Definition:
Inflation is defined as the gradual increase in the price of goods and services, which results in a decrease in the purchasing power of a given currency.
What is Inflation?
As inflation increases, less and less goods and services can be bought with the same amount of money because inflation reduces the value of the dollar (or other currency). The measure of inflation over time is known as the inflation rate. These changes appear in many areas of our lives.
If you think about it, rising prices of housing, food, fuel, and consumer goods occur for a reason-these processes are the result of rising inflation. But it’s not all bad: moderate inflation can bring some benefits, such as reducing the national debt. Nevertheless, consumers tend to focus most of their attention on the decreasing solvency of their money.
What are the causes of inflation?
Here are three main causes of inflation:
– Demand-pull inflation
Demand-pull inflation occurs when demand for goods and services exceeds supply. Buyers are willing to pay more, so suppliers raise the price.
– Cost-push Inflation
This phenomenon occurs when the cost of producing a product increases. It may be caused by an increase in labor costs or an increase in the cost of raw materials to produce a product.
– Built-In Inflation
The third type of inflation that we will look at is built-in inflation. As prices of goods and services increase, wages must also rise. As wages rise, so do the costs of doing business. So, eventually, prices must rise as well.
Analysis of inflation in America
The inflation rate is determined by experts based on the past year, this means that the inflation rate for 2023 will be estimated at the beginning of 2024. As we found out earlier, this value depends on many factors, so it can change from year to year.
For instance, the inflation rate in 2020 was 1.2%, in 2021 it was 4.7%, and in 2022 inflation peaked in June at 9.1%, but had already slowed to 6.5% by December. According to experts, the CPI inflation rate could drop to 2.5% by the end of the year in 2023.
However, inflation does not necessarily always have to rise. A negative inflation rate is called deflation, a phenomenon when a dollar or other currency can suddenly buy more goods and services than before, but such cases have been extremely rare for the world economy in the past few years.
In addition, there is the term hyperinflation, in which the rate of inflation increases too quickly. Periods of inflation and deflation often correlate with bull and bear markets. A bull market is more likely to experience inflation; a bear market is more likely to experience deflation.
Inflation indexes
There are two main ways to track inflation: one is consumer-oriented, the consumer price index (CPI); the other is producer-oriented, the wholesale price index (WPI) or the producer price index (PPI).
1. Consumer Price Index
This index measures inflation by analyzing changes in prices of goods and services in various industries. The main industries included in this calculation are food and beverages, housing, clothing, transportation, education and communications, recreation, health care, and other goods and services.
2. Wholesale Price Index or Producer Price Index
The Wholesale Price Index (WPI) is similar to the Consumer Price Index because it, too, tracks changes in the price of goods. However, instead of tracking prices at the consumer level like the CPI, the WPI tracks changes at the producer level. Consequently, it is based on the price of goods sold in bulk from one company to another, rather than from company to consumer.
However, after 1978, the Wholesale Price Index was replaced by the Producer Price Index (PPI), which includes prices for both services and goods.
Calculating Inflation
The inflation rate is easy to find using the CPI inflation calculator created by the U.S. Bureau of Labor Statistics (BLS). The BLS uses the following calculation to determine the inflation rate:
Increase in Inflation = Final Consumer Price Index / Initial Consumer Price Index.
Inflation: advantages and disadvantages
The perception that inflation is always a bad thing has become entrenched in society. Of course, people have a right to think so, as with this phenomenon, everything becomes more expensive. However, this does not mean that inflation has no pluses.
The Pros of Inflation
First of all, a moderate rate of inflation is a sign of economic growth. It is normal that when the economy is healthy, inflation rises slightly.
The second positive effect of inflation on the economy is less obvious, but no less significant: As the value of the dollar decreases, so does the value of debt. Income usually rises as inflation rises, which means that your monthly debt payments can take up a smaller portion of your income.
The Cons of inflation
The downside of inflation is perhaps more obvious. Inflation lowers the value of the dollar and makes goods and services more expensive. Of course, higher spending is always unwelcome in society, but if incomes rise at a slower rate than inflation develops, they can become a serious problem for much of the population.
Inflation can also damage savings and retirement accounts. Money that is earned over time will eventually have more solvency than money held in savings and retirement accounts, so a potential pension will be less solvent than it may seem now.