You must have experienced situations in which the price of a product has changed dramatically within a short time span. The current price for 1 kg of sugar is almost double, or even triple the price it was 10 years ago.
What is the reason for this rapid increase in inflation? These are the questions that inflation answers. You may be asking yourself the question, "What is inflation?". Read on to learn more about this fascinating concept.
Inflation is technically the rate at which prices for goods and services rise over a period of time. The Consumer Price Index, also known as inflation (CPI), is a percentage.
A high rate of inflation has the main effect of decreasing the purchasing power of money. Let's say, for example, that 1 kg of salt went up in price from Rs. 10 to Rs. 20. With Rs. You can now buy only half a kilogram with Rs. The purchasing power of Rs. This effectively means that the purchasing power of Rs.
A high rate of inflation also has the effect of making consumers stock up on products to protect their currency from losing its purchasing power. This causes a shortage in goods, which then disrupts the supply and demand cycle. It also causes more inflation. It increases the amount of money available to the economy when people buy goods faster than it takes to make them. As the purchasing power drops further, this leads to more inflation.
However, inflation can also have a positive impact on the economy. Inflation encourages and pushes people towards saving and investing more, in the hope that the returns from their investments would be sufficient to offset the inflation rate.
Let's now understand what inflation is and how it affects us. Contrary to popular belief, inflation is not caused by one factor. There are many. Let's take a look at the factors that directly or indirectly contribute to an increase in inflation.
- An increase in the production costs of goods and services
- An increase in demand and a decrease in supply of goods or services
- More money printed by central banks of countries
- An increase in the money supply in the economy
- The unemployment rate in an economy
- The ratio of an economy's debt to its income
Allowing inflation to increase without any controls will continue to reduce the purchasing power of money until it reaches absolute zero. The money in the economy will cease to be worth anything and it will become impossible to purchase any goods.
The central banks, such as the Reserve Bank of India or the U.S. Federal Reserve, often curb inflation by implementing monetary policies to prevent this from happening. These central banks intervene when there is high inflation to decrease the money supply.
This is usually done by increasing the interest rates in India (also called the repo rate in India). Central banks increase the cost of borrowing which decreases money supply and reduces inflation.
However, restricting money supply too much can lead to a country's economic stagnation. In an effort to stimulate the economy, central banks sometimes lower interest rates. The central banks are involved in balancing the economy by reducing inflation. They closely monitor the economy and adjust monetary policies based on its direction.