There must have been times when you’ve encountered situations where the price of a product changed drastically within a span of just a few years, right? For instance, the current price of 1 kilogram of sugar is surely almost double or even triple that of the price 10 years ago.
Why do you think this happens and what might be the cause of this meteoric increase? The answer to these two questions is something called inflation. If the question ‘what is inflation?’ is running on your mind right now, then read on to find out everything there is to know about this fascinating concept.
What is inflation?
Technically, the rate at which the prices of goods and services increase over a specific period of time is what is termed as inflation. Also known as the Consumer Price Index (CPI), the inflation rate is represented as a percentage.
What are the effects of high inflation rates?
The main effect of a high rate of inflation is that it lowers the purchasing power of money. For instance, let’s assume that the price of 1 kilogram of salt increased from Rs. 10 to Rs. 20. Now, with Rs. 10, which you paid the last time to purchase 1 kilogram of salt, you can currently purchase only half a kilogram of salt. This effectively means that the purchasing power of Rs. 10 has gone down.
Another major effect that a high rate of inflation has is that it prompts consumers to stock up and hoard on products in the fear of their currency losing even more of its purchasing power. This leads to a shortage of goods and completely disrupts the demand and supply cycle. And it also leads to another effect – more inflation. When people start to buy products faster than the time it takes to manufacture them, it increases the supply of money in the economy. This leads to even more inflation as the purchasing power falls even further.
That said, there’s also a positive effect that inflation has on the economy. It encourages and pushes people to save and invest more in the hopes that the returns on their investment would be enough to cancel out the inflation rate.
What is the cause of inflation?
Now that you know what inflation is and what its effects are, let’s try to understand the cause of inflation. Contrary to popular opinion, there isn’t just one cause of inflation, but many. Here’s a brief look at some aspects that directly and indirectly lead to a rise in the inflation rate.
– Increase in the cost of production of goods and services
– Increase in the demand and decrease in the supply of goods and services
– Printing of more money by the central banks of countries
– Increase in the supply of money in the economy
– The unemployment rate of an economy
– The debt to income ratio of an economy
What are the measures undertaken to curb inflation?
If the rate of inflation is allowed to continue to rise without any checks, it would keep reducing the purchasing power of money till it reaches absolute zero. At this point, the money in the economy becomes completely worthless and would be incapable of purchasing anything.
To prevent such a situation from transpiring, the central banks such as the Reserve Bank of India and the U.S. Federal Reserve typically curbs inflation through monetary policies. Whenever there are high rates of inflation in the economy, these central banks step in through contractionary monetary policies to reduce the supply of money.
They generally do this by raising the interest rates (also known as the repo rate in India) in the country. By raising the interest rates, central banks effectively increase the cost of borrowing, which reduces the supply of money and thereby curbs the inflation rate.
But then, restricting the supply of money a little too much can end up stifling the economic growth of a nation. That’s primarily why the central banks occasionally decrease the interest rates in a bid to boost the economy. Therefore, curbing inflation is effectively a balancing act that the central banks are constantly involved in. They monitor the economy very closely and introduce monetary policies depending on where it is headed.