Inflation can be a scary topic when it comes up in the news. That’s because of how it affects everyone by making things more expensive, so the same amount of money will let you buy less in the future than it does now.
This might make you think that inflation is always bad, and that the economy will experience trouble when it’s present. But is this accurate? Read on for the details.
Inflation basics
In simple terms, inflation is the increase in the prices of goods and services. When you’re paying more for the same amount of weekly groceries or if that 2-piece chicken meal is more expensive than before, that’s because of inflation.
When inflation is high, it can increase much faster than salaries do. This means that you’ll end up having a hard time doing all the financial activities (like saving, paying for things and investing) that you do now.
If you’re following a budget, you’ll probably need to redo it to take into account the higher expenses.
There are two major types of inflation. In the first, production cost (including higher labor wages and more-expensive materials) rise. Since making products requires more money, the prices of these items rise to compensate. This is known as cost-push inflation.
The supply of items may also be reduced, as some manufacturers will find it hard to maintain their previous output. Demand, however, remains at the same level.
The second type is known as demand-pull inflation. In this, demand for products rises while output stays the same. This typically happens when there’s a lot of money in the financial system, like when the economy is doing well and salaries are on the rise.
This is a direct reflection of the economic principle of supply and demand.
Inflation can also affect the money that you’ve saved, because its value (as determined by its purchasing power) will grow less and less over time. Growing your money at a rate that is at least the same as the inflation rate will help you maintain this value.
It can even affect the strength of a country’s money, making it weaker than other currencies. This would be bad news for importers, who would pay more for the items that they procure abroad.
Is inflation ever good?
Some economists believe that at a normal (also called mild) level, inflation can be a good thing. That’s because consumers will expect higher prices in the future, causing them to spend more now (which makes demand rise).
This, in turn could lead to stores selling more and manufacturers raising output, all of which contribute to economic activity.
Mild inflation also helps prevent deflation, which is when prices fall. While this may sound good for consumers, this can cause people to hold off on their purchases to see if things will get even cheaper.
The result is reduced demand, which often ends with factories lessening their output. They may then need less workers or implement shorter operating hours.
Higher unemployment or unemployment often follows, which causes less money to be spent for circulation through the system. In the long run, deflation may have an even stronger negative impact on an economy than inflation.
