Inflation is the rate at which the prices for goods and services increase. Inflation often affects the buying capacity of consumers. Most Central banks try to limit inflation in order to keep their respective economies functioning efficiently.There are advantages and disadvantages to inflation.
Causes of Inflation
Inflation is caused by multiple factors, here are a few: 1. Money SupplyExcess currency (money) supply in an economy is one of the primary cause of inflation. This happens when the money supply/circulation in a nation grows above the economic growth, therefore reducing the value of the currency.In the modern era, countries have shifted from the traditional methods of valuing money with the amount of gold they possessed. Modern methods of money valuation are determined by the amount of currency that is in circulation which is then followed by the public’s perception of the value of that currency.2. National DebtThere are a number of factors that influence national debt, which include the nations borrowing and spending. In a situation where a country’s debt increases, the respective country is left with two options: Taxes can be raised internallyAdditional money can be printed to pay off the debt3. Demand-Pull EffectThe demand-pull effect states that in a growing economy as wages increase within an economy, people will have more money to spend on goods and services. The increase in demand for goods and services will result in companies to raise prices that consumers will bear in order to balance supply and demand.4. Cost-Push EffectThis theory states that when companies face increased input costs on raw materials and wages for manufacturing consumer goods, they will preserve their profitability by passing the increased production cost to the end consumer in the form of increased prices.5. Exchange RatesAn economy with exposure to foreign markets mostly functions on the basis of the dollar value. In a trading global economy, exchange rates play an important factor in determining the rate of inflation.
The plus side to Inflation
A healthy inflation rate (2-3%) is considered positive because it directly results in increasing wages and corporate profitability and maintains capital flowing in a growing economy. Steps to offset Inflation and its effects on Your RetirementFactoring for inflation is an essential process for financial planning. The question is how much will you actually need when you retire? Here are a few ways you can retire financially sound keeping inflation in mind.1. Invest in long-term investments.When it comes to long-term investments, spending money now can allow you to benefit from inflation in the future.. 2. Save MoreRetirement requires more money than one might imagine. The two ways to meet retirement goals are to save more or invest aggressively. 3. Make balanced investmentsThough investing in bonds alone feel safer, invest in multiple portfolios. Do not put all your eggs in one basket to outpace inflation.
Deflation is generally the decline in the prices for goods and services that occur when the rate of inflation falls below 0%. Deflation will take place naturally, if and when the money supply of an economy is limited.Deflation in an economy indicates deteriorating conditions. Deflation is normally linked with significant unemployment and low productivity levels of good and services. The term “Deflation” is often mistaken with “disinflation.” While deflation refers to a decrease in the prices of goods and services in an economy, disinflation is when inflation increases at a slower rate.Deflation can be caused by multiple factors:1. Structural changes in capital marketsWhen different companies selling similar goods or services compete, there is a tendency to lower prices to have an edge over the competition.2. Increased productivityInnovation and technology enable increased production efficiency which leads to lower prices of goods and services. Some innovations affect the productivity of certain industries and impact the entire economy.3. Decrease in supply of currencyThe decrease in the supply of currency will decrease the prices of goods and services to make it affordable to people.
Effects of Deflation
Deflation may have the following impacts on an economy:1. Reduction in Business RevenuesIn an economy faced with deflation, businesses must drastically reduce the prices of their products or services to stay profitable. As reducing in prices take place, revenues begin to drop. 2. Lowered Wages and LayoffsWhen revenues begin to drop, businesses need to find means to reduce their expenses to meet objectives. One way is by reducing wages and cutting jobs. This adversely affects the economy as consumers would now have less to spend.