Inflation is a word, that often appears in the press, media, and everyday conversations. It simply means, that your money loses its value. A simple example. Having a certain amount of money for instance 100 EUR, you can buy a specific amount of a given goods. For example, you can buy 20 breads of 5EUR each. If inflation rises by 5%, that is, the purchasing power of your money decreases by 5%, then for the mentioned 100 EUR you will buy not 20 loaves but 19. Technically, the price of bread will most likely increase to 5,25 EUR. But first question, is money inflation always dangerous to your money?
What is inflation and what are its consequences for economy
I don’t want to go into specialized definitions. Simple saying: inflation should be defined as the sustained price increase in the economy for a long time, combined with the simultaneous loss of the value of money. Pay attention to the elements included in the description above:
- Price increase,
- Loss of value for money.
They are two sides of the same coin, that must go hand in hand to talk about inflation. One more important aspect should be noted. In order to be able to talk about, it must be universal, i.e. it cannot refer to just one article, but to the general increase in the prices of the entire basket of goods, usually determined by the specific statistical office in specific country. It should be noted, that spectacular increases in mass goods, such as crude oil, may also trigger or strengthen inflation. Going further, if we talk about in a given economy, it should be assumed, that the value of money owned by people is decreasing. They can buy fewer and fewer goods with them over time.
How to count level of inflation?
Of course I will not precisely describe how to calculate of inflation rate. You just need to know, that it is calculated by the Central Statistical Office, that in each country has another name and base on the basket of goods and changes in its prices.
What is included in the basket of goods?
The largest share in the basket of goods are food, housing costs and transport costs. Changes in the prices of individual goods in this basket are determined by the level of inflation. Ultimately, depending on the share of individual goods and the increase in their prices. One common, averaged increase in this basket is calculated and gives a level of inflation, this is price increase.
What is influence to your life?
So we know money value losing rate. If you have 1000 EUR and inflation is on level 2% per year, then your 1000 EUR loses 20 PLN during the year. In fact, if the prices of goods would not change, you could buy as many goods if you had 980 EUR instead of 1000. But in reality, you have the same amount of money, but you can buy less then before – depending on the rate of losing of money value.
Inflation itself can be classified and main types are:
- The first most important is demand inflation. It is caused by the excess of money in the market, this is conducted by overprinting by the government.
- If production costs rise for some reason, it is cost inflation. The most striking example is when crude oil rises as a result of, for example, unrest in the Persian Gulf. Rising prices affect transport costs and automatically increase all means of production, starting from raw materials, machines, but also indirectly food or housing costs.
The causes that create inflation
The above types of inflation can be caused by a number of different reasons. I will only highlight the most important ones. Note, if such situations arise, it is certain, that inflation will occur:
- Incorrect monetary policy of the state as regards the budget deficit. When he lacks funds, he finances deficit by printing money.
- Excessive increase by social transfers.
- Increase in the prices of strategic raw materials, especially crude oil, but also for instance: electricity.
- Limiting the supply of food in particular grains and thus rapidly increasing demand and thus prices.
- Excessive tax burden.
- Excessive amount of monopolies in the economy.
Of course not all reasons could be listed. They will be varied and change over time. However, new ones will probably be created all the time.
What are the effects of inflation
In a way, this question has already been answered before. Inflation itself implies many phenomena, which in most cases are negative for ones economy. Let’s try to list them:
- Your money is losing value, including your savings. You suffer the biggest losses by keeping your money outside a bank on account. If you keep money on a bank deposit, then you only get the difference between your deposit profit and inflation. A simple theoretical example. The interest rate on the deposit is 4% and the inflation rate is 3%. The investor’s profit is then only 1%. Note, if inflation is, for example, 5% and your deposit has an interest rate of 3%, although you win in nominal terms, your money actually loses purchasing power.
- Credit costs are rising. Losing of money value forces the government to react by raising interest rates, which determines the cost of loans – I mean loans with a variable interest rate. Lower inflation makes loans cheaper. Mortgage loans are also the most important loan for the economy and people.
- Declining value of money can result in less investment.
- May cause higher taxes.
- Another very important point. Inflation causes people to lose confidence in their own currency. Such a situation may mean, that despite the improvement in the economic situation and the pressure to lower the inflation rate, its rate does not decrease. People do not believe. which causes money to weaken and sell off further.
- Finally, high inflation hampers economic activity. Its rapidly growing level may mean that, for example, commercial companies will not want to sell the purchased goods. The increase in the value of these goods will be greater than the margin obtained from their sale.
Maybe inflation is not so bad?
Regarding the last point, however pay attention to a one exception, when inflation is “good” (!). Slight inflation (I emphasize SMALL) for companies selling certain goods can give higher profits. Example: a trading company buys a commodity for 100 EUR and stores it for a year at an inflation rate of 2% a year. The value of the goods rises to the level of 102 EUR. He can sell it, additionally collecting the profit from the increase in its value (apart from the margin). As mentioned, inflation cannot be high. With high inflation, entrepreneurs buying goods will not want to sell them. A generally healthy economy with little inflation is fine. Sick economies, politicized, sooner or later generate high levels of inflation: hyperinflation.
What to do in order not to lose your money
The answer is very simple. Your money must earn. The rate of profit must be higher than the rate of inflation. There are many solutions, although someone may accuse me that it is easy to say, harder to do, and besides, these methods do not necessarily work. Common suggestions include:
- Real estate investments. There are few periods with decline in real estate prices.
- Bank deposits. Currently, unfortunately, there are no such deposits that would effectively protect our money against real loss of value.
- Investments in treasury bonds, unfortunately, give the effect practically similar to bank deposits.
A few words about deflation
Speaking about, one can not avoid deflation. It is, in simple words, the opposite to inflation. What does it mean. In a nutshell, it is a decrease in the value of goods and services in relation to the value of money, simultaneously with an increase in the value of this money. Switzerland has been struggling with this problem for several years, more or less. Point is, that deflation are bad for the economy.
The topic of inflation is huge. What is in this post is the tip of the iceberg, nothing more. This topic has been analyzed and diagnosed for decades, if not hundreds of years, and will probably be the focus of attention in the coming years. Even a series of articles will not exhaust that topic. The very nature of inflation seems to be changing. Its causes and methods of combating it are changing, but economics is not an exact science and cannot be described by a simple formula. It is similar with inflation at different times. It is caused by various factors, that have just different influences. Finally, it can be extinguished at different times by different methods.
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