What Is Inflation?
Inflation seems to be the new buzzword these days especially in financial news. Many people hear about it, but only a handful seem to know what it is about. But despite that, everyone at some point in their lives has experienced inflation. It is a situation where the prices of goods or commodities increase, relative to the purchasing power of a country’s currency. Inflation has an incremental impact on the price of goods and services within an economy. One of two things happens during inflation, it is either the consumer has to spend more than they previously did to purchase the same product or the consumer is unable to buy the same product due to the increase in the price of the goods. A decrease in the consumer’s purchasing power occurs when the consumer’s income does not keep pace with the price increments. If consumers earn the same level of income and their cost-of-living increases, they will be incapable of purchasing as much as they used to before the inflation hit, and the economy will slow or stagnate.
Inflation can allow banks or other lenders to raise the interest rate so that Return on Investments keeps pace with inflation. The central bank (the State’s monetary and currency management institution) plays an important role in controlling interest rates for lenders. If there is no control from the central bank, lenders will lose money because they will have to repay debt with less valuable money than what they borrowed.
A lot of developed nations have experienced inflation in recent years. Although it has mostly been only single-digit inflation annually, double-digit inflation, even in developed economies, was not uncommon decades ago. One reason inflation has been brought under check is that economic and financial analysts now have a better idea of what triggers it and how countries should combat it.
HOW INFLATION OCCURS
Inflation occurs in response to definite market forces. These forces are identifiable, measurable, and definite. Understanding these factors will help countries in reducing inflation and boost economic growth. Two common factors are responsible for the rise in the price of goods:
- Demand push inflation – This is the major reason why inflation occurs. This happens when the demand for goods and services is higher than the supply, if the producers are unable to meet the high demand of the consumers, inflation will occur. Producers may be unable to meet the consumer’s high demand due to factors like; scarcity of raw materials, lack of skilled and competent workers, inadequate time to build the required manufacturing to increase supply. If sellers do not increase their prices, they will run out of stock. They quickly realize they now have the option of increasing prices. Demand-pull inflation is usually caused by five major factors:
- A good economy
- An expectation of inflation by consumers
- Too much money in circulation
- Inflation of assets
- Government spending
- Cost-push inflation – A decline of supply is directly caused by an increase in the cost of production, this type of inflation is triggered by a rise in the price of products such as labor, raw materials, machinery, and so on. If there is an increase in the price of the factors of production, the supply of products from the manufacturer will decrease. Although the level of demand remains unchanged, the commodity prices rice and this results in an increase in the price level as a whole. The rise in the prices of inputs might also lead to supply-side inflation. Other factors could be things like natural disasters, resource depletion, government intervention, or market dominance, etc. Inelasticity inelastic demand causes increased costs.
Preparing for inflation
Inflation doesn’t have to be high before it affects your finances. Even a moderate amount of inflation will cause your cash and bank savings to lose a significant amount of purchasing power.
Trustworthy investments of any kind are an effective way to protect your money from decreasing in value. Invest early and hold your investments as long as you can because the returns on investment increase with time. By diversifying your investments, you can make your money grow faster than if it was simply sitting in a savings account.
You can decide to invest in the stock market because it can potentially give you an edge over inflation. If your stock portfolio increases in value (annually) faster than the inflation rate, you have successfully beaten inflation. Learn how to invest in stocks here . Before you invest in the stock market or any other market, ensure that you do proper research and become more aware of current financial market conditions to uncover trusted opportunities to increase your wealth. Invest with both eyes open.
Another asset you can invest in to protect yourself from the negative effects of inflation is real estate. As funny as it might sound, but inflation is usually advantageous to real estate. When there is inflation, naturally rents would increase in response. This will eventually lead to many potential buyers seeking to purchase properties as a way of getting the tax benefits to relieve the stress of inflation. Increase demand for real estate will increase its price, hence those who own real estate properties will be safe from the effects of inflation.
Consumers frequently associate the term “inflation” with a negative connotation and as a phenomenon to be avoided. However, price and wage increases are unavoidable, consumers should be aware that inflation can occur at any point in time and make preparations for it to prevent it from having a detrimental effect on them. Inflation, if managed properly, can be beneficial to the economy as a whole. Inflation is much more detrimental to people who have cash in hand or savings in the bank, as the value of their money decreases during inflation, but it would be beneficial to those who took their time to invest in hard assets.
Inflation is more or less inevitable, but you can make contingency plans to be able to manage it and still thrive in it.