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INFLATION

A sustained, rapid increase in prices, as measured by some broad index (such as Consumer Price
Index) over months or years, and mirrored in the correspondingly decreasing purchasing power
of the currency. It has its worst effect on the fixed-wage earners, and is a disincentive to save.
There is no one single, universally accepted cause of inflation, and the modern economic theory
describes three types of inflation: (1) Cost-push inflation is due to wage increases that cause
businesses to raise prices to cover higher labor costs, which leads to demand for still higher
wages (the wage-price spiral), (2) Demand-pull inflation results from increasing consumer
demand financed by easier availability of credit; (3) Monetary inflation caused by the expansion
in money supply (due to printing of more money by a government to cover its deficits).
Inflation vs Deflation
Most of us don't stop to think about it, but the value of a dollar is always changing. It swings up
and down with the financial fortunes of the United States. Sometimes a dollar is worth more than
others, and sometimes it seems like a dollar is worth nearly nothing. The differences in the value
of a dollar from one point to another are caused by inflation and deflation.
Inflation
When a dollar buys less than you would expect it to, we call that inflation. Inflation is caused by a
variety of factors, but most of them are related to interest and debt. When the Federal Reserve
bank raises interest rates, it causes the dollar to inflate. There is more money in the system, so
every dollar is worth just a little bit less.
Deflation
Deflation is the opposite of inflation. When there are fewer dollars to go around, every one of
them is worth more in terms of real goods and property. Deflation comes about when interest
rates are low, and when the economy is performing better than the rest of the world. Deflation
makes it cheaper to buy things in the store, but companies who sell their products overseas
often see a slowdown in sales.
Inflation: Advantages and disadvantages
Inflation occurs when there is a sustained increase in the general price level. Traditionally high
inflation rates are considered to be damaging to an economy. High inflation creates uncertainty
and can wipe away the value of savings. However, most Central Banks target an inflation rate of
2%, suggesting that low inflation can have various advantages to the economy. Some economists
even argue we should target a higher inflation rate during periods of economic stagnation.
The Advantages of Inflation:
1. Deflation (a fall in prices negative inflation) is very harmful. During a prolonged period of
deflation and very low inflation, the Japanese economy has suffered lower growth because of
deflationary pressures. When prices are falling people are reluctant to spend money because
they are concerned that prices will be cheaper in the future, therefore, they keep delaying
purchases. Also, deflation increases the real value of debt and reduces the disposable income of
individuals who are struggling to pay off their debt. When people take on a debt like a mortgage,
they generally expect an inflation rate of 2% to help erode the value of debt over time. If this
inflation rate of 2% fails to materialise, their debt burden will be greater than expected. See
more Costs of deflation
2. Moderate inflation enables adjustment of wages. It is argued a moderate rate of inflation
makes it easier to adjust relative wages. For example, it may be difficult to cut nominal wages
(workers resent and resist nominal wage cut). But, if average wages are rising due to moderate
inflation, it is easier to increase the wages of productive workers wages; unproductive workers
can have their wages frozen which is effectively a real wage cut. If we had zero inflation, we

could end up with more real wage unemployment, with firms unable to cut wages to attract
workers.
3. Inflation enables adjustment of relative prices. Similar to the last point, moderate inflation
makes it easier to adjust relative prices. This is particularly important for a single currency like
the Eurozone. Southern European countries like Italy, Spain and Greece became uncompetitive,
leading to large current account deficit. Because Spain and Greece cannot devalue in the Single
Currency, they are having to cut relative prices to regain competitiveness. With very low inflation
in Europe, this means they have to cut prices and cut wages which causes lower growth (due to
effects of deflation). If the Eurozone had moderate inflation, it would be easier for southern
Europe to adjust and regain competitive without resort to deflation.
4. Inflation can boost growth. At times of very low inflation the economy may be stuck in a
recession. Arguably targeting a higher rate of inflation can enable a boost in economic growth.
This view is controversial. Not all economists would support targeting a higher inflation rate.
However, some would target higher inflation, if the economy was stuck in a prolonged recession.
See: Optimal inflation rate
For example, the Eurozone has had a very low inflation rate in 2013-14, and this has
corresponded to very weak economic growth and very high unemployment. If the ECB had been
willing to target higher inflation, then we could have seen a rise in Eurozone GDP.

Disadvantages of Inflation
Inflation is usually considered to be a problem when the inflation rate rises above 2%. The higher
the inflation, the more serious the problem it is. In extreme circumstances hyper inflation can
wipe away peoples savings and cause great instability, e.g. Germany 1920s, Hungary 1940s,
Zimbabwe 200s. However, in a modern economy, this kind of hyper inflation is rare. Usually
inflation is accompanied with higher interest rates so savers do not see their savings wiped away.
However, inflation can still cause problems.
Inflationary growth tends to be unsustainable leading to a damaging period of boom and bust
economic cycles. For example, the UK saw high inflation in the late 1980s, but this economic
boom was unsustainable and when the government tried to reduce inflation, it led to the
recession of 1990-92.
Inflation tends to discourage investment and long term economic growth. This is because of the
uncertainty and confusion that is more likely to occur during periods of high inflation. Low
inflation is said to encourage greater stability and encourage firms to take risks and invest.
Inflation can make an economy uncompetitive. For example, a relatively higher rate of inflation in
Italy can make Italian exports uncompetitive, leading to lower AD, a current account deficit and
lower economic growth. This is particularly important for countries in the Euro-zone because they
cant devalue to restore competitiveness.
Reduce value of savings. Inflation leads to a fall in the value of money. This makes savers worse
off If inflation is higher than interest rates. High inflation can lead to a redistribution of income
in society. Often it is pensioners who lose out most from inflation. This is particularly a problem if
inflation is high and interest rates low.
Menu costs costs of changing prices lists which becomes more frequent during high inflation.
Not so significant with modern technology.
Effects of Inflation - The Positives and the Negatives
Definition

Before going more in depth about the positives and negatives of inflation, the term
"inflation" must be defined.rice of products goes up, jet people are still buying them.
There are two major types of inflation; core inflation and inflation in the broader
sense. Core inflation is a measure of average. In this case a very carefully selected
group of goods' (in economics it is called "basket of goods") change in consumer price
over a period of time is observed, and then those consumer prices are averaged.
Consumer prices are simply that people pay for the product (there is also an industrial
price and inflation measuring supplier price changes). The most widely used periods
over which inflation is measured are: 1 month, quarterly, semi-annual, and annual.
Core inflation means only the very basic products's prices are monitored, such as
bread for example. When there is a high inflation, its an indicator that the economy is
booming, as the price of products goes up, jet people are still buying them.
Probably the most significant effect of inflation is its effect on the revenues of the
government. When inflation is higher than previously thought and planned with, the
revenues of the government increases, which is good as the budget balance of the
government improves. The reason why revenues of the government increases when
inflation incrases is because the government has higher tax revenues. For example a
company sells its products and services at higher prices, which increases the total
income of the company, which in turn increases the gross (before tax) profits of the
company (provided that all other factors influencing profits remain constant). Greater
before tax profits result in greater taxes paid to the government.
Inflation also slows the economy, thus serving as a natural economy balancer, as well
as a crucial indicator. The reason why growing inflation moderates economic growth,
and also potential overheating of the economy, is because, when prices increase and
increase people, as well as companies from their suppliers, start to buy less and less.
This function of inflation decreases the needs of central bank base rates' hikes, which
in itself has many negative side effects (like increasing the interest payment
obligations of governments).
Most of the times inflation and exchange rate of the currency of a country move more
or less parallel. This means that if inflation increases, and the official statistical office
of a country publishes the figures of the speeding up of inflation, the exchange rate of
the currency of the country against foreign currency is also expected to, and in reality
it really does more often than not, devalue. The reason why exchange rates are so
important is because they affect the competitiveness of exporting companies of a
company. The importance of exporting lies in the arrival of new money into the
economy of a country. For example, if a country has, say, 100 billion dollars of
national economic output, 1 billion more means that companies have 1 billion more to
spend in the country, and also the government has more tax income which it can
spend on spending more on social matters. This means that inflation, in this aspect
also, is a significant indicator.
Inflation, on the other hand, can also be quite destructive. For example, a slow in
inflation make importers' products cheaper, whereas domestic manufacturers' product
prices remain the same. A sudden slow in inflation causes lower imported product
prices, meaning two things. First, because of the lower import prices, more people
will by imports opposed to domestically manufactured products. This hurts domestic
production, which in turn may result in rising unemployment (domestic producers fire
employees to keep up with shrinking sales revenue)
Another problem with rising inflation arises when inflation starts to increase
excessively. For example, when inflation surpasses 10 percent, that has two effects.
People will start spending more, hurting companies, especially those companies that
are domestic companies and are selling their products domestically. Also the real

value of savings of both people and organisations also decrease, having a negative
effect on CDs (certificate of deposits), and other fixed rate investment instruments.