What Is Inflation? Key Things You Need To Know!

You go to the supermarket and purchase items that you always have at home on one occasion. Then, two weeks later, you repeat the action, only to discover that what you purchase is somewhat more expensive than before. What’s going on here? The following explains how inflation is responsible for this problem.

Bartering has evolved alongside economic progress since the beginning of civilisation. From that point forward, there has been a continual inflow of new products and services, accompanied by fluctuating pricing from one era to the next. Goods can be purchased with official currencies such as the euro in the European Union.

In every country, there are ways to measure how well the economy is doing and what events have occurred. One of these factors is measuring inflation, which is when prices start going up for goods and services so people can’t buy as much or save money as easily, as well as increasing production costs.

Each country calculates its own indicators in order to assess this impact. In Spain, for example, the consumer price index (CPI) is used to calculate consumer price inflation, which reflects changes in the prices of the country’s most representative items and services consumed by households. These include everyday items such as food; other goods consumed over a longer period of time, such as household appliances and clothing; and services we purchase in specific circumstances, such as home insurance. We see prices rise all over the market. Average prices of everything increases.

Energy and food prices have a direct impact on core inflation. The prices of these two products have a significant weight in the CPI and, as a consequence, their evolution will determine the general price trend as well as inflation data.

For example, let’s say the cost of diesel rises 20%. This will lead to an increase in the prices of all goods and services that require energy in their production or transportation processes. This is fuel inflation. The same happens when the price of wheat rises; the cost of bread will also increase.

It can also lead to a decrease in real wages. If, for example, inflation is 10% and salary growth is 5%, then purchasing power has declined by 5%. This puts extra pressure on people’s budgets with regards to food and energy prices.

The HICP (harmonised index of consumer prices) is used to compare prices in different countries within the European Union. The method is standardised and based on criteria from the European Central Bank.

If the index rise persists, people will save less, and they will be able to purchase fewer goods and services for the same amount of money. The value of our currency drops and uncertainty rises as a result of what we are seeing: inflation is on the rise.

What exactly causes inflation?

Some of the more frequent causes behind price fluctuations, such as inflation, are due to an imbalance in supply and demand, and rising prices. For example, when too many consumers try to buy a scarce good, this drives up prices. Additionally, if there is excess supply (i.e., not enough demand to meet it), then inflation will decrease or become negative (deflation).

Inflation might come about as a result of increasing operational costs, for example, the cost of energy or logistics services. This has an immediate consequence on the price at which they will provide their services. Another cause is an increase in the quantity of money in circulation in a specific nation. As a result, excess cash must be curtailed since demand may fail to rise as a result of an imbalance in the system.

Now that we have seen the causes of inflation, it is important to understand its different levels.

  • Moderate inflation: a slight annual increase in prices (under 10%). 
  • Rampant inflation: Two or three digit annual inflation can have a very negative impact on the economy of a country. As the value of money drops, people focus their spending on essential goods.
  • Hyperinflation: if a nation is affected by this type of inflation, it means it is suffering a severe economic crisis. The generally accepted definition of hyperinflation among economists is monthly inflation in excess of 50%. The value of money plummets as a consequence and affects price stability.

“Stagflation” is the term used to describe a struggling economy that is accompanied by high inflation rates and raising interest rates. This was first seen during the 1970s oil crisis, where multiple countries’ economies slowly grew as a result of devastating inflation levels. This also affected the money supply.

Why does inflation affect a country’s economy?

Most people believe that inflation is always bad, but some countries Purposefully create inflation to jumpstart their economies. Although it can be beneficial in moderation, too much inflation will have dangerous consequences for both citizens and the government.

The most crucial impacts are currency depreciation, a decline in people’s purchasing power and saving capacity, and economic uncertainty, as previously said. The central banks increase interest rates to combat inflation, which in turn affects companies’ operational costs and their ability to invest and expand. When this happens, economic growth slows down, which affects annual growth rate.

In conclusion, inflation is a complex economic concept that can have different levels and causes. Its effects are both positive and negative, depending on the situation. A country’s central bank must be able to control inflation in order to achieve economic growth and stability.

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