05 Mar A guide to inflation, how it works and why you should care
For individuals in any economy, keeping track of certain indices can be an easy way of working out how to keep ahead of rising costs. Inflation is one such indicator. As a simple guide to inflation, it’s important to understand that at a basic level it is a sustained rise in overall price levels. It affects all aspects of the economy, for instance: consumer spending, business investment, tax policies and interest rates.
It is generally considered to be a rise in the overall level of prices for goods and services consumed by households. Inflation-targeting is used to keep it from spiralling out of control. The level of inflation is regarded as a measure of an economy’s stability and growth.
In most countries, inflation is represented by a basket of goods and services consumed by the average person, while the major index used is the Consumer Price Index (CPI). CPI is a measure of changes in the purchasing power of a currency and the rate of inflation
Demand-pull inflation is when the demand for goods is more than supply. This leads to the price of goods going up. It may be a sign of economic growth. It is also when the government or central bank stimulates the economy by increasing the money supply. What this leads to is more money chasing the same amount of goods, which then leads to higher demand and higher prices.
Cost-push inflation on the other hand, is when the cost of buying, importing or manufacturing goods goes up. This may cause taxes to increase. Essentially, when inflation is high, the cost of making products rises.
A simple guide to inflation:
The unfortunate reality is that salaries don’t go up each year to match inflation. As a consumer, understanding complex economic terms can be confusing and challenging, but it’s important that you know how the economy works in order to improve your financial standing.
You need to be aware of how inflation affects you so that you can make it through financially challenging times.
The effects of hyperinflation, for instance, can be quite devastating. This is the quick rise in inflation over a short period of time. This occurs when inflation reaches double digits.
When hyper-inflation occurs, it generally means that the money in an economy becomes worthless.
Deflation is when inflation is too low or even negative, so the process of cost-push inflation goes into reverse.
An indicator used to measure inflation is generally the Consumer Price Index (CPI), which reflects retail prices of goods and services.
At a broader level, inflation is important to understand because it can reduce the value of investment returns. Inflation affects investment returns by chipping away at real savings and investment returns. On the other hand, it can be good news for debtors. It reduces the real interest rate that they have to pay, so the value of their debt falls in real terms.
The best way to fight the effects of in inflation is to increase your earning ability and income.