What is inflation?

What is inflation?

Over the span of this turbulent year, the effects of inflation are more apparent than ever. Across the globe currencies have seen a rise in prices and a decline in purchasing power, this trend is the basis of what we call inflation.

The decline is usually gradual but as time progresses, the strength of each dollar can heavily impact the purchasing power of your savings over several years. John Schmidt, an editor for Forbes Advisor explains that “in 1980 for example, a movie ticket cost on average $2.89. By 2019, the average price of a movie ticket had risen to $9.16. If you saved a $10 bill from 1980, it would buy two fewer movie tickets in 2019 than it would have nearly four decades earlier.”

Inflation doesn’t just relate to prices of individual goods or select services, it can be related to entire industries on a broader scale. There can be mixed views about whether inflation is a positive or negative contributor to an economy. On one hand, having your money lose its value can be stressful but on the other hand, small amounts of inflation can encourage spending and create innovative investment opportunities. Inflation can be tracked using a broad basket of indexes relating to goods and services, the most common being the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).

Stimulating the economy can be a benefit of short-term inflation but it can become a “destructive force” when given the chance to rise dramatically. If left unchecked, “inflation can topple a country’s economy, like in 2018 when Venezuela’s inflation rate hit over 1,000,000% a month, causing the economy to collapse and forcing countless citizens to flee the country.” This is also known as hyperinflation, which occurs when inflation is rapidly rising to cause the currency to increase just as fast which results in the downfall of a country’s currency value.

Inflation can be classified into three types; demand-pull inflation, cost-push inflation, and built-in inflation. The demand-pull effect arises when there’s an increase in the supply of money and credit which creates a higher demand for goods and services, impacting the economy’s production capacity causing prices to rise. “It creates a demand-supply gap with higher demand and less flexible supply which results in higher prices.”

Cost-push inflation is when there is an increase in prices while working through production process inputs. When money and credit supplies are driven towards commodities or other asset markets, the economy is led towards higher costs in a broad basket of intermediate goods; “these developments lead to higher cost for the finished product or service and work their way into rising consumer prices.”

Built-in inflation is tied to adaptive expectations, this is the notion that individuals anticipate inflation rates to continue creating a lasting economic impact. “Increased wages result in higher cost of goods and services, and this wage-price spiral continues as one-factor incudes the other and vice-versa.” With an increase in prices of goods and services, comes a demand for higher wages to maintain a manageable standard of living for the working class.

This form of inflation can be associated with the term stagflation which describes when there is high inflation without economic growth, the result being rising numbers of unemployment.

Deflation, in contrast, is when the purchasing power of money increases while prices decline. At first glance, it may appear to be helpful to have more bang for your buck but deflation can end up being a larger hindrance to an economy than unchecked inflation.

Inflation can impact an economy on large scales; from the value of a country’s currency to the demand and production of goods and services. While there are many ways inflation is able to economically stimulate growth byways of consumer spending and export relations, those trying to save money may find inflation periods difficult as it holds them back from maintaining their investments in the future.

By Surina Nath