflation types include demand pull, cost pull, creeping, galloping, and hyperinflation. In this situation, borrowers, businessmen, entrepreneurs, farmers, and employees enjoy the profits.
• It is mainly caused by increased monetary supply, government policies, rate fluctuations, and similar things.
• Consumer price index (CPI), Producer price index (PPI), and Wholesale price index (WPI) are the main indicators to measure it.

Inflation in economics is a rate or an indicator showing that the value of money depreciates with time. In simple words, expensive products and services today might become more expensive tomorrow. For example, the price of 10gram gold in 1990 was $40. However, the same quantity of gold today is available at $576.

This concept has existed since ancient times. In the initial kingdom rule, people used metal coins extensively. However, they started hoarding the coins, leading to a shortage. By the late 17th century, the government had started accepting fiat money as notes.

In the 18th century, Scottish philosopher and economist David Hume first used the word 'inflation.' Hume stated that prices would continue to rise as the supply of money increases, giving rise to massive price rises. Later in the mid-20th century, American economist Milton Friedman stated that the money supply should increase as the economy grows as it stabilizes the fluctuating prices. Later, many other economists like John Maynard Keynes and Ludwig von Mises worked on it. Keynes proposed the theory of income, stating that inflation occurs when the demand for goods exceeds its supply.

The theory works on the foundation of two main factors: prices and money supply. If the government increases the money supply in the economy, people will have more money. It can be either easy loans or hiked income. Since people have money, they will demand (buy) more items. As a result, firms will increase their prices in return. As this cycle continues, inflation appears on the surface. So the government either raises interest rates or reduces the money supply to curb it.

Let us look at the types of inflation that are currently existing in the economy:

#1 - Demand Pull Inflation

It occurs when the demand exceeds supply. Thus, forcing the firms to increase the prices. For instance, the Lawson boom of the late 1980s. At that moment, the United Kingdom saw a huge rise in the prices of houses. Also, household consumption increased massively. Therefore, as a result of increasing prices, the demand surpassed supply.

#2 - Creeping Inflation

In the initial stage, the inflation rate is around 2%, 3%, or 5%. At this point, the prices rise at a very minimal rate gradually. However, ignoring them can cause prices to rise.

#3 - Cost-Pull Inflation

This situation appears when the cost of production forces firms to increase their prices. For example, the factors of production like labor, raw material, and technology are getting expensive.

#4 - Walking Inflation

The hike is said to be walking when the rate rises by 3% to 10% yearly. In September 2022, Sweden's central bank announced an inflation report of 9%, probably the highest since 1990. Later, the western countries had inflation news of 7-8%.

#5 - Galloping Inflation

Galloping inflation occurs when the rate is between 20-1000%. In such situations, there is too much instability within the economy. As a result, the governing bodies fail to bring situations within control. For example, in the 1990s, Russia faced a galloping situation where the prices of food and goods increased severely. In 1993, the rate in Russia was 839.21 %.

#6 - Hyperinflation

Hyperinflation occurs when the rate is above 1000%. At this stage, the value of money depreciates faster.

Let us look at the causes of inflation that affects the economy:

#1 - Increased Money Supply

The money supply is one of the prime reasons for causing inflation. It occurs when the government prints more currency than the prevailing growth rate. For example, in 2009, Zimbabwe printed excess currency to normalize the economic situation. Similarly, other African nations also print money to increase their supply.

#2 - Government Policies

At times, government plans and policies can also cause inflation. For example, restrictions on imports cause the cost of production to rise. As a result, the firms try to adjust that extra cost by increasing the prices of their products.

#3 - Changes In Exchange Rates

If the dollar's value fluctuates, consumers have less purchasing power. As a result, the prices of products rise, causing this situation.

#4 - Rising Wage Rates 

The rising wage rate is one of the vital factors for inflation. As the government increases the money supply, the salaries of individuals also increase. Thus, consumers tend to buy products causing prices to rise.

Here are some inflation effects for understanding the concept clearly -

#1 - Depreciation Of Money

The constant effect of the concept is the decline in money's value. It indicates depreciation in the value of money. An item that was affordable a day before becomes expensive the day after. For example, the average price of a car back in 1974 was $97. However, now it ranges at around $13,800.

#2 - Increased Bank Rates

Rising prices force the government to increase bank rates. For example, the Federal government has constantly increased bank rates by 0.5 points in the past few months. If they continue to do so, consumers will borrow less and try holding money.

#3 - High Standard Of Living

Since consumers have a good income, they tend to spend more on goods and services. For example, a middle-class family avoids buying an oven earlier. However, having extra money helps them to upgrade their living standards.

#4 - Hiked Prices

One of the major impacts of inflation is on prices. If the firms learn about it, they will increase their prices. The firms believe customers are ready to pay any amount, so services and goods become expensive.

#5 - Income Distribution Inequality

Price rise impacts the poor and makes the rich richer. Simply put, firm owners (businessmen and entrepreneurs) become rich by rising prices. In contrast, the consumers keep paying them, leading to less income.

#6 - Negative Impact On Exports 

As the prices of raw materials increase, the exports also get affected. As a result, the demand for products in the foreign market drops. Thus, there is a drop in export revenues.

#7 - Impact On Investors

As prices rise, investors try to save less and spend more. However, the market will react negatively if a country has a high rate.

The three indicators for measuring inflation are the following -

#1 - Consumer Price Index (CPI)

The consumer price index (CPI) is an indicator to measure the average price of basket goods (fixed goods) that consumers tend to buy. For example, transportation, medicines, fuel, and similar things. The base year's price divided by the current year's price yields the rate.

#2 - Wholesale Price Index (WPI)

The wholesale price index (WPI) measures the prices of goods before distribution. In other words, goods are necessary for the firm to produce finished items. It varies from country to country. For example, fuel and power.

#3 - Producer Price Index (PPI)

The producer price index measures the prices of goods primarily used in production. These include raw materials like wheat, rice, cotton, and yarn. The only difference between CPI and PPI is that the former concentrates on consumer goods. In contrast, the latter focuses on producer goods.

To calculate the rate, users need to gather data on a prior basis. Then, later, use the CPI formula to calculate a particular period's rate. Now, let us look at the formula for calculating inflation for a better understanding:

Where B = Price of product in the current year 

           A = Price of product in the previous (base) year

For instance, if the price of 1kg mango in 2021 was $0.96 and currently the price is $1.27. So, using the formula, the price of mangoes has inflated by 32%.

Here is an example of inflation to comprehend the concept better.

The eurozone inflation in August 2022 touched a high of 9.1%. In the European Union countries, CPI rose 0.6% each month. As a result of the Ukrainian war crisis, eurozone inflation has risen. Another inflation report says that the Sweden government has increased interest rates by 100 points, warning against the upcoming situation. Besides that, the inflation news about Japan saw a rise in the CPI, which was 2.8% in August 2022.

Let us look at the benefits of inflation on different parts of the economy:

#1 - Borrowers With Previously Brought Loans

Although it does not benefit everyone, some borrowers benefit from it. It forces the government to increase bank rates. Thus, people who have previously bought loans at fixed interest do not need to pay a higher interest rate.

#2 - Businessmen And Manufacturers

Inflation causes a rise in the prices of goods and services. As a result, the producers will make massive profits. On the other hand, situations like demand-pull inflation will force consumers to buy items even at a higher price. For example, energy plant owners benefit from price rises because energy is crucial despite the situation. Likewise, the food industry has a similar theory as humans continue consuming food.

#3 - Lenders

Because of hiked interest rates, lending institutions like banks are profitable. But, for example, borrowers now have to pay a higher interest rate to lenders due to it.

#4 - Investors

Investors and shareholders are the primary beneficiaries of this situation. First, the stock market sees a rise in share prices. As the market rallies, the share prices turn bullish. As a result, the shareholders also receive high dividends.

#5 - Primary Producers

Primary producers like farmers are the winners in this situation. This is because their revenue also doubles as the cost of factors increases.

#6 - Employees 

Lastly, the cycle of inflation is incomplete without employees. Increased money supply also hikes the wage rate of workers. As a result, they get to spend extra income and enjoy a formal living.

This article has been a guide to Inflation and its meaning. Here, we explain its types, causes, effects, measures, formula, and benefits. You may also find some useful articles here -

• Inflation vs Recession
• Inflation Targeting
• Core Inflation