• Ganesh

Why inflation is your biggest enemy.?

Have you ever wondered why the prices of goods and services keep increasing? why groceries and other products cost more than what it would cost you before 10 years? i.e, 500rs worth of groceries will cost you more today than it would cost you in 2010, which means the purchasing power of 500rs has reduced in a decade. Many economies around the globe have collapsed because of inflation. Why does inflation occur, is it really a bad thing, how does it affect other economic factors and what it means to you? This article is all about it.

rupees lying on the ground
(Picture by Syed Hussaini on Unsplash)

Inflation is the increase in prices of goods and services over time. It reduces the purchasing power of the currency and increases the cost of living. So as prices rise, your money buys less than that of what it would buy a year back or so, and your standard of living might reduce. The RBI manages inflation by using monetary policies, you'll know how at the end. Well, there are 4 main causes of inflation

Demand and supply (demand-pull inflation)

houses in a neighbourhood

Demand-pull inflation occurs when the demand for goods increases with less supply so, the prices of goods increase. Let's imagine there are 50 houses for sale in a neighborhood and 40 got sold for a typical price and 10 houses are remaining but all of a sudden the government announces 0% property tax for real estate in that neighborhood, so everyone will rush to buy those remaining 10 houses due to more demand for those remaining houses and prices will increase. Now only those who have more money can afford the house, causing inflation. This type of inflation applies to all the goods and services out there.

But sometimes demand-pull inflation occurs because of fear of inflation itself, it occurs when more people rush to buy goods with the fear of increasing prices which in turn causes inflation.

Cost-pull Inflation

log of wood in forest

Cost-pull Inflation occurs when the production cost of a product increase due to an increase in the cost of raw materials, labor costs, or other geographical factors that affect production. As production cost increase the supply of goods produced decrease but the demand for the goods remains the same. This increases the price of goods. For example, if the crops are affected by bad monsoons farmers produce less output so, the price of Wheat, Rice, and vegetable increases, or if the government hikes tax for importing a product the cost of the product increase.

Wage-push inflation

Wage-push inflation occurs if the wage of employees hikes. yes, you read it right! companies increase wages for many reasons. when the minimum salary increases in a country, people generally have more money to spend eventually, the prices of goods and services in the overall market increase.

Inflation and unemployment

Printing more money

yes! printing more money causes inflation, when the government prints more currency, the supply of money increases in the economy. When too much money chases too few goods, the prices of goods skyrockets. If the prices of goods and services soar over 50% in a single month then the economy is experiencing hyperinflation. Many economies have been hit by hyperinflation in the past the most recent example is Venezuela's crisis, because of political instability and mishandled the oil riches. In 2018 Venezuela's inflation rate hit 830,000%. Take a look at prices.

Money and toilet paper placed on a plastic box
2.6 million bolívars can just buy you toilet paper in Venezuela (image: bussinessinsider)

How does the central bank manage inflation

The central bank controls inflation using monetary policies. The idea rate of inflation is 2% to 3% in developed countries. when the central bank(it is RBI in case of India) increase the internet rate i.e, repo rate( the interest rate at which the RBI lends money to the bank), since banks get money from RBI for high-interest rate it would increase the rate at which it lends money to people so, credit is not easily accessible and there will be fewer borrowers of loan from the banks and hence less economic activity takes place, less economic activity for a longer period of time will lead the economy to deflation, when deflation happens the prices of goods and services reduce and if the economy had 2 consecutive quarters of negative GDP growth then it is said to be in rescission.

Basically if the economic growth of a country increases, then so would inflation, and if there is a recession in a country and there's no economic growth, then inflation would also decline.

There is also another case where the country's economic growth shrinks and the economy falls into recession but Inflation hikes. This situation is called "Stagflation".

This happened to the US economy in the 1970s and early 1980s. But there was also an economic boom Both the people and the businesses were making more money and employment was on the rise, this boom was backed by productivity. That was a time when there was technological progress at such a rapid pace, which compensated deflation.

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(Inflation rate in India)

How to protect your money against inflation

Inflation affects you personally. The money that you save up would lose value over time so, you should buy assets, an asset is something that has an economic value and can put money in your pocket. Like gold, stocks, stocks that pay you dividends, bonds, index funds, commodities, valuable artworks, real estate, and cryptocurrencies. Know the myths before investing