What is Inflation and How Does it Impact You?

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation in order to keep the economy running smoothly.

Causes of inflation

Inflation is caused by an overall increase in the money supply, an increase in government spending, and demand-pull inflation.

Increase in money supply

When the money supply increases faster than the rate at which the economy is growing, prices rise as there is more money chasing the same amount of goods and services. This is called demand-pull inflation.

Increase in government spending

An increase in government spending can lead to inflation if the government finances its spending through borrowing or printing more money, rather than by collecting enough taxes. This can lead to an increase in the money supply and demand-pull inflation.

Demand-pull inflation

Demand-pull inflation is caused by an increase in demand for goods and services, which leads to higher prices. This can happen when there is economic growth, a rise in population, or an increase in consumer confidence.

Effects of inflation

Inflation can have both positive and negative effects on the economy.

Positive effects

• Inflation can encourage people to spend their money rather than save it, which can boost economic growth.
• Inflation can also help reduce the real value of government debt.
• Inflation can redistribute wealth from people who have saved money to those who are in debt.

Negative effects

• Inflation can erode the purchasing power of people's savings.
• Inflation can create uncertainty and make it difficult for businesses to plan for the future.
• Inflation can lead to higher interest rates, which can slow economic growth.

Measuring inflation

Inflation is typically measured using a consumer price index (CPI), which is a measure of the average change in prices over time for a basket of goods and services consumed by households. The CPI is used to calculate the inflation rate, which is the percentage change in the CPI over a certain period of time.

How Does Inflation Impact You?

Example:

In 2020, the cost for a movie ticket might have been ₹300. Due to inflation, in 2023, the price could have risen to ₹350. Despite having the same ₹300, you can't afford the ticket anymore. That is the impact of inflation: the decrease in the purchasing power of your money.

Coping with Inflation

1. Invest in stocks: Companies like Infosys might raise prices in response to inflation, potentially leading to higher stock prices.
2. Opt for inflation-indexed bonds: These bonds adjust the interest rate based on inflation, helping protect your investment's purchasing power.
3. High-interest savings accounts: Look for saving options that offer interest rates above the inflation rate.

Conclusion

In summarizing, inflation signifies the decline in your money's value over time, influencing everything from your daily expenses to long-term savings and investments. Understanding and planning for inflation is crucial for effective financial management.