What is inflation & what causes it?

The type of economic activity in which products and services tend to increase in price, leading to a decrease in buying power, is what we call inflation. In this context, it explains how money is depreciating in value. Also, it shows how it influences economic policies, savings rates, and cost of living. Inflation is crucial for financial, investment, and government strategies aimed at ensuring economic stability. Therefore, the knowledge of inflation is vital.

An overview of inflation- what is it?

Inflation is defined as the final decline in a currency’s buying power. One way to quantify the pace of decline in buying power in an economy is to look at how fast the average price level of a selected basket of goods and services rises over time.

It is measured using many indices, including the Consumer Price Index (CPI). Cost-push pressures, demand-pull variables, or inherent inflation are some of the causes of inflation. Moderate inflation may be a sign of economic prosperity. However, excessive inflation can cause economic instability, diminish savings, and increase living expenditures.

The reasons behind inflation-exploring the causes

Many complex economic variables which are intertwined trigger the process of inflation. Identifying effective management techniques is contingent on the comprehension of pre-existing problems. The major factors of inflation are given below:

1. Demand-pull inflation

   This happens when an economy’s supply of products and services cannot keep up with the demand from consumers. Scarcity results from this, and that raises prices. This usually happens when the economy is doing well or the government is spending more money. It is the primary reason behind inflation.

2. Cost-push inflation

   When manufacturing costs rise and finished goods and services become more expensive, this is known as cost-push inflation. Increased taxes, growing wages, and rising raw material costs are major causes of cost-push inflation. Increases in manufacturing costs are passed on to customers by firms as increased pricing, which contributes to inflation.

3. Built-in inflation

   This phenomenon, often referred to as wage-price inflation occurs when an economy spirals into an endless loop of rising wages and rising prices. Businesses respond to growing living expenditures with hiked prices. With it, they try to cover increased labour costs, while workers want higher salaries. This series of events has the potential to set off an endless loop of price increases and wage demands always feed inflation.

4. Monetary devaluation

   Monetarists believe that excessive money pursuing an insufficient supply of goods leads to inflation. This theory holds that the value of money is governed by supply and demand. It is more like the value of any other item available on the market. The value decreases as the supply increases. When money loses value, its purchasing power decreases and goods become comparatively more costly.

5. The Housing Market

   Inflation is heavily influenced by the property industry, especially when it comes to rental rates and home prices. Considering that a large portion of consumer expenditure goes toward housing, these increases add to the total rate of inflation. Higher housing costs may also result in more borrowing, which would boost inflation and economic activity even more.

6. Expansionary Fiscal and Monetary Policy

   Governments may raise the amount of discretionary cash available to consumers and companies by implementing expansionary fiscal policies. If a government lowers taxes, companies could use the money for capital projects, employee raises, or new hires. Increasing funding for infrastructure projects is another way the government may boost the economy.

Conclusion

Demand-pull, cost-push, wage-price cycles and economic policies are some of the causes of inflation. To manage its effects on the economy and personal financial planning, it is important to comprehend these factors.