What is price inflation?

Inflation means prices rise, which can also be considered money losing its buying power over time. The average rate of price increases for a group of goods and services over a certain amount of time can show how fast buying power is falling. Because prices have increased, usually shown as a percentage, one unit of cash can’t buy as much as it could in the past. Conversely, deflation happens when prices decrease and people’s buying ability increases.

How to Understand Inflation

It’s simple to track how the prices of a few goods change over time, but people need a lot more than that. People need many goods and services to live a happy life. Commodities are things like food grains, metals, and fuel. Utilities are things like power and transportation. And services are things like healthcare, entertainment, and work.

Inflation is a way to figure out how price changes for many different goods and services affect the economy as a whole. Only one number can show how much the prices of goods and services have increased in a market over time.

Since prices are going up, a dollar can only buy so much of everything. The cost of living for most people goes up because of this loss of buying power, slowing down economic growth in the long run. Most economists agree that a country has sustained inflation when its money supply grows faster than its economic growth.

3.1%

The CPI-U (Consumer Price Index for All Urban Consumers) rose from November 2022 to November 2023. When natural factors were considered, prices increased by 0.1% from October to November.

This is why the monetary authority (usually the central bank) controls the amount of money in circulation and credit. This keeps inflation within acceptable ranges and the economy running efficiently.

Monetarism is a standard theory explaining how inflation and an economy’s money supply are connected. For instance, when the Spanish took over the Aztec and Inca empires, vast amounts of gold and silver poured into the markets of Spain and other European countries. The value of money dropped because the money supply increased, which made prices rise so quickly.

There are different ways to measure inflation based on the things and services being tracked. Conversely, deflation means prices generally decrease when the inflation rate falls below 0%. Remember that deflation differs from disinflation, which means a slower positive expansion rate.

Why prices are going up?

Inflation starts when the amount of money in circulation rises. This can happen in the market in several different ways. The monetary leaders of a country can make more money available by:

• Making more money and giving it to people
• Legally lowering the value of the money that is legal tender

The most popular way to do this is to buy government bonds from banks on the secondary market and loan new money into the banking system as reserve account credits.

In each of these situations, the money loses its value over time. It causes three different kinds of inflation: inflation caused by demand, inflation caused by cost, and inflation already there.

Effect of Demand-Pull

If the amount of money and credit in the economy grows, the demand for goods and services grows faster than the economy can produce them. This is called demand-pull inflation. Because of this, desire goes up, and prices go up.

People feel good about buying things when they have more money. In turn, this makes people spend more, which drives up prices. It makes the demand-supply gap bigger, with more people wanting to buy and less changeable supply, increasing prices.

The cost-push effect

The rise in prices of goods and services used in production leads to cost-push inflation. Adding more money and credit to the markets for commodities or other assets increases the prices of all secondary goods. This is especially clear when a nasty economic shock affects the supply of essential goods.

These changes cause the finished good or service to cost more, which in turn causes buyer prices to go up. For example, when the money supply grows, speculation increases oil costs. This means that the price of energy can go up, leading to higher prices for everyone, as shown by different types of inflation.

Inflation built-in

Adaptive expectations, or the idea that people think inflation rates will stay the same in the future, are linked to built-in inflation. People may think prices will keep increasing at the same rate as prices for goods and services. Because of this, workers may ask for higher pay or costs to keep up their standard of living. The cost of goods and services goes up because their wages go up, and this wage-price loop keeps going because one thing causes the other, and so on.

Different kinds of price indices

Different types of baskets of goods are calculated and kept as price indexes based on the chosen goods and services. Most of the time, the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) are used to measure prices.

The Index of Consumer Prices (CPI)

When you look at the CPI, you can see the weighted average of the prices of a group of goods and services that most people need. Some of them are food, medical care, and transportation.

To find the CPI, you take the price changes for all the items in a set box and average them based on how much they make up the whole basket. The prices being looked at are the regular prices of each thing that regular people can buy.

People look at changes in the CPI to see how much the cost of living has changed in price. This makes it one of the most common ways to tell when prices rise or fall. In the United States, the Bureau of Labor Statistics (BLS) calculates the CPI every month and has done so since 1913.

Since it was created in 1978, the CPI-U has shown that about 88% of the non-institutionalized population of the United States shops.

The WPI, or Wholesale Price Index

Another well-known way to measure inflation is the WPI. It checks how prices change before they reach stores and keeps track of those changes.

Things on the WPI list change from country to country, but most of the time, they are sold by producers or in bulk. It lists prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing.6

Many countries and groups use the WPI, but the U.S. and others use a related version called the producer price index (PPI).

The PPI, or Producer Price Index

The Producer Price Index (PPI) is a group of indexes that show how the prices of goods and services produced in the United States have changed on average over time. The CPI looks at price changes from the buyer’s point of view, while the PPI looks at price changes from the seller’s point of view.

If the price of one part goes up (like oil) and the price of another part goes down (like wheat), that could happen in all of them. Overall, each index shows the average weighted price change for the things that make it up, and this can be used for the whole economy, a particular industry, or a commodity.

How to Find the Value of Inflation

You can use the above price measures to determine how much inflation there was between two months (or years). There are many ready-made inflation tools on financial websites and portals, but it is always better to know how they work to make sure they are accurate and that you understand how they do their calculations. In terms of math,

The percentage rate of inflation is equal to (Final CPI Index Value – Initial CPI Value) times 100.

In September 1975, $10,000 bought a lot of things. In September 2018, it cost a lot less. Price index data can be found as a table on several websites. You can get the CPI numbers for those two months from that table. The first CPI number was 54.6 in September 1975, and the last was 252.439 in September 2018.

When you put the code in, you get:

The inflation rate is (252.439 ÷ 54.6) x 100, which equals (4.6234) x 100, or 462.34%.

How much would $10,000 from September 1975 be worth in September 2018? Multiply the amount by the inflation rate to get the new dollar value.

Value Change = 4.6234 x $10,000 = $46,234.25

In September 1975, $10,000 would be worth $46,234.25. You could say that a basket of goods and services (part of the CPI formula) that cost $10,000 in 1975 would cost $46,234.25 in September 2018.

What are the pros and cons of inflation?

This price change can be seen as either good or bad, based on your point of view and how quickly it happens.

The pros

People who own goods paid in their home currency, like real estate or stockpiles, may want inflation because it makes their goods more valuable so they can sell them for more.

Businesses often take risks on risky projects because of inflation, and people buy company stocks because they think the returns will be higher than inflation.

People often talk about the best amount of inflation to get people to spend some of their savings instead of saving it. There may be a more substantial reason to spend now instead of saving and spending later if the value of money goes down over time. It could lead to more spending, which could help a country’s economy. The value of inflation is thought to stay in a good range if policies are fair.

Pros and cons

People who want to buy these things might not like inflation because they must pay more. People who own things worth money in their home currency, like cash or stocks, might not like inflation because it lowers their value. Because of this, buyers who want to keep their money safe from inflation should consider investing in gold, commodities, and real estate investment trusts (REITs). Another popular way investors can make money from inflation is to buy stocks tied to inflation.

When high inflation rates change, it cannot be perfect for an economy. When businesses, workers, and customers buy, sell, and plan, they must consider how prices affect them.

This adds to the economic confusion because they might be wrong about how fast inflation will rise. The time and money spent studying, guessing, and changing how economies work will likely rise to the same level as prices. That’s not the case with real economic fundamentals, which always cost the country.

Some people think an otherwise low, steady, and easy-to-predict inflation rate is best for the economy, but it can cause big problems. That’s because of where, when, and how the new money comes in.

Certain people or businesses always get new money and credit when it comes to the market. They spend the new money, moving from person to person and account to account in the market. This changes the price level to match the new money supply.

A lot of prices go up at different times because of inflation. The fact that prices and buying power change in a particular order (called the “Cantillon effect”) shows that inflation does more than raise prices over time. Along the way, though, it changes relative prices, wages, and rates of return.

Economists generally know that when relative prices are thrown out of balance, it’s terrible for the economy. Some Austrian economists think this is one of the main reasons the economy goes through rounds of recession.

Pros

• It causes things to be sold for more money
• The best amounts of inflation make people spend.

Cons

• The prices of goods and services have gone up.
• Put more costs on the economy.
• Different prices go up at different times

Keeping inflation in check

Keeping inflation in check is essential for a country’s financial regulator. To do this, steps are taken through monetary policy, which is what a central bank or other groups do to control the amount of money in circulation and how fast it grows.

The Federal Reserve’s (Fed) monetary policy goals in the U.S. are stable prices, low long-term interest rates, and full employment. All of these goals are meant to make the financial world more safe. Long-term inflation goals are made clear by the Federal Reserve so that the long-term inflation rate stays stable, which is thought to be good for business.

When prices stay the same, or inflation stays low, businesses can plan for the future because they know what to expect. The Fed thinks this will help reach maximum employment based on non-monetary factors that change over time and can be altered.

Because of this, the Federal Reserve doesn’t set a clear goal for maximum employment; instead, businesses decide what that goal is. The number of people working does not always equal the number of people unemployed because people permanently quit and start new jobs.

A rate of 50% or more per month is often called hyperinflation.

Monetary leaders also take extra steps when the economy is in bad shape. One example is that after the financial collapse of 2008, the U.S. Fed kept interest rates close to zero and bought bonds through a program called quantitative easing (QE).

Critics of the program said it would lead to a rise in inflation in the U.S. dollar. However, inflation rose in 2007 and slowly decreased over the next eight years. There are many complicated reasons why quantitative easing (QE) did not cause inflation or hyperinflation. The simplest is that the recession itself was a very deflationary environment, and QE made its impact stronger.

So, officials in the U.S. have tried to keep inflation at a steady 2% per year. The European Central Bank (ECB) has also used quantitative solid easing to fight deflation in the eurozone, and interest rates have even decreased in some places. People fear deflation could happen in the eurozone, hurting the economy.

In addition, countries with faster growth rates can handle higher inflation rates. India wants to reach about 4%, with a range of allowances from 6% to 2%. Brazil wants to reach 3.25 %, with a range of allowances from 4.75% to 1.75%.

How to Protect Against Inflation

Stocks are considered the best way to protect yourself from inflation because the rise in stock prices includes the effects of inflation. In almost all modern economies, bank credit injections bring more money into circulation. This means the most instant effect on prices is felt in financial assets priced in their home currency, like stocks.

Specific financial tools can be used to protect assets from inflation. Treasury Inflation-Protected Securities (TIPS) are one type. TIPS are low-risk Treasury securities linked to inflation, meaning that the capital amount invested grows by the same percentage as inflation.

You can also choose a TIPS joint fund or an ETF based on TIPS. You’ll likely need a trading account to get stocks, ETFs, and other funds that can help you protect yourself from inflation risks. There are so many stockbrokers out there that it can be hard to pick one.

People also think of gold as a way to protect themselves from inflation, though this doesn’t always seem genuine when you look back.

Very Bad Examples of Inflation

Since all of the world’s currencies are paper money, the money supply could increase for political reasons. This would cause prices to rise quickly. The German Weimar Republic in the early 1920s was the most well-known case of hyperinflation.

The countries that won World War I wanted Germany to pay them back, but they couldn’t use German paper money because it was worthless. After all, the government had borrowed it. Germany tried to print money, use it to buy money from other countries, and then use that money to pay off their bills.

The German mark dropped in value quickly because of this strategy, accompanied by hyperinflation. The Germans tried to spend it as quickly as possible through the cycle because they knew their money would be worth less and less the longer they waited. As more and more money came into the market, its value fell so low that people would stick bills on their walls that weren’t even worth much. Peru had a similar event in 1990, and Zimbabwe had one between 2007 and 2008.

Why does inflation happen?

Inflation is caused by three main things: cost-push inflation, demand-pull inflation, and already-existing inflation.

For goods and services to be priced higher, there must be insufficient supply to meet rising demand. This is known as demand-pull inflation.

On the other hand, cost-push inflation happens when the prices of goods and services increase because it costs more to make them.

When workers want higher pay to keep up with rising living costs, built-in inflation is sometimes called a wage-price spiral. In turn, this makes businesses raise their prices to cover the higher cost of wages. This creates a cycle of price and pay increases that feeds on itself.

Are rising prices good or bad?

Most of the time, too much and too little inflation are bad for a business. Many experts say that inflation should be between 0% and 2% per year, which is in the middle.

Higher inflation hurts savers because it makes their savings less valuable. On the other hand, it can help borrowers because their bills become less valuable over time when adjusted for inflation.

What does inflation do to people?

There are several ways that inflation can hurt businesses. For instance, if inflation makes a country’s currency fall, this can help exporters because it makes their goods cheaper when priced in other countries’ currencies.

On the other hand, this could hurt imports by raising the prices of goods made in other countries. People will want to buy things quickly before the prices increase, which can also lead to more spending when inflation is high. One group that might lose value is savers. If this happens, they might be unable to spend or invest as much.

What’s up with the rise in prices?

Prices went up the most since the early 1980s in 2022, both in the U.S. and worldwide. There isn’t just one reason why prices are going up so quickly worldwide; many things happened simultaneously to make inflation so high.

Early in 2020, the COVID-19 pandemic caused lockdowns and other restrictions that messed up global supply lines in a big way. For example, factories had to close, and ports got backed up. At the same time, governments sent out stimulus checks and raised unemployment benefits to help people and small companies deal with the financial effects of these steps. When COVID-19 vaccines became widely available, and the economy quickly recovered, demand quickly surpassed supply, which was helped in part by stimulus money and low-interest rates. Supply still had difficulty getting back to where it was before COVID.

Because Russia invaded Ukraine without reason in early 2022, it faced several economic sanctions and trade limits. This made it harder for the world to get oil and gas since Russia produces many of these fuels. At the same time, food costs increased because Ukraine couldn’t export its big grain crops. As food and fuel prices increased, prices further down the value chain also increased. Since 2022, the Federal Reserve has been raising interest rates to fight high inflation. Inflation has decreased significantly since 2023 but is still higher than before the pandemic.

Conclusion

• This is the rate at which the prices of items and services go up.
• Demand-pull, cost-push, and built-in inflation are three types that are sometimes used to describe it.
• The Consumer Price Index and the Wholesale Price Index are the two most popular ways to measure inflation.
• Inflation can be seen as good or bad, depending on the person and the amount of change.
• People who own real estate or goods they keep in stock may want inflation because it makes their assets worth more.