What Is Inflation: Reasons and Consequences

What is inflation? What is the reason for that? How does it affect the economy and what methods are there to control it? In this article we will try to answer these questions. Let's start.

What is inflation?

Inflation is an index of growth in general prices of goods and services. When prices rise, one unit of the national currency can buy fewer goods and services. Therefore, inflation facilitates a decrease in the purchasing power of money. The opposite of inflation is deflation, which is a continuous decline in the prices of goods and services.

In other words, inflation is the rate (expressed as a percentage) of growth in the general level of prices for goods and services. The inflation rate shows how much prices have risen in the country over a certain period of time. Inflation causes the prices of various assets to rise over time. The higher inflation reaches, the more prices go up.

Index for assessing inflation

A special index is used to assess inflation over a certain period of time.

The Consumer Price Index (CPI) shows the weighted average price change for goods and services in the basic basket over a certain period of time. This is known as consumer inflation, which includes food, clothing, medical services, etc.

The producer price index (PPI) evaluates the average change in the selling price of domestic producers of goods and services. It evaluates price changes from the seller's point of view and includes the production of consumer goods, capital goods, processing of raw materials, etc.

The Wholesale Price Index (WPI) is another inflation index that evaluates and tracks changes in the price of goods gradually before they reach retailers. To calculate it, we use the prices of a number of commodities that are important in the first stage of trading.

The reason for inflation

Inflation can be triggered by a number of factors. The most common are:

Demand inflation occurs when the demand for certain goods and services exceeds the ability of the economy to meet them. When demand exceeds supply, prices are under upward pressure, which causes inflation. The most obvious example is the growth of the inflation index due to an increase in energy demand and prices.

Cost inflation shows itself as an increase in prices, which is caused by an increase in wages and material costs. These costs are usually passed on to consumers in the form of increased prices for goods and services.

increase in money supply: The total amount of money in sales increases, including cash, coins, and money in bank accounts. If the money supply grows faster than goods are produced, it can trigger inflation. The money supply is usually regulated by the country's central bank.

devaluation is a decrease in the exchange rate of a national currency, which reduces its purchasing power. Currency devaluations stimulate exports, causing foreign customers to buy more domestic goods while foreign goods become more expensive.

How inflation affects the economy

Inflation can be a negative or positive phenomenon depending on its growth rate and other events in the economy. Excessive inflation is considered bad for the economy, but no inflation at all is a negative event. Most economists consider stable inflation at 2% per year to be optimal.

Here is how inflation affects the economy depending on its speed:

inflation is below 10% per annum and, thanks to its predictability and manageability, supports sustainable economic growth and does not lead to a sudden devaluation of the national currency.

Inflation gallops between 10% and 100% per year. This has a negative impact on the country's economy. Producers of goods and services prefer fixed prices to stable, convertible world currencies. People are trying to save their money by investing it in a variety of tangible goods: cars, household appliances, real estate – and this increases the price even more.

hyperinflation is very high, more than 100% per year. Not infrequently, such inflation can be the result of an acute political crisis or war that requires decisive action from the government. It can completely destroy the movement of goods and cash and the entire financial system of the country due to the loss of confidence in money.

According to a Gallup poll, 32% of Americans see rising inflation as their biggest financial problem of the year