What is inflation?
Inflation is a word that’s commonly heard in financial reports and everyday economic news. Like GDP and unemployment, inflation is an important measure of the state of the economy. Inflation is a sustained, generalized increase in the prices of goods and services. Inflation erodes the value of money and financial assets. The value of money depends on what it will buy. As prices go up, the purchasing power of money declines. The value of your bank balance also decreases since with higher prices, it takes more money to purchase the same quantity of goods and services. Inflation is one of those big financial forces that even affect day to day lives.
Definition of Inflation :
Inflation is defined as the reduction in the value of currency, as evidenced by prices in that currency going up. Every increase in price is not inflation, though. Inflation must be a sustained increase in prices. It is a generalized increase in price which means the prices of all, or at least most, goods and services go up. Inflation can be so high that it causes significant problems in the working of the economy. The decreasing value of the currency requires more of the currency requires more of the currency to transfer the same amount of wealth. Inflation is measured by a central government authority, which is in charge of adopting measures to ensure the smooth running of the economy. In India, the Ministry of Statistics and Programme Implementation measures inflation.
Inflation stealing your money :
If I say that money is being stolen from your wallet right now. How will you feel? If you keep Rs. 1 lakh in your locker right now and you open the locker straight after 10 years, then you won’t have 1 lakh rupees! You’ll only have sixty thousand! But who stole this money? The answer is INFLATION. When it comes to money matters, don’t take any decision without proper research. I used to carry Rs.10 to school in case my tiffin was too less, I’d buy food and also save Rs. 1 as well. With that same logic if I go to buy food today, I may not be able to afford bread with Rs. 10. In short is same money buying lesser stuff in future. Inflation is a decline in the purchasing power of a given currency as the cost of living goes up. The purchasing power of my money is going down. So even if the Rs. 10 looks the same after 10 years. The value or the things it can buy reduces for me. A consumer has to make some spends to live his/her life, for e.g.: food, housing, clothes, transport, electronics, medical costs, education, etc. If the process of these essential items increases, more expenditure will be there every year. If you spend Rs. 10000 a month, in 2021 for your needs and in 2022, you need Rs. 10500 to buy same things, every month, so the Rs. 500 or 5% is the yearly inflation rate. If someone understands the concept of inflation best from your home is your domestic help who has already decided before she takes your work that her salary will increase, every year, by 10% or more. She does this because she knows prices raise every year, therefore, her income needs to rise so she can afford necessities. If our income increases by the inflation rate every year then we will not be impacted by inflation. But this doesn’t happen in real life, does it? In the beginning, as we read about keeping Rs. 1 lakh idle and its value decreases by 40%. There is a way of calculating it “ Rule of 72” with which it can be calculated if savings stay idle in one place, how much time will it take for them to halve in value. Take the rate of inflation; divide 72 by rate of inflation. At present, the rate of inflation in India is 6%. So today’s 1 lakh will be worth Rs. 50000 in 12 years.
DISCUSSION:
Why does inflation happen? There are broadly 3 types of inflation:
Cost-Push Inflation: Let’s consider an example close to home, petrol prices are rising. But I don’t have my own personal vehicle, what difference do petrol prices make to me? It does make a difference! Whether I directly buy petrol/diesel or not but the food that comes on our plate is brought by traders from the farm to the final markets. If transport cost rises, it is passed on to the end customer. This is called cost-push inflation.
This means that when a business’s operational costs rise, that cost is included in the cost of the final product. A business incurs many different types of costs. For business to be sustainable it has to raise prices from time to time.
Demand Inflation: Let’s take the example of a house/apartment. Mumbai’s population is always increasing but space is limited. A builder keeps this fact in his mind and keeps raising the price of the property till the time the company is getting buyers. In the tug of war between demand and supply, when demand keeps rising but supply doesn’t at the same rate, it causes prices to rise.
Printing Excess Money: The Netflix web series, Money Heist raised an interesting point, through liquidity injections or through bad policies authorities keep reducing the value of paper money, this directly impacts our lives. Theoretically, the impact of printing unlimited money on us and the economy has worse effects because excess money supply can lead to hyperinflation.
What difference does inflation makes in the lives of common people? When we plan for a future goal we consider today’s values. Today, Rs. 1 crore seems like a huge sum for us. But in 30 years, its value will be much less than today. Long term goals like buying a house, foreign education, retirement, has the biggest enemy which is inflation.
Inflation is an invisible thief; it keeps you under the illusion that your money is safe, but it actually keeps reducing money’s value. Today, 5% return is given on fixed deposit, but if inflation rate in that year is 6% then money kept in fixed deposit is losing 1% every year and the impact of tax will reduce returns even more.
Is there a way to be safe from inflation? One can save itself from the impact of inflation by calculating the real return on investment.
REAL RETURNS = ACTUAL RETURNS – TAX – INFLATION
For e.g.: You are on an escalator that is continuously going down, whereas you need to go up to reach your goals, if you stay in one place you’ll automatically go down. The solution is that if you want to go up the escalator then you need to go up faster than the escalator’s speed.
Traditionally, gold was considered as a hedge against inflation, it is believed that prices of gold increase with inflation.
Today, we don’t need to hold gold physically, we can hold digital gold, gold ETFs, sovereign gold bonds as well.
CONCLUSION:
Inflation steals your money by making your currency hold less value. Economists justify this as part of their role as overseers of the economy – to keep the money flowing. The modern monetary theory argues that governments should be allowed to print as much money as they need to remain solvent. Belief in this concept is not widely held, but the notion of printing as much money as needed always makes its way on the table in a crisis, and the corona virus pandemic is no exception.
This article is written by Ishita Mishra who is a student of Amity University Gwalior.
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