inflation

What is Inflation?

deltafx writer 17 January 2022

Inflation is the gradual loss of a currency’s buying value. Economists use the rise in the average price level of a group of chosen goods and services in an economy over a while to calculate a quantitative estimate of the pace at which buying power declines. An increase in the overall level of prices, commonly stated as a percentage, indicates that a unit of money now has less buying power than before. Demand-Pull inflation, Cost-Push inflation, and Built-In inflation are three forms of inflation.

The reasons for inflation

Inflation is caused by an increase in the quantity of money in circulation, but this can occur through a variety of economic causes. The government can increase the amount of money in circulation by printing more money and giving it away to individuals, lowering the value of the currency, or lending new money through the banking system.

The buying power of money decreases in all circumstances of a rise in the money supply. There are three sorts of mechanisms that cause inflation: demand-pull inflation, cost-push inflation, and built-in inflation:

Demand-Pull Effect

Demand-pull inflation happens when the amount of money and credit available in an economy grows faster than the number of goods and services made in that economy. This causes more people to look for goods and services, and as the demand increases, prices go higher. Increased demand for goods and services pushes up prices due to more positive sentiment among consumers and rising expenditure. The difference between supply and demand will raise prices.

Cost-Push Effect

Cost-push inflation happens when the cost of production and the overall cost of goods and services rise. It leads to an increase in the end product or services for consumers. It’s a form of inflation that comes from the supply side, and it occurs when there is less of a commodity or service to buy. Demand-pull inflation is the opposite of this, and it happens when more people want something, which causes prices to go up. Natural disasters, depletion of natural resources, monopoly, government regulation or taxation, and changes in currency rates might all contribute to supply-side inflation.

Built-in Inflation

Workers expect their salaries or wages to rise when the prices of goods and services rise so that they can keep up with their living costs. This is called built-in inflation. As you can see, having built-in inflation can have some pros and cons. The more salary the workers receive, the higher the cost of production will be, making it more expensive to live. People who work might demand more money when the cost of living increases. All of these factors work together to create a cycle. There is, however, no way for built-in inflation to happen on its own. It happens due to demand-pull inflation or cost-push inflation.

Pros and Cons of Inflation

Moderate inflation diminishes real debt value. Deflation raises the actual worth of debt.

Inflation rates that are moderate enable prices to adapt and commodities to reach their true value.

Moderate wage inflation allows for relative pay adjustment.

Inflation is a good indicator of a healthy economy if the rate is not too high. Inflation is almost always a byproduct of strong economic development.

Deflation has the potential to be exceedingly harmful to the economy, as it might result in lower sales and economic growth. When prices are falling, for example, buyers may be encouraged to put off purchasing in the hopes of a lower price in the future.

Inflation causes uncertainty and discourages investment. Usually, nations with high inflation have bad investment and economic growth rates.

 Incomes values fall due to inflation and no income growth.

Inflation may lower the actual value of savings, which can be especially detrimental to elderly persons who rely on their savings.

The actual value of government bonds will be reduced by inflation.

Hyperinflation has the potential to ruin an economy. Out-of-control inflation may lead to a vicious cycle in which increasing inflation leads to increased inflation expectations, which pushes the prices higher. Hyperinflation may wipe away middle-class savings and help those who are in debt. 

How to control inflation

There are three ways to control inflation:

  • A contractionary monetary policy is a prominent approach of reducing inflation. A contractionary policy’s purpose is to decrease an economy’s money supply through lowering bond prices and raising interest rates.
  • The second method is to raise reserve requirements, which are the minimum amounts of money that banks must maintain on hand to cover withdrawals. The more money banks keep in reserve, the less money they can lend to customers. Consumers will borrow less if the banks have less money to lend, resulting in lower expenditure and lower demand.
  • The third way is to lower the money supply directly or indirectly by establishing methods that support this reduction.  Asking for the payment of debts to the government; Also, boosting the interest paid on bonds to encourage more investors to purchase them can help this process.

How to benefit from inflation

There are two main ways to help you increase your capital in countries with a high inflation rate. The first one is being in debt! You can take a loan from a bank, invest the money in any field that generates profit. You can still make a small profit even if you keep the value of the borrowed money stable. The value of your debt keeps falling over time. When you pay your debt, for example a year later, the value of borrowed money which is invested by you is more than your debt.

The second way is to buy safe and stable assets which are hard to produce and replace and hold them for a while. Gold and precious metals are always among the best choices in this regard. Their value will grow over time when inflation is high, and you can make some profit.

Conclusion

As you see, inflation has some advantages and disadvantages for us. it high and negative inflation rates can be terrible for any economy. However, the low and moderate inflation rates can help an economy flourish. Countries with high inflation rates where governments try to control them are the best place for opportunist investors to make big profits.

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