In an inflation ridden economy, For shoppers, it means higher prices, and for workers, it means a loss of buying power.
Inflation is when there is an increase in the price of things you can buy within a given timeframe. Higher inflation means a struggling economy, and to others, it means that the economy is booming and expanding. We generally use inflation as the overall purchasing power of money in the economy. At times inflation can be specific to a sector.
Generally, the government battles inflation by increasing the income threshold to balance purchasing power and rising prices.
There are two major types of inflation:
Cost-push inflation occurs when the price of the final product increases because of increased expenses in production. When raw material gets harder to source and labour becomes expensive, so does the cost of the final product.
Cost-push inflation balances out the demand and supply in any given sector. When production cost increases, it translates into less final stock in supply at old prices because the producers can’t make as much of the same amount of money.
When there is limited supply for a product in comparison to its demand. To combat this imbalance in supply and demand, the price of the product increases.
Supply and demand in one sector can ripple through the whole economy. For example: if there are 100 iPhones available to 200 people, it creates demand for iPhones and pushes the price higher to balance out the market. To meet the iPhone demand, Apple asks all their suppliers to make more parts and double its labour force, creating demand in the labour market.
In the Covid-19 economy, there is an extreme shortage of labour in almost every sector. The labour shortage in the forestry and logging sector caused lumber prices to increase. The labour shortage in construction combined with rising lumber prices, a massive surplus of home buyers and near-zero internet rates sent the housing market into the stratosphere.
Additional money supply in the economy-
Money Printing can increase the rate at which inflation rises when the government prints money and hands it out to the general public in stimulus packages. If the money supply outpaces the demand for money, it can do more harm than good. It can decrease the dollar’s value, which is when investors flock to buy assets or rare metals to keep their portfolio in the green and avoid the volatility in the dollar.
The exchange rate can effect the price of goods at times. On Foreign exchange, when the dollar’s value has decreased, it makes the dollar less valuable than other currencies, increasing the price of imports.
The National Debt level-
The national debt level too can effect the inflation rate. If the national debt rises faster than the economy, the government increases the interest rates or prints more money to combat the imbalance. If they print money to pay it off, then it decreases the currency value. Higher taxes means a higher cost of living.
Consumers tend to think of the word “Inflation” with a negative undertone and something to avoid. But the increase in price and wages over time is inevitable — If it is kept in check, it’ll result in a growing economy. If inflation isn’t effectively controlled, it can wreak havoc on the economy.
Inflation and interest rates have an inverse correlation. Inverse correlation means that if inflation is higher than standard, the interest rates fall and vice versa.
Low-interest rates in the economy encourage more spending of money as it is cheaper to buy, resulting in a growing economy and rising inflation.
On the other hand, when interest rates are higher. It restricts borrowing and spending more money as the borrower pays more in interest on their loans. When the circulation of cash reduces in an economy, it decreases the rate of inflation.
While this is a simplified version of the relationship, it shows why interest rates and inflation tend to be inversely correlated.
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