Understanding Inflation: Types, Causes, and How to Manage It

What is Inflation?

Inflation, the ongoing rise in prices, comes in two forms: rising demand and higher production costs. It can be slow, moderate, or running. Currently, we face creeping inflation, impacting low and middle-income earners the most. Governments use monetary policy to control inflation and achieve economic goals.

Definition of Inflation

The word inflation in the broadest possible sense refers to any
increase in the general price level which is sustained and non-seasonal in character.

－ Peterson

Types of Inflation

Have you noticed things costing a bit more lately? That’s inflation! Inflation just means prices are generally going up over time. This can affect how much we can buy with our money and how well the whole economy runs. There are different reasons why inflation happens, but the important thing is to understand how it can impact our everyday lives.

1. Demand-Pull Inflation

Imagine everyone has a little extra cash and wants to buy more stuff. This can lead to demand-pull inflation. When there’s more demand for goods than what’s available, stores might raise prices because people are willing to pay more to get what they want.

What causes this?

• More Money in People’s Pockets: Maybe people get raises or bonuses, or the government gives out money. With more cash, they buy more.
• Big Government Spending: When the government spends a lot on projects or programs, it can also boost demand for goods and services.
• Lower Interest Rates: Sometimes, banks make it cheaper to borrow money. This can lead people to spend more,which increases demand.

What happens when demand pulls prices up?

It can be a sign of a good economy where people are buying things. But, if prices rise too quickly, our money won’t buy as much anymore. That’s why keeping inflation under control is important.

2. Cost-Push Inflation

Imagine it costs more to make the things we buy, like higher wages for workers or pricier materials. This can lead to cost-push inflation. Businesses can’t swallow these extra costs entirely, so they might raise prices to keep making a profit.

What causes this?

• More Expensive Workers: Maybe workers get raises, or there’s a shortage of workers driving up wages. This makes production more expensive.
• Costlier Ingredients: If the price of things like oil or metal goes up, it can make finished products more expensive too.
• Higher Taxes: Sometimes, the government raises taxes on businesses, which can also add to production costs.

What happens when costs push prices up?

Businesses might make less money, and things might cost more for us to buy. This can slow down the economy a bit.

3. Built-In Inflation

Sometimes, inflation can become a bit like a game of chase. When prices go up, people might ask for higher wages to keep affording things. Businesses then raise prices to cover their increased costs, which can lead to even higher wage demands. This cycle of rising wages and prices is called built-in inflation.

What gets this cycle going?

• Expecting Prices to Rise: If everyone thinks things will cost more later, workers might ask for raises now. This can push prices up even faster.
• Automatic Wage Increases: Some contracts guarantee raises based on inflation. While this can help workers keep up with rising costs, it can also fuel the cycle.

What’s the problem?

This cycle can make it hard to control inflation because higher wages keep pushing prices up, and vice versa. It can take strong measures to break this cycle.

4. Creeping Inflation

Inflation can sometimes turn into a cycle where rising prices and wages chase each other. When prices increase, people often ask for higher wages to maintain their buying power. Businesses then raise prices to cover these higher wages, leading to even more wage demands. This continuous loop is known as built-in inflation.

What Triggers This Cycle?

1. Expectations of Price Increases: If people expect prices to rise in the future, workers may ask for raises now, which can accelerate inflation.
2. Automatic Wage Increases: Some contracts include automatic raises based on inflation rates. While this helps workers keep up with rising costs, it can also perpetuate the inflation cycle.

Why Is It a Problem?

This cycle makes it challenging to control inflation because higher wages lead to higher prices, and higher prices lead to higher wage demands. Breaking this cycle often requires strong and decisive measures.

5. Walking Inflation

Imagine prices are going up a bit faster than usual, maybe 3 to 10% each year. That’s walking inflation. It’s more noticeable than slow price increases, and it can start to worry people because things are getting a little more expensive.

What causes this?

• Economy Picking Up Speed: Sometimes, when the economy grows quickly, there can be more demand for things than what’s available, which can push prices up a bit.
• Getting Things Around is Tough: If there are problems getting things from where they’re made to where they’re sold, it can make them more expensive to buy.

What’s the concern?

If prices keep going up faster than wages, the things we buy with our money won’t stretch as far. This can make it harder to save money and buy what we need.

6. Running Inflation

Running inflation occurs when prices rise by 10-20% per year. It can significantly affect the economy, reducing the value of money quickly.

What causes this?

• Excessive Money Supply: Too much money in circulation can lead to higher demand and prices.
• Severe Supply Shortages: Drastic reductions in supply can drive up prices rapidly.

What’s the concern?

Running inflation can cause economic instability, making it difficult for consumers and businesses to plan for the future.

7. Hyperinflation

Imagine prices going up not just a little, but a LOT, like more than 50% every month! That’s hyperinflation. It’s very rare,but it can happen when a country’s money system goes haywire.

What causes this?

• Printing Too Much Money: If a government prints a lot more money than there are goods and services available,it can make the money itself less valuable, leading to hyperinflation.
• Unrest and Uncertainty: When there’s a lot of political trouble in a country, people might lose trust in the currency, which can also lead to hyperinflation.

What’s the big deal?

Hyperinflation can be devastating. Savings become worthless because prices rise so fast. Businesses struggle, and people can’t afford basic necessities. It takes very strong actions to get things under control again.

Cause of Inflation

Here are some key factors contributing to inflation:

• 1) Market-Determined Pricing: Prices are set by market forces such as demand and supply, not by the government. This can lead to price increases for essential products.
• 2) Expectation of Future Price Rises: Events like bad monsoons, reduced industrial production, fear of shortages, wars, and global price increases can lead to expectations of rising prices. This often results in hoarding, which further drives up prices.
• 3) Devaluation of the Rupee: The rupee’s value has been reduced against other currencies in 1949, 1966, and 1991. Devaluation makes imports more expensive and exports cheaper, increasing production costs for imported raw materials and reducing domestic supply, which raises prices.
• 4) Increase in Unproductive Public Expenditure: Government spending on non-developmental items, such as grants, subsidies, security, and elections, increases the money supply, leading to higher demand and demand-induced inflation.
• 5) Brand-Induced Inflation: Major companies invest heavily in branding, driving up the prices of premium brands. Consumers’ preference for famous brands increases demand, contributing to higher overall price levels.
• 6) Black Money: The presence of black money creates a parallel economy that the government cannot control. This money is often spent on luxury and non-essential items, increasing demand and contributing to inflation.
• 7) Rising Income and Growth of the Middle Class: Increased national and per capita income has led to higher demand for primary products like dairy, edible oils, pulses, fruits, vegetables, and industrial goods. While industrial supply has risen, primary product supply has not kept pace, driving up prices, especially for food items.
• 8) Hoarding: The anticipation of price increases can lead to hoarding of goods, which exacerbates the rise in prices.
• 9) Global Influences: Rising prices in other countries can affect domestic prices, as increased global prices for essential imports raise costs for domestic production, further contributing to inflation.

How to Manage Inflation

Here are some practical tips to manage your finances during inflation:

• 1) Track Your Spending: Monitor where your money goes to identify areas where you can cut back as prices rise. Prioritize needs over wants. Use budgeting apps or spreadsheets to keep a close eye on your expenses and make adjustments as needed.
• 2) Embrace Smart Shopping: Look for deals and discounts, consider buying store brands, and explore cost-effective alternatives. Use coupons, compare prices online, and take advantage of sales to stretch your budget further.
• 3) Prioritize Debt Repayment: Focus on paying off high-interest debt first, as inflation can erode the value of your debt over time. This reduces your financial burden and frees up more money for savings and investments.
• 4) Invest Wisely: Consider inflation-resistant investments like stocks or real estate (consult a financial advisor for personalized advice). Diversifying your investment portfolio can help protect your savings from losing value over time.
• 5) Boost Your Income: Look for ways to increase your earning potential through a side hustle, negotiation, or skills development. Consider freelancing, part-time jobs, or online gigs to supplement your primary income.
• 6) Plan for the Future: Factor in potential inflation when budgeting for long-term goals like retirement or education. Adjust your savings plans to ensure you’re setting aside enough money to meet future needs despite rising costs.
• 7) Stay Informed: Keep yourself updated on economic trends and potential government policies that might impact inflation. Understanding the economic environment can help you make informed financial decisions.

Conclusion

Inflation, though a challenge, can be navigated through informed choices. By tracking our spending, seeking cost-effective alternatives, and potentially exploring inflation-resistant investments, we can manage its impact on our everyday lives. However, managing inflation also requires broader solutions. Governments play a crucial role in utilizing monetary and fiscal policies to achieve price stability. By working together, individuals and policymakers can navigate inflationary periods and ensure a healthy economic environment for everyone.

FAQ on Inflation