Most countries around the world have been talking about a rise in inflation rates, and consumers are expressing grave concerns about the rising prices of daily household items. The central banks of all major countries have prioritised putting a check on this massive issue.
Inconsistency in supply chain and surge in demand, every time an economy opened up to heal from the pandemic, has been a significant contributor to the global inflation of 2021.
But what exactly is inflation, and how does it impact economies?
Let us understand the basics of inflation.
What is Inflation?
Inflation can be described as a slow rise in prices, along with the decrease in your currency’s purchasing power.
Imagine this. If you could buy 2 burgers for Rs.100 in 2010, but now can buy only 1 for the same price in 2022, it is indicative of inflation. The value of your currency is the same, but its ability to buy the same quantity (purchasing power) has reduced. At the same time, the price of burgers has also increased.
This was only an example. Inflation does not occur to only one or two items, but to industries and sectors, overall. This, in turn, affects the economy of a country.
Slight inflation implies a healthy economy and serves well for the growth of a nation. It promotes the consumers to invest or spend the money, rather than save it, which helps pump the money back into the market. But if left unchecked, it can cause major setbacks to nations.
Causes of Inflation
Inflation can be brought upon due to various reasons. Among the major ones are:
- Monetary Policies: When governments pump money into the economy, it generally leads to inflation. Excess money in the market, means the consumer has slightly more disposable income. This translates into a rise in demand for products since the consumers are more likely to spend. This rise in demand, if not met by the production of the goods, leads to a hike in prices.
- Fiscal Policy: The borrowing, saving, and spending trends of a government impact the inflation for that nation. If the government has an increase in debt (borrowed money), the value of its currency will diminish, ultimately paving way for inflation.
- Exchange Rate: Fluctuations in exchange rates can induce inflation, further leading to a decrease in the value of the currency and giving rise to a cyclical process.
Types of Inflation
- Demand-Pull Inflation: When there is a surge in demand of products, and the production and supply cannot match the same, prices of the goods begin to rise. Once this rise spreads over the industry or the sector, it creates a demand-driven inflation.
- Cost-Push Inflation: In this case, the production cost of goods goes up. As a result, the cost price of products is forced to go up, as well. The factors affecting surge in cost of production could include changes in labour costs or hikes in procurement of raw materials, among many others. But once the cost price of products goes up, it forces the production cost up, and the cycle goes on, until intervened.
- Built-in Inflation: On many occasions, companies decide to increase prices of their products for profits. Though the increase could be marginal, on a large scale, it could lead to huge profits for the company. When one company decides to do so, it sets a precedent for the others to follow, and soon spreads across the industry in which the companies operate. This impacts the purchasing power of the consumer, giving rise to inflation.
Now that we have understood what inflation is, its causes and the types of inflations, let us move onto the current situation and dig a little deeper.
Soaring rate in 2021-22
The Covid pandemic saw most consumers hold onto their savings and disposable income, due to the uncertainty surrounding mass-layoffs and unemployment. Cash flow in the market was tight. To add to it, governments provided citizens with financial aids through unemployment benefits and healthcare benefits. This only added to the savings which the consumers were already holding onto. With many companies trying different methods to retain funds, stock prices went up, making the rich richer. Stock owners benefitted because the value of their investments went up, and redemption of the same added to their savings.
Then, in mid-2021, many countries opened their economies, giving their citizens a chance to spend the money they had been so dearly saving. It was a huge change for the market to bear. Demands for products shot up, and since the production of goods was on the decline, due to labour-layoffs, the mismatch of demand and supply resulted in the rise of prices.
Businesses which are trying to get back to the pre-Covid state, began offering higher wages to the talent they wished to attract. To adjust for this, the prices of their products and/or services went up.
The rise in inflation rates has been due to a combination of Demand-Pull and Cost-Push, with each playing its part in maintaining the cyclic nature of the process.
How can we combat it?
Various countries are considering raising their Interest Rates, in order to promote savings and investments, while demoting spending at the same time. This is a method used to decrease demand and combat the resulting surge in prices.
Apart from conventional savings, consumers may opt for:
- Stocks: investing has always been used as a counter-measure for spending. When played in a well-diversified manner, for the long run, it is an excellent tool for beating inflation.
- Bonds: Though the returns may be lower than those of stocks, investments in bonds are considered a safer option. Furthermore, it allows governments to use investor money, rather than print more to inject back into the economy.
Though the spending habits of consumers have changed due to the pandemic, combatting inflation is critical for the growth and trade of nations. The alarming rate at which it is rising, has raised many eyebrows. With the spending trend remaining similar for the next year or two, it is no surprise that governments shall do everything in their power to promote consumer saving, to slow the flow of money in the global markets.
What methods are your governments using to combat inflation? Let us know in the comments below.