What Is Inflation?

Inflation is a gradual loss of purchasing power that is reflected in a broad rise in prices for goods and services over time. The inflation rate is calculated as the average price increase of a basket of selected goods and services over one year. High inflation means that prices are increasing quickly, while low inflation means that prices are growing more slowly. Inflation can be contrasted with deflation, which occurs when prices decline and 澳洲幸运5官方开奖结果体彩网:purchasing power increases.

Understanding Inflation

An increase in the 澳洲幸运5官方开奖结果体彩网:money supply is the root of inflation, though🌠 this can play out through different mechanisms in the economy. A country’s money supply can be increased by the monetary authorities by:

• Printing and giving away more money to citizens
• Legally devaluing (reducing the value of) the 澳洲幸运5官方开奖结果体彩网:legal tender currency
• Loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market

Other causes of inflation include supply b𓆏ottlenecks and shortages of key goods, which can push prices to rise.

When inflation occurs, money loses its purchasing power. This can occur across any sector or throughout an entire economy. The expectation of inflation itself can further sustain the 澳洲幸运5官方开奖结果体彩网:devaluation of money. Workers may demand higher wages and businesses may charge higher prices, in anticipation o༺f sustained inflation. This, in turn, reinforces the factors that push prices up🔯.

Types of Inflation

Inflation can be classified into three types: demand-pull inflation, cost-push i💫nflation, and built-in inflation.

Demand-Pull Effect

澳洲幸运5官方开奖结果体彩网:Demand-pull inflation occurs when an increase in the supply of money and credit stimulates the overall demand for goods and services to increase more rapidly than the econom꧃y’s production capacity. This increases demand and leads to pri💃ce rises.

When peopl🅺e have more money, it leads to positive consumer sentiment. This, in turn, leads to higher spending, which pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices.

Cost-Push Effect

澳洲幸运5官方开奖结果体彩网:Cost-push inflation is a result of the increase 🍰in prices working through the productio🅷n process inputs. When additions to the supply of money and credit are channeled into a commodity or other asset markets, costs for all kinds of intermediate goods rise. This is especially evident when there’s a negative economic shock to the supply of key commodities.

These developments lead to higher costs for the finished product or service and work their way into rising consumer prices. For instance, when the money supply is expanded, it creates a speculative boom in 澳洲幸运5官方开奖结果体彩网:oil prices. This means that the cos💎t of energy can rise and contribute to rising consumer prices, which is reflected in various measures of inflation.

Built-In Inflation

Built-in 𒁃inflation is related to adaptive expectations or the idea that people expect current inflation rates to continue in the future. As the price of goods and services rises, people may expect a continuous rise in the future at a 𒀰similar rate.

As such, workers may demand more costs or wages to maintain their standard of living. Their increased wages result in a higher cost of goods and services, and 澳洲幸运5官方开奖结果体彩网:this wage-price spiral continues as one factor induces the other and vice v🐻ersa.

How Inflation Impacts Prices

While it is easy to measure the price changes of individual products over time, human needs extend beyond just one or two products. Individuals need a big and diversified set of products as well as a host of services to live a comfortable life. They include 澳洲幸运5官方开奖结果体彩网:commodities like food grains, metal, fuel, utilities like electricity and transportation, and services like 澳洲幸运5官方开奖结果体彩网:healthcare, entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of products and services. It allows for a single value representation of the increase in the price level of goods and services in an economy over a specified time.

Prices rise, which means that one unit of money buys fewer goods and services. This loss of purchasing power impacts the cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation’s 澳洲幸运5官方开奖结果体彩网:money supply growth outpaces economic growth.

To combat this, the monetary authority (in most cases, the 澳洲幸运5官方开奖结果体彩网:central bank) takes the necessary steps to manage the money supply and cඣredit to keep inflation within permissible limits and keep the economy running smootဣhly.

Theoretically, 澳洲幸运5官方开奖结果体彩网:monetarism is a popular theory that explains the relationship between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of 澳洲幸运5官方开奖结果体彩网:gold and silver flowed into the Spanish and other European economies. Since the money supply rapidly increased, the value of money fell, contributing to rapidly rising prices.

Inflation is measured in a variety of ways depending on the types of goods and services. It is the opposite of 澳洲幸运5官方开奖结果体彩网:deflation, which indicates a general decline in prices when the inflation rate falls below 0%. Keep in mind that deflation shouldn’t be confused with 澳洲幸运5官方开奖结果体彩网:disinflation, which is a related term referring to a slowing down in the (positive♔) rate of inflation.

How to Protect Your Finances During Inflation

There are a range of measures that individuals can take to 澳洲幸运5官方开奖结果体彩网:protect their finances against inflation. For instance, one may choose to invest in asset classes that outperform the market during inflationary times. This might include commodities like ♋grain, beef, oil, electricity, and natural gas.

Commodity prices typically stay one step ahead of product prices, and price increases for commodities are often seen as an indicator of inflation to come. Commodities, which ca🌠n also be volatile, are easily affected by natural disasters, geopolitics, or conflict.

Real estate income may also help buffer against inflation, ⛦as landlords can in꧋crease their rent to keep pace with the rise of prices overall.

The U.S. government also offers 澳洲幸运5官方开奖结💟果体彩网:Treasur🦄y Inflation-Protected Securities (TIPS), a type of ꧑security indexed to inflatꦺion to protect against declines in purchasing power.

Types of Price Indexes

Depending upon the selected set of goods and services used, multiple types of baskets of goods are calculated and tracked as price indexes. The most commonly used price indexes are the 澳洲幸运5官方开奖结果体彩网:Consumer Price Index (CPI) and the 澳洲幸运5官方开奖结果体彩网:Wholesale Price Index (WPI).

Consumer Price Index (CPI)

The CPI is a measure that examines the 澳洲幸运5官方开奖结果体彩网:weighted average of prices of a basket of goods and services that are of primary consumer needs. They include 🎃transportation, food, and medical care.

CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them based on their relative weight in the whole basket. The prices in consideration are the retail prices of each item, as available for purchase by the individual citizens. 澳洲𒀰幸运5官方开奖结果🌱体彩网:CPI can impact the value of one currency against those of other nations.

Changes in the CPI are used to assess price changes associated with the 澳洲幸运5官方开奖结果体彩网:cost of living, making it one of the most frequently used statistics for identifying periods of inflation or deflation. In the United States, the 澳洲幸运5官方开奖结果体彩网:Bureau of Labor Statistics (BLS) reports the CPI each month and has calculated it as far back as 1913.

Wholesale Price Index (WPI)

The WPI is another popular measure of inflation. It measu𓆉res and tracks the changes in the price of goods in the stages before the retail level.

While WPI items vary from one country to another, they mostly include items at the producer or wholesale level. For example, it includes cotton prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing.

Although many countries and organizations use the WPI, many other countries, including the U.S., use a similar variant called the Producer Price Index (PPI).

Producer Price Index (PPI)

The PPI is a family of indexes that measures the average change in selling prices received by domestic producers of intermediate goods and services over time. The PPI measures price changes from the perspective of the seller and differs from the CPI, which measures price changes from the perspective of the buyer.

In all variants, the rise in the price of one component (say oil) may cancel out the price decline in another (say wheat) to a certain extent. Overall, each index represents the average weighted price change for the given constituents which may apply at the overall economy, sector, or commodity level.

The Formula for Measuring Inflation

The above-mentioned variants of price indexes can be used to calculate the value of inflation between two particular months (or years). While a lot of ready-made are already available on various financial portals and websites, it is always better to be aware of the underlying methodology to ဣensure accuracy with a clear understanding of the calcula🃏tions. Mathematically,

Percent Inflation Rate = (Final CPI Index Value ÷ Initial CPI Value) × 100

Say you wish to know how the purchasing power of $10,000 changed between January 1975 and January 2024. One can find price index data on various portals in a tabular form. From that table, pick up the corresponding CPI figures for the given two months. For September 1975, it was 52.1 (initial CPI value), and for January 2024, it was 308.417 (final CPI value).

Plugging in the formula yields:

Percent Inflation Rate = (308.417 ÷ 52.1) × 100 = (5.9197) × 100 = 591.97%

Since you wish to know how muꦉch $10,00🐼0 from January 1975 would be worth in January 2024, multiply the inflation rate by the amount to get the changed dollar value:

Change in Dollar Value = 5.9197 × $10,000 = $59,197

This means that $10,000 in January 1975 will be worth $59,197 today. ♒Essentially, if you purchased a basket of good𒆙s and services (as included in the CPI definition) worth $10,000 in 1975, the same basket would cost you $59,197 in January 2024.

Advantages and Disadvantages of Inflation

Inflation can be c🌳onstrued as either a good or a bad thing, depending upon which side one takes, and how rapidly t▨he change occurs.

Advantages

Individuals with tangible assets (like property or stocked commoditꦅies) priced in their home currency may like to see some inflation as that raises the price🐼 of their assets, which they can sell at a higher rate.

Inflation often leads to 澳洲幸运5官方开奖结果体彩网:speculation by businesses in risky projects and by in♐dividuals who invest in company stocks because they expect🐽 better returns than inflation.

An optimum level of inflation is often promoted to encourage sཧpending to a certain extent instead of saving. If the purchasing power of money falls over time, there may be a greater incentive to spend now instead of saving and spending later. It may increase spending, which may boost economic activities in a country. A balanced approach is thought to keep the inflation value in an optimum and desirable range.

Disadvantages

Buyers of such assets may🦩 not be happy with inflation, as they will be required to shell out more money. People who hold assets valued in their h𝓀ome currency, such as cash or bonds, may not like inflation, as it erodes the real value of their holdings.

As such, investors looking to 澳洲幸运5官方开奖结果体彩网:protect their portfolios from infla꧃tion should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts (REITs). 澳洲幸运5官方开奖结果体彩网:Inflation-indexed bonds are another popular option for investors to 澳洲幸运5官方开奖结果体彩网:profit from inflation.

High and variable rates of inflation can imp🍸ose major costs on an economy. Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and♋ planning decisions.

This introduces an additional source of uncertainty into the economy, becauജse they may guess wrong about the rate of future inflation. Ti🔯me and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices. That’s opposed to real economic fundamentals, which inevitably represent a cost to the economy as a whole.

Even a low, stable, and easily predictable rate of inflation, which some consider otherwise optim𒁏al, may lead to seriou𝄹s problems in the economy. That’s because of how, where, and when the new money enters the economy.

Whenever new money and credit enter the economy, it is always in the hands of sඣpecific individuals or business firms. The process of price level adjustments to th🐻e new money supply proceeds as they then spend the new money and it circulates from hand to hand and account to account through the economy.

Inflation does drive up some prices first and drives up other prices later. This sequential change in purchasing power and prices (known as the Cantillon effect) means that the process of inflation not only increases the general price level over time but also 澳洲幸运5官方开奖结果体彩网:distorts relative prices, wages, and rates of return along the way.

Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and 澳洲幸运5官方开奖结果体彩网:Austrian economists even believe this process to be a major driver of cycles of recession in the economy.

How Inflation Can Be Controlled

A country’s financial regulator shoulders the important responsibility of keeping inflation in check. It is done by implementing measures through 澳洲幸运5官方开奖结果体彩网:monetary policy, which refers to the act🍬ions of a central bank or other committees that determine the size🦹 and rate of growth of the money supply.

In the U.S., the Fed’s monetary policy goals include moderate long-term interest rates, price stability, and maximum employment. Each of these goals is intended to promote a stable financial environment. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady 澳洲幸运5官方开奖结果体彩网:long-term rate of inflation, which is tho🎃ught to be beneficial to the economy.

Price stability or a ෴澳洲幸运5官方开奖结果体彩网:relatively constant 𒉰level of inflation allows businesses to plan for the future since they know what tꦇo expect. The Fed believes that this will promote maximum employment, which is determined by non-mon﷽etary factors that fluctuate over time and are therefore subject to change.

For this reason, the Fed doesn’t set a specific goal for maximum employment, and it is largely determined by employers’ assessments. Maximum employment does not mean zero unemployment, as at any given time there is a certain level of 澳洲幸运5官方开奖结果体彩网:volatility as people vacate and start new jobs.

Monetary authorities also take exceptional measures in extreme conditions of the economy. For instance, following the 2008 financial crisis, the U.S. Fed kept the interest rates near zero and pursued a bond-buying program called 澳洲幸运5官方开奖结果体彩网:quantitative easing (QE).

Some critics of the program alleged it would cause a spike in inflation in the U.S. dollar, but inflation peaked in 2007 and declined steadily over the next eight years. There are many complex reasons why QE didn’t lead to inflation or 澳洲幸运5官方开奖结果体彩网:hyperinflation, though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects.

Consequently, U.S. policymakers have attempted to keep inflation steady at around 2% per year. The 澳洲幸运5官方开奖结果体彩网:European Central Bank (ECB) has also pursued aggressive quantitative easing to counter deflation in the eurozone, and some places have experienced 澳洲幸运5官方开奖结果体彩网:negative interest rates. That’s due to fears that deflation could take hold in the eurozone and lead to economic stagnation.

Moreover, countries that experience higher rates of growth can absorb higher rates of inflation. India’s target is around 4% (with an upper tolerance of 6% and a lower tolerance of 2%), while Brazil aims for 3.25% (with an upper tolerance of 4.75% and a lower tolerance of 1.75%).

Meanin♉g of Inflaꦏtion, Deflation, and Disinflation

While a high inflation rate means that prices are increasing, a low inflation rate does not mean that prices are falling. Counterintuitively, when the inflation rate falls, prices are still increasing, but at a slower rate than before. When the inflation rate falls (but remains positive), this is known as 澳洲幸运5官方开奖结果体彩网:disinflation.

Conversely, if the inflation rate becomes negative, that means that prices are falling. This is known as 澳洲幸运5官方开奖结果体彩网:deflation, which can have negative effects on an economy. Because buying power increases over time, consumers have less incentive to spend money in the short term, resulting in falling economic activity.

Hedging Against Inflation

Stocks are considered to be 澳洲幸运5官方开奖结果体彩网:the best hedge against inflation, as the rise in stock prices is inclusive of the effects of inflation. Since additions to the money supply in virtually all modern economies occur as bank 澳洲幸运5官方开奖结果体彩网:credit injections through the financial system, m🐽uch of the immediate effect on prices happens in financial assets that are priced in their h🎃ome currency, such as stocks.

Special financial instruments exist that one can use to safeguard investments against inflation. They include 澳洲幸运5官🐟方开奖结果体彩网:Treasury Inflation-Protected Securities (TIPS), a low-risk treasury security that is indexed to inflation where the principal amount invested is increased by the percentage of inflation.

One can also opt for a TIPS mutual fund or TIPS-based 澳洲幸运5官方开奖结果体彩网:exchange-traded fund (ETF). To get access to stocks, EඣTFs, and other funds that can help avoid the dangers of inflation, you’ll likely need a brokꦉerage account. Choosing a stockbroker can be a tedious process due to the variety among them.

Gold is also considered to be a hedge against inflation, although this doesn’t always🦹 appear to be the case looking backward.

Examples of Inflation

Since all world currencies are 澳洲幸运5官方开奖结果体彩网:fiat money, the money supply could increase rapidly for political reasons, resulting in rapid price level increases. The most famous example is the hyperinflatio🌌n that struck the German Weimar Republic in the early 1920s.

The nations that were victorious in World War I demanded reparations from German💝y, which could not be paid in German paper currency, as this was of suspect value due to government borrowing. Germany attempted to pr🙈int paper notes, buy foreign currency with them, and use that to pay their debts.

This policy led to the rapid devaluation of the 澳洲幸运5官方开奖结果体彩网:German mark along with the hyperinflation that accompanied the development. German consumers responded to the cycle by trying to spend their money as fast as possible, understanding that it would be worth less and less the longer they waited. More money flooded the economy, and its value plummeted to the point where people would paper their walls with practically worthless bills. Similar situations occurred in Peru in 1990 and in Zimbabwe between 2007 and 2008.

The Bottom Line

Inflation is a rise in prices, which results in the decline of purchasing power over time. Inflation is natural and the U.🙈S𝓀. government targets an annual inflation rate of 2%; however, inflation can be dangerous when it increases too much, too fast.

Inflation makes items more expensive, especially if wages do not rise by the same levels of inflation. Additionally, inflation erodes the value of some𒈔 assets, especially cash. Governments and central banks seek toꦇ control inflation through monetary policy.