What is inflation ?

Introduction:

     Hii! I am Deepjit Karmakar founder of  thecommercialinfo.com, today here in this article I am gonna explain you what is inflation. 

Inflation:

Ever wondered how your grandparents bought a house with what would barely be enough to buy a used car today ? Yes, the prices for things are constantly going up, and the main reason is inflation. Here is a fun fact for you. If you had bought a pint of milk in the UK, in 1960, it would have cost you three pence. Today that will cost you fifty Pence. Can we even buy anything with three pence today? Probably not.

Definition of inflation:

"Inflation is the rate of increase in the price of goods and services over a period of time."

   

 Let's talk about inflation.

Basics of inflation:

Traditional economics would dictate that there are two main causes for inflation.

There is demand push inflation and cost push inflation.

(I) Cost-push inflation: 

Cost push inflation happens when business expenses increase, and these extra costs are passed on to their customers. Soap with cost-push inflation, what happens is that the price of your inputs are your raw materials goes up over time, and that could be because of anticipated events or unanticipated events, likes a natural disaster. A good example of that would be say what has happened to many of the world's economic coming out of covid-19 lockdown. And on the back of that, we have seen a lot of supply chain bottle-necks, we have seen a rise in shipping costs, we have seen in certain areas a labour shortage, and because of those, the most of those inputs will go into the price of manufacturing, inevitably that has led to higher costs.

(II) Demand-pull inflation:

Demand pull inflation happens when the demand for goods and services outpaces supply. This tends to happen when the economy is strong. Demand pull is probably a better reflection of what happens when the economy is very close to full capacity. In the case of a very well functioning economy, people may feel that they have more disposable income to spend, and therefore demand for goods and services may go up. And if companies are operating at full capacity, they won't be able to increase their production to keep up with that demand. Some economist also see increasing money supply as another major causes of inflation. Around the 70s, a new type of you came to the forefront. And that was posited by famous economist Milton Friedman, and his view, and he actually said this, is that inflation, primarily and everywhere is monetary phenomenon.

(Q) So, is Milton Friedman theory always right, that increasing money supply causes prices to increase? 

     

    Keynesian economics is all about what governments do. Milton Friedman is saying, well this is actually the domain of Central banks, and if you look at the response to the great financial crisis, to the pandemic, what Central banks have done globally, at least advance economies, has contributed to an increase in the amount of money supply that's available. And so many of the people who believe in the Milton Friedman monetary theory of inflation, suspect that because there has been such an expansion of money supply, eventually that is going to be extremely inflationary. The most widely used measure of inflation is an economic indicator called the consumer price index. It's calculated by measuring the percentage change in the price of basket of selected goods and services a typical household uses over a period of time. This is called basket can include the price of goods such as food, cars, furniture, and apparel, as well as the price of services such as rent, medical costs and recreational spending.

Consumer Price Index (CPI)

Formula of calculating consumer price index  (CPI): 

Usually inflation is a sign of a well functioning, productive and growing economy. But when we talk about hyper inflation then we are entering into a completely different stratosphere.

Hyper inflation:

Hyper inflation is when prices spiral out of control, within inflation rate typically increasing by more than 50% per month. Though many things can trigger hyperinflation, it's most commonly caused by excessive money supply and a loss of confidence in the economy or monetary system. In the case of the the weimar republic, in Germany, for example, post World war one, they were experiencing inflation, average information of about 300 % points per month.

There are loads of these images from the 20s of  little kids using stockpiles of cash as Lego, because cash was worthless. But inflation does not need to spill over into hyper inflation territory to cause trouble. In the 1970s, many of the world's developed economy was witnessed double digit inflation. But it was how the chair of the U.S.'s Central Bank handle it that made the history books. Essentially, what happened is you had a couple of supply shocks. So we talked about cost push, you know, one of them was an energy supply shock, you had that around 1973 1974 with the oil embargo, and then the Iranian revolution in 1979. So that led to skyrocketing oil prices. At the same time, you had a couple of other things going on, back in the U.S. President Nixon had pulled the the US out of bretton woods. He had remove some price controls on certain goods and in the food space. So all of those things contributed to a slow and steady rise in inflation. Until, we talk about secondary effects, it led to a wage spiral. So workers started demanding an increase in pay. And at one point, inflation reached about 14 %. And this was around 1980. And and and then Fed chair Paul Volcker came in and said,"okay, well, inflation is the enemy, we have got to cure this." And the only way we can cure this is by hiking interest rates. So he kept hiking and hiking hiking, the fed started this interest rate hiking cycle, at which interest rates in the U.S. reached 20 percentage points. Eventually they managed to start taming inflation and inflation went down to three percentage points by the mid 80s. But, it came in a very heavy cost, because U.S. had more than 4 million Americans unemployed at the time. And it was it basically led to an economic recession in the U.S. So that was the trade-off dad they had to make, in order to keep inflation team or to bring it back to tame levels, the economy had to go through a very painful adjustment period. And that is a reason why in this day and age, nobody wants to go back to what happened in the 70s and then the painful trade-offs that unsued afterwards.