Inflation is the overall rise in the prices of goods and services over time. It could also be defined as the reduction in purchasing power of a currency, income or person. A practical example is this:
In 2015, a 50kg bag of rice cost #8,000 (Eight thousand Nigeria naira), but as of today, that same bag of rice cost no less than #50,000 (Fifty thousand Nigeria naira. So, if you usually delegate say #25,000 for rice. In 2015, that amount will get you three bags, but today, it will get you no more than half a bag. What happened? It's the same #25,000. Well, inflation happened. Over the years, the cost of goods has been increasing which has brought the cost of that rice to where it is today. "I don't want inflation, it's bad". Not necessarily, at least for the economy.
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Inflation can be good or bad depending on multiple factors and how quickly it rises. To understand, you must get that there are different kinds of inflation.
There's the creeping inflation which is about 2% - 4%, walking inflation up to 10%, and running inflation, which if unchecked can lead to hyperinflation. There's a consensus among most economists that a little inflation is good for the economy, as people tend to spend in the present if they expect a future rise in the price of goods and services When consumers spend money, producers make a profit, which they further invest and this is generally good for economic growth.)
What Causes Inflation
Inflation can be caused by a myriad of factors, but there are two major categories, which according to Bloomberg are:
"Demand-Pull Inflation
Demand-pull inflation is when demand for goods or services increases but supply remains the same, pulling up prices.
Demand-pull inflation can be caused in a few ways. In a healthy economy, people and companies increasingly make more money. This growing purchasing power allows consumers to buy more than they could before, increasing competition for existing goods and raising prices while companies attempt to ramp up production. On a smaller scale, demand-pull inflation can be caused by the popularity of certain products.
For example, at the start of the coronavirus pandemic, the increase in demand for indoor, socially distant activities combined with the highly anticipated release of Animal Crossing: New Horizons saw the price of the Nintendo Switch gaming system almost double on some secondary markets. Because Nintendo could not increase production, due to factory production halts from Covid-19, Nintendo could not raise its supply to meet rising consumer demand, resulting in increasingly higher prices.
Cost-Push Inflation
Cost-push inflation is when the supply of goods or services is limited in some way but demand remains the same, pushing up prices. Usually, some sort of external event, like a natural disaster, hinders companies’ abilities to produce enough of certain goods to keep up with consumer demand. This allows them to raise prices, resulting in inflation.
For example, think about oil prices. You—and pretty much everyone else—need a certain amount of gas to fuel your car. When international treaties or disasters drastically reduce the oil supply, gas prices rise because demand remains relatively stable even as supply shrinks."
How Does Inflation Affects The Economy
The effect of inflation on an economy depends on the type, severity and monetary policies of the authorities that apply. Generally, when it's mild, mostly the positive effects manifest, but when left unchecked, the majority of its negative effects manifest.
Negative Effects Of Inflation On An Economy
Fixed-income earners suffer reduced income due to reduced purchasing power.
The reduction in the purchasing power of fixed income, results in greater inequality in income distribution, as the rich who own the factor of production earn more due to inflation, while the purchasing power of the lower earners is eroded.
There's increased cost to government spending and speculative investing becomes the other of the day, since people expect prices to rise in the future. This is not good for the economy.
Reduction in savings and capital accumulation as people would rather spend their money at today's value than wait for it to erode more in the future. If this keeps up for long, it will further drive inflation, until the price of most commodities can not be afforded by low-income earners. At the point of hyperinflation, even high and medium-income earners might run into trouble.
Positive Effects Of Inflation On An Economy
There's higher profit for producers, which means more money for the government through taxation, which increases public spending.
Due to the higher profit to producers, investors and entrepreneurs are as a result more incentivized for their investment, which will result in them investing more, which furthers economic growth.
Better returns on investment will lead to further investment, which in effect
equals more production.Ith the increase in production, there's an attendant need for more about, which leads to more employment, driving down unemployment, as well as government welfare spending. It also leads to higher wages and income.
These are but a few of the effects of inflation on an economy. However, as stated earlier, if left unchecked, inflation could become a self-feeding monstrous feedback loop, where a rise in inflation leads to further rise, and further rise, until you are using a wheelbarrow of the highest denomination of your country's currency to buy bread.
How Is Inflation Controlled
Inflation is kept at bay by an authority's monetary control policy. Each country has an establishment tasked with that role. That could be the central bank, treasury or federal reserve, they all usually adopt the same method.
When inflation is running rampant, they usually increase the interest rate. What does this do? It helps to reduce the amount of money in circulation. This is because more people are incentivized to save rather than spend their money. It also reduces the money supply by increasing the cost at which people can take loans from financial institutions. With less money, there's bound to be reduced consumption and with less money pursuing available goods, there will be a price drop. This
When inflation is too slow, especially when it's tending towards stagflation or deflation(which is negative inflation), monetary policymakers will almost certainly reduce the interest rate (sometimes even up to negative values) to encourage more consumer spending. When people realize that saving their money earns little to nothing, they will rather spend it now, which will be good for the economy. Also, if the interest rate is negative, people will naturally be rewarded to take loans from banks, because they will be repaying less money than they borrow, which they will spend, thereby increasing consumer spending. This will increase production as producers can take loans from banks to increase production.
Having talked all about the negatives and positives of inflation in an economy. We must realize that some of it are playing out before our eyes today. With the reduction in the amount of crude oil in the market due to the war in Ukraine and the Embargo on Russian oil, we are seeing inflation that is cost-pushed. Inflation in the energy sector always has a way of burning through the whole economy and quite quickly and severely, especially for underdeveloped and developing countries in Africa and Asia. But no matter, right? It's no big deal if Africa or the rest of the world for that matter dies as long as the US and its western allies prevail over Russia, right? Yea, yeah right...
References
- https://www.investopedia.com/articles/insights/122016/9-common-effects-inflation.asp
- https://www.toppr.com/guides/fundamentals-of-economics-and-management/money/impacts-of-inflation/
- https://www.forbes.com/advisor/investing/what-is-inflation/
- https://www.thebalancemoney.com/inflation-impact-on-economy-3306102
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