Inflation

Inflation

Subject: Economy

Context: While Covid has destroyed our way of life, few predicted how global shutdowns of factories, refineries, and mines could impact prices.

Concept:

Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials. Higher costs of production can decrease the aggregate supply (the amount of total production) in the economy. Since the demand for goods hasn’t changed, the price increases from production are passed onto consumers creating cost-push inflation.

Demand-pull inflation is the upward pressure on prices that follows a shortage in supply, a condition that economists describe as “too many dollars chasing too few goods. ““When demand surpasses supply, higher prices are the result.”

This is demand-pull inflation. A low unemployment rate is unquestionably good in general, but it can cause inflation because more people have more disposable income. Increased government spending is good for the economy, too, but it can lead to scarcity in some goods and inflation will follow.

The main causes of inflation

• Monetary Policy: It determines the supply of currency in the market. Excess supply of money leads to inflation. Hence decreasing the value of the currency.
• Fiscal Policy: It monitors the borrowing and spending of the economy. Higher borrowings (debt), result in increased taxes and additional currency printing to repay the debt.
• Demand-pull Inflation: Increases in prices due to the gap between the demand (higher) and supply (lower).
• Cost-push Inflation: Higher prices of goods and services due to increased cost of production.
• Exchange Rates: Exposure to foreign markets are based on the dollar value. Fluctuations in the exchange rate have an impact on the rate of inflation.

Benefits from inflation

• Inflation being a cause of concern for the economy, doesn’t affect everyone in a bad way. It is a boon for a certain set of people. While consumers lose a part of their purchasing power to inflation, investors gain from it.
• Investors investing in assets affected by inflation, if held on for a long time will certainly benefit from it. For example, an increase in housing prices might affect consumers. However, those who have already bought a house will benefit from capital appreciation.

Prevent inflation

• To prevent inflation, the primary strategy is to change the monetary policy by adjusting the interest rates. Higher interest rates decrease the demand in the economy. This results in lower economic growth and therefore, lower inflation. Other ways to prevent inflation are:
• Controlling the money supply can also help in preventing inflation.
• Higher Income Tax rate can reduce the spending, and hence resulting in lesser demand and inflationary pressures.
• Introducing policies to increase the efficiency and competitiveness of the economy helps in reducing the long term costs.

The effects of a rise in the inflation rate

• A rise in an inflation rate can cause more than a fall in purchase power.
• Inflation could lead to economic growth as it can be a sign of rising demand.
• Inflation could further lead to an increase in costs due to workers demand to increase wages to meet inflation. This might increase unemployment as companies will have to lay off workers to keep up with the costs.
• Domestic products might become less competitive if inflation within the country is higher. It can weaken the currency of the country.