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Inflation – The Hidden Reality

Prolong increase in the level of price of goods and services is called Inflation. It is measured on an annual percentage basis. Suppose the rate is 2% per year and the Price of a commodity if Rs. 100 in the year 2020 than in next year’s (2021) price of that commodity will increase by 2% and will cost Rs. 102.

What are you going to explore:

  1. What are the Causes?
  2. Levels or types of Inflation
  3. Different scenarios
  4. How to measure Inflation?
  5. Effects of Inflation
  6. How to deal with it?
  7. Conclusion
  8. FAQs

The value of currency decreases with time due to Inflation. As the time pass individual has to pay more price for goods and services. It is one of the reasons behind the fluctuation in the value of currencies which causes an imbalance between different currencies of different countries.

It adversely affects the economic growth of the country. The value of a currency is determined by the purchasing power, which physical commodity or service can be avail or purchase by that money.

What are the Causes?

CausesExplanations
Demand-Pull or Wage Pull Inflation or Excess demand.In this scenario demand for commodities and services are more as compared to supplies. The prices of commodity or service increases in this situation.
Example: Wars or Military funding, dramatic changes in the economy by govt, etc.
Cost-Push or Supply factorIn this scenario price of commodities and services are more in respect of supplies of commodities and services available in the market which creates a resultant effect of the increase in price.

Cost-push It majorly impacts production costs like raw material, labor, etc. The price of essential commodities and services substantially increases as compared to other or no alternatives available in the market.
Example: pandemic like COVID-19, natural calamities, etc.
Excess in Money supply or Excess Currency printingIn this scenario, excess money is infused in the market as compared to Commodities available in the market as a result price of commodities and services rises exponentially. The currency will start to devalue as compared to other currencies of the world.
Excessive Purchasing Power of peopleDue to the increase in purchasing power people have excess money they start spending drastically which causes high demand in the market. As a result price of commodities will rise and can be a cause of it.
National DebtIn this scenario when a country’s government borrows money from citizens, other countries, international monetary fund or world bank for functioning and development which in some cases increase the tax rates and directly or indirectly the burden could create an increase in Dearness.
Example: Japan, Greece

Levels or types of Inflation

Levels of Inflation infographic image

Creeping (0-3%)

A situation where it starts increasing slowly up to 3% or below.

Trotting (4%-10%)

A situation where rate gradually starts increasing more than creeping which is at 3% maximum. It is also known as walking or running inflation because the rate of dearness is in a manageable phase it can be controlled easily.

Galloping (double to triple-digit Percentage)

A situation where rate starts jumping and booming to an extent. The price of commodities and services starts rising at double to a triple-digit rate of it and starts impacting significantly on the life of citizens and the economy of the country.

Hyperinflation (Unexpectedly high)

When the tendency of it goes out of control or when there is a rapid spike in it which goes on an extreme level. In this situation prices of commodities and services goes exponentially high that never been ever.

Example: Germany (1922-1923), Venezuela (2016)

Note: Percentages used with heading is for understanding the tendency

Different scenarios

Deflation

graphical-representation-of-deflation

In this situation due to a reduction in money flotation in an economy cause a slight decline in the price of commodities and services.

Deflation has a negative effect on unemployment because of less demand in the economy. Deflation may cause economic depression in the long run.

Example: The great depression

Stagflation

graphical-representation-of-stagflation

In this situation, the economic growth of a country is considered as slow along with a spike in unemployment. It the long run stagflation can cause a rise in the price of commodities and services available in the market.

Example: India

Disinflation

In this situation decline in the rate of inflation observed. When there is a decrease in dearness for a short span of time it is called disinflation. Disinflation is also called a period of slow inflation.

graphical-representation-of-disinflation

Example: Inflation from 2001 to 2002:

101/100 -1 = 1%

Inflation from 2002 to 2003

102.1/101 -1 = 1.1%

Reflation

In this situation, the Government of the country performs different activities to stimulate the economy by an increase in financial supplies or by reducing taxes and other fees.

The government manipulates fiscal and monetary policies to expand a country’s output. Reflation can be done by manipulating financial policies like reducing tax rates, interest rate, change in money supply factor, and adjustment in the financial budget.

Example: Decline in the dearness rate of the country from 5% to 2% due to deflationary pressure.

Recession

downside graphic recession image

In this situation GDP (Gross Domestic Product) of the country starts performing negative growth continuously from the last two quarters in a financial year. This is an event when the economic activities of countries or the world start declining.

How to measure Inflation?

 The incline or decline in the common price of commodities and services is measured against the price of reference year is called the base year. It means a rise in the price of commodity or service as compared to the base year price of that commodity or service.

Inflation= Current price of the commodity -price of the commodity in base year x 100  

The index of Indian prices was released in 1861. There are two different primary measures:

  • Wholesale Price index with the base year of 2004-05 and 676 items.
  • Consumer price index with the base year of 2011-12 which includes four groups:
  • Urban non-manual employee
  • Agricultural labor
  • Rural Labour
  • Industrial worker
  • Basket of CPI also includes food products

Effects of Inflation

Effects depend on the assumptions made by the individuals and business.  

                        CASE 1                                     CASE 2
If the rate does not go as per expectation then it can rise problem and it can affect the individual in a negative way.  

Example: People like retirees who live on fixed income notice a decline in their purchasing power and consequently, their standard of living.  
If the rate does not go as per expectation then it can rise problem and it can affect the individual in a negative way.  

Example: People like retirees who live on fixed income notice a decline in their purchasing power and consequently, their standard of living.  

If the rate is higher than that of other countries domestic products become less competitive. In case of investments – the value of investments is trashed with time. Non-uniform inflation can create tough competition across the globe and is a threat to small economies.

How to deal with it?

  1. Get familiar with inflation

    Understand the concept of inflation and get familiar with it never underestimate inflation always have a sight on it.

  2. Importance of investment

    Understand the concept of investment; understand the concept o compounding – compounding is the 8th wonder of the world said, Warren Buffett. Learn about investment and start investing money for your future.

  3. Cash holding

    Avoid holding cash in saving accounts locker. A savings account should not hold cash more than the monthly expenses of 3-6 months. One should save a minimum of 30%-40% of their monthly income out of which at least 50%-60% should

  4. Avoid long term loans

    Try to avoid unnecessary loans and if possible long term loans with fixed or high-interest rates because it will make the condition even worst this will eat up your income by the impact of inflation and interest of loans.

  5. Educate yourself

    Any monetary investment can be crashed at any point in time. The best investment in the world is to educate yourself to learn new skills, get knowledge about different industries, learn how things work. Learning new things will help you grow in your job, business or you can generate side income sources.

Conclusion

Dearness is a reality and cannot be neglected. As time passes it is important for people to understand and know how to deal with it and take care of their money.

When inflation occurs it will increase the cost of living By understanding the concept of it. It not only impacts the lifestyle of an individual but also contribute to economic growth for future inflation.

People should take steps towards wealth management and should understand how purchasing, selling, and other activities impact the markets and the economy which indirectly impacts back to them.

Also read: Personal finance, Taxes in India, Inflation forecast, NBFC crisis

FAQs

Which inflation faced by India at present?

Trotting inflation approximately 6%

 Will it increase in 2020?

Yes due to lockdown

Can inflation be controlled by RBI invention?

Yes by fluctuation rate policies.

Can inflation be zero?

Yes, if all the appropriate factors are available.

Can inflation and recession occur together?

Yes inflation can be a reason for recession.

Can inflation be reversed?

Yes it is possible

Who inflation hurts the most?

Poor and middle class

Who controls inflation?

The central Bank

Who does inflation benefit?

If the inflation rate goes as per the expectation then we can counterbalance and cost will be manageable or not too high. It can benefit price fluctuating professions.

How inflation can be controlled?

By maintaining the right demand and supply. Spending habits, etc.

 How inflation affects the economy?

Yes inflation directly impacts the economy.

When inflation rises?

If there are less supply and high demand

When inflation and unemployment occur together?

In Stagflation

What inflation rate is good?

A situation where inflation starts increasing slowly up 3% or below is good

 What inflation rate is bad?

When the tendency of inflation goes out of control double or triple digits.

 What inflation does?

It will decrease the value of money with time

Are inflation rates rising?

Yes inflation will rise with time.

Are inflation and interest rates inversely related?

Yes, when interest decreases borrowing increases. 

Why inflation is good?

If the inflation rate goes as per the expectation then we can counterbalance and cost will be manageable or not too high. Then it is good.

Why inflation is bad?

If the inflation rate does not go as per expectation then it can rise problem and it can affect the individual in a negative way. Then it is bad

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