What is inflation?
Inflation is simply an increase in the level of prices. This means that you can buy less for your money. Most economists consider a normal level of inflation to be 2-3% per year. A negative inflation rate is called deflation, and signifies a drop in the overall level of prices.
Inflation can be measured in a variety of ways, but the most common method is using the Consumer Price Index (CPI). The CPI is a measure of goods and services purchased by a normal consumer. By using a CPI, economists can see how prices rise and fall over time.
Another way of gauging inflation is using a Retail Price Index (RPI). Like a CPI, it measures the changes in prices of goods and services over time. The RPI also includes mortgages, though. As a result, the RPI can show more dramatic changes when there’s a change in the interest rate.
What causes inflation?
Economists differ in opinion on what causes inflation.
The Monetarist view is that inflation is caused when there is too much money in circulation. While this occasionally occurs when a government prints too much money, it is usually the result of a drop in interest rates. When interest rates fall, consumers stand to gain less from saving. Instead of saving, they use the money to buy goods and services. However, the amount of goods and services available stays the same. Because there’s more demand for goods than there is for the money, the prices go up. This is called ‘demand-pull inflation’.
Keynesian economists disagree with the idea that too much money causes inflation, instead arguing that it is purely the effect of more demand for goods than can be met by the available supply.
Another type of inflation occurs when businesses have increased costs. In order to maintain their profit margins, they pass the increase on to the customers. The result is a higher price for the same goods. This is termed ‘cost-push inflation’. Cost-push inflation can be caused by a number of factors, including increases in workers’ wages, increases in raw material prices, and increases in import prices.
Low rates of inflation are considered normal, and demonstrate a healthy economy. When the inflation rate gets too high, though, it is a problem. The extreme version of this is hyperinflation.
The aftermath of inflation and hyperinflation
Hyperinflation occurs when inflation increases rapidly within an economy. It is generally defined as being a 100% increase over three years or 50% per month, but these are just guidelines.
Hyperinflation is primarily caused by three things: too much money being printed, large government debt, and inflation being left unchecked. The increase of the money supply is one of the most recognisable parts of hyperinflation. Images of people buying a loaf of bread with a wheelbarrow full of notes are common representations of such economic crises.
A notable example of hyperinflation was Germany in 1923, when prices were doubling every few days. The value of the Mark dropped so low, the currency had to be adjusted with the introduction of the Rentenmark. In some cases, though, a single currency adjustment isn’t sufficient. In Argentina, hyperinflation started in 1975 and was not fully controlled until 1992, after three currency adjustments in less than a decade. Brazil had a similar experience, adjusting their currency seven times between 1967 and 1994.
More recently, hyperinflation has been seen in Zimbabwe, where inflation reached a daily increase of 98%, making it the second worst hyperinflation in history. (The worst hyperinflation occurred in Hungary in 1946, with a daily inflation rate of over 207%.)
Hyperinflation causes a number of problems within an economy, which makes it even more difficult to control. The ‘menu cost’ problem, for example, is the problem of dealing with a rapidly increasing inflation rate. It is represented by the price of a menu item increasing in the amount of time it takes to eat it.
Another problem is the devaluation of savings. In unchecked inflation, the interest rate earned on savings can’t keep up with the inflation rate. Money that may have been saved in a more stable economy is suddenly worthless. This also leads to a lack of consumer confidence in finance, meaning that people stop trusting banks to handle their money.
While these problems are especially bad in hyperinflation, even moderate levels of inflation can cause problems. Higher inflation rates can result in lower competitiveness in international markets, which can itself lead to a devaluation of currency. Uncertainty over the future can also lead to lower rates of investment. That is, when consumers and businesses aren’t sure about the way inflation will effect their investments, they are less likely to invest. Instead, they will purchase goods. This can lead to a hoarding effect, in which people stockpile goods as a way of protecting wealth, thus creating a shortage of those goods.
Inflation is also a significant political motivator, and has been at the root of social and political upheavals. A high inflation rate often causes, or coincides with, a lack of confidence in a governmaent.
Yet, kept in check, inflation is seen as a normal part of a healthy economy. Low inflation rates or deflation can be bad for an economy as they generally signify a recession and can create as many problems as a high inflation rate can. Inflation rates are an important measure of an economy, and the control of inflation is a main factor in the monetary policies of governments around the world.
Posted on 29 January 2013 | No responses
Mervyn Kings replacement as Governor of the Bank of England – Mark Carney has motioned that higher inflation in the UK can be excepted in the face of a struggling economy. The Banks current target for inflation stands at 2% with the actual rate coming in at 2.7%.
Posted on 23 January 2013 | No responses
In a recent policy meeting the (BOJ) Bank of Japan has agreed on an agressive plan of action to buy up billions worth of asetts in an attempt to curb deflation and kick start the economy. The aim, to double the inflation target to 2%
Japan has been stuck in a vicious cycle of deflation for close to 20 years. With falling prices dampening consumer spending, this move has been welcomed by many who currently view the future as bleak.
The asset buying program will not start immediately. It has been pushed back to January 2014, many wish it could be implemented sooner. This bold move hopes to see a weakening to the Yen, which currently remains very strong, hampering essential export revenues for the country.
Posted on 10 January 2013 | No responses
After months of deliberating the Office For National Statistics will leave how Retail Price Inflation is calculated unchanged. It has now been decided to create a brand new index simply titled ‘RPIJ’.
For years, many have argued that RPI is inaccurate often running higher than Cost Price Inflation. The decision came after worries that in altering the way RPI is calculated would have a negative effect on pensions in the private sectors well as savers with index linked government bonds.
As well as the newly created RPIJ the ONS will be looking, in March to create CPIH. Closely related to CPI – CPIH will graph the cost in the housing market.
Posted on 17 December 2012 | No responses
Chief Economist for the Bank of England Spencer Dale warns of a fall in the standard of living for many Britons in 2013. The Uk is still recovering from the shock of the financial crisis, this process is a slow and painful one. With a high unemployment rate of 7.8% and wage growth struggling to keep up with inflation, 2013 is looking to be another year of hardship.
Latest predictions at the Bank of England forecast that inflation will not fall below target until the later half of 2014. Describing inflation as “Sticky” Dale said “This Inflation is a by product of the real adjustment that our economy has been forced to make”
Posted on 15 December 2012 | No responses
Experts have warned that over the next two years energy prices could rise by as much as 15%. This is a massive increase in comparison with the inflation target for 2014 weighing in at 2.5%.
Energy suppliers have been quick to pin the blame largely on environmental policy costs and warn that there could be further rate rises in the near future.
Consumer groups have rushed to criticize the hike in rates warning that many households are already struggling to pay their energy bills with many more, such as the elderly living in fuel poverty.
Posted on 10 November 2012 | No responses
Stabilization is predicted for the UK housing market in 2013 but this levelling of prices is threatened in the face of inflation.
In 2013 the housing market will look to rise by 0.5% climbing to 1.5% in 2014. The overall outlook will see a rise of 11.5% over the next five years. However once inflation has been added in to the equation this figure of 11.5% could look to fall by as much as 3%.
With weak economic growth and restricted access to mortgage debt the housing market is looking fairly flat for the for seeable future.
Posted on 5 November 2012 | No responses
A report by Faisal Islam recorded at the beginning of October by Channel 4. This report covers the Governor of the Bank of England – Sir Mervyn King’s speech at the 20 year anniversary of the introduction of the Inflation target. Is this a clear indicator that the £375bn of quantitative easing hasn’t worked.
Posted on 4 November 2012 | No responses
A recent survey has revealed that two out of three savers are depositing their money in to savings accounts paying an interest rate too low to curb inflation.
The survey also revealed that the majority of these savers had no idea what the current interest rate was on their savings account, despite the fact when questioned many believed they had a firm hold on their money.
Experts advise that a better low risk option is to place savings in to an ISA which would provide a better return and have the added benefit of being tax free.
The current UK rate of inflation stands at 2.2% with the RPI (Retail Price Index)coming in at 2.6%
Posted on 1 July 2012 | No responses
A drop in the consumer price index caught the market by surprise this May raising expectations that the BOE will increase stimulus to boost the UK economy.
Slower increases in foods & soft drinks as well as a welcomed drop in the price of fuel are contributing factors to the recent drop in CPI, however the current rate of CPI of 2.8% is still along way off the target rate of 2%
With the outlook of the UK still being in recession this coming quarter further monetary stimulus is looking more likely.
Posted on 18 March 2012 | No responses
This report taken from Channel 4 highlights how today’s pensioners are seeing their hard earned money and pension returns dwindle in the face of high inflation & low interest rates. Ros Altmann of the SAGA Group & Ruth Lee interviewed by Faisal Islam back on 09 February 2012 discuss the PRO’s & CON’s of Quantitative Easing with CON’s quite easily taking 1st place.