What is Inflation and how it affects the economy

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Inflation

Inflation is the increase in prices of consumer goods and services of a country over time. In other words, the gradual decrease in the purchasing power of a unit of currency in a country. Every country has some amount of inflation in its economy. It is one of the major factors affecting a countries currency value. Therefore, with the increasing inflation, the countries currency lost its value over time. With the result that, people in such a country pays more than they paid before. 

 

Any country has its own fluctuation in currency value. When currency value increases, the purchasing power of a unit of the currency goes up. According to the definition, inflation goes down. Like this, when the currency value goes down, inflation automatically rises. Currency value has the strongest connection with inflation. Demand and supply for consumer goods and services also affect inflation. When demand for goods and services increase over time, it represents the buying power of the customers. As they are willing to pay more, inflation reaches higher in value. Inflation also can occur when the production cost of any good or service increases due to natural disasters and rising employee wages.  

Types of Inflation

Different types of inflation can be found in an economy. Four of them are considered as major types. They are categorised by their rate of increase. Other than the four major types, there are a few more specific types. Namely,

  • Creeping
  • Walking
  • Galloping
  • Hyperinflation
  • Core
  • Wage
  • Asset

Let us describe each type of inflation and its effect on the economy.

 

Creeping 

This happens when inflation rates rise up to 3% a year. Generally, any government sets it's target inflation rate up to 2%. It helps an economy to grow at a certain level. When creeping inflation effects, consumers buy more to defeat higher future prices. This increases demand and it makes the economy to grow over time.

Walking 

This is an effect of the rising inflation from 3% to 10% in a year. This type is harmful to the economy. It stimulates economic growth over limits. So that the consumers purchase a lot more than the amount they need. This increases demand until suppliers fail to continue. As a result, wages increase affecting the prices of consumer goods and services to rise.

Galloping 

When inflation passes 10% limit, it creates a currency devaluation. Employee wages get fail with the rising prices of goods and services. Furthermore, the economy goes down.

Hyperinflation

Hyperinflation makes prices to increase by more than 50% a month. Any country with hyperinflation experiences a harsher situation in peoples lives.

Core

Core inflation describes the rising prices except for energy and food.

Asset

Assets like crude oil, gas, gold, silver, grains, coffee, iron, food, ...etc get affected by this type of inflation. As a result, industries like housing, food manufacture, textile, medicine,...etc get their prices to increase.

Causes of Inflation

Employee wages increase over the cost of living due to several reasons. Furthermore, unemployment rates below 4% and employee unions fight for higher wages causes wage inflation.

There are two causes of inflation we see in an economy. 

  1. Cost-push 
  2. Demand-pull 

Cost-push Inflation

This type of inflation occurs due to rising prices of material and employee wages. There are some reasons for the rising material price and wages. Namely, 

 

  • rising commodity price - crude oil, natural gas, grains, vegetables...etc
  • Natural disasters 
  • Shortage of qualified labour while having low unemployment rate
  • Currency devaluation

 

Commodities like oil, gas, grains...etc have price fluctuations in its own markets. With the rising prices of commodities, the material price automatically increases. Also, natural disasters create extra pressure on the economy. It turns the smooth run of a country to a harsh situation. So that it makes peoples’ lives hard to continue. Employee wages and compensations will increase in a very short period of time. The effect of the disaster will make prices of inputs to reach higher values. Furthermore, if such a country has low employment rate with a well-performing economy while having a shortage of labour, production companies must have to pay more for their labours. 

 

Above mentioned points create a higher price for goods and services. But demand stays unchanged. This effect describes as Cost-Push inflation.

Demand-pull Inflation

When demand for goods and services increases, supply decreases respectively. When demand increases without having enough supply, consumers willing to pay more for goods and services. In business, companies can raise their prices due to demand. Demand shows consumers’ capacity to purchase so that the capacity causes companies to increase price margins. Other than companies, cooperations can raise commodity prices like crude oil price and natural gas prices just because of the huge consumer demand.

 

When interest rates are higher, people tend to invest more. It creates a demand for the currency and inflation goes down. When the interest rates are reduced by the government, companies and consumers both get more money to spend. It creates more availability in money, making prices of goods and services to reach a higher value.

Benefits  and who takes it

Rising inflation itself makes consumers spend more and more money on day to day goods and services. While prices reach higher and higher levels, companies get more and more profits. Every time inflation rises, consumers feel much more stress on their general expenses. Every cost increment in production passed on to consumers making the companies income levels better while experiencing higher inflation.