What you MUST know about Inflation

“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” — Sam Ewing.

“Inflation and credit expansion, the preferred methods of present day government openhandedness, do not add anything to the amount of resources available. They make some people more prosperous, but only to the extent that they make others poorer.” – Ludwig von Mises.

Everyone is facing the brunt of rising prices. Prices of all essential commodities are rising not just in India but across the world due to a fall in supply. Inflation has spiralled all over the world. With India importing food items, it is only adding more woes to the people.

The Indian economy is also facing a slowdown. The markets have also shed huge gains — March 25 was a sort on anomaly — taking a cue from global meltdown. Industrial production has slowed down, further decelerating the economy. There were risks from turbulence on global financial markets and from rising oil, metals, and wheat and rice prices worldwide. The rise in Inflation is a matter that causes worry to any government. When inflation is on the rise, all of us should be concerned.

What is inflation?

“Inflation is the most regressive form of taxation because it hits the poor the most.”-Narendra Jadhav, Vice Chancellor, University of Pune.

 Inflation is a rise in the prices of a specific set of goods or services. In either case, it is measured as the percentage rate of change of a price index. Food prices are soaring . . . all essential items like vegetables, oil, milk, sugar are getting costlier. Rentals and real estate rates have almost doubled in just a few months in most cities. The real estate prices are at record highs making life miserable, especially for people who have migrated to cities for jobs.

Why inflation hurts us badly

“Inflation is bringing us true democracy. For the first time in history, luxuries and necessities are selling at the same price.” — Robert Orben.

Inflation hits you badly as prices are rising. You end up spending more money for things that you could buy for les earlier.

What you could buy for $ 100, a few years ago, would now cost you nearly double. As a result, your savings will come down. As prices rise, the purchasing power of money goes down too. So to fight inflation, you must always invest money wisely. When you invest money, you must be careful about the return on your investment. The return on your investment must always be higher than the rate of inflation. You may have got a good pay hike, but were you able to save the extra cash? Well, if inflation is high, you end up spending more money so in effect the hike makes little sense. A high inflation rate negates the salary hike you have received.

Inflation reduces the purchasing power of your money. It hits retired folk and people with fixed incomes very badly. Inflation destabilizes the economy as consumers and investors change their spending habits. People tend to spend less when prices are up as a result production slows down resulting in job losses as well. Inflation also affects the distribution of income. Lenders and borrowers are also hit. Experts say a little inflation is good for the economy. It keeps the economy active as the prices of goods keep changing. In the short term, it encourages spending and borrowing and also encourages long term investments.

How inflation hits you

“The first panacea for a misguided nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” — Ernest Hemingway.

Economists attribute inflation to a demand-pull theory. According to this, if there is a huge demand for products in all sectors, it results in a shortage of goods. Thus prices of commodities shoot up.

Another reason for inflation is the cost-push theory. It says that labor groups also trigger inflation. When wages for laborers’ are increased, producers raise the prices of products to make up for salary hike. The rising prices of food products, manufacturing products, and essential commodities push the inflation rate further.

Spiraling global crude oil prices have worsened the situation. Sometimes, banks create more liquidity by allowing more loans for people, giving them the purchasing power to buy more, as a result of which prices are driven up further. The demand-supply gap also drives inflation rates.

How is inflation calculated?

“Inflation is taxation without legislation.” Milton Friedman.

India uses the Wholesale Price Index to calculate and then decide the inflation rate in the economy. Most developed countries use the Consumer Price Index to calculate inflation. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market.

 In India, data on a total of 435 commodities’ prices is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions.

CPI is a measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation.CPI are a fixed quantity price index and considered by some a cost of living index.

Many economists say that India must adopt CPI to calculate inflation as CPI measures the increase in price that a consumer will ultimately have to pay for. United States, the United Kingdom, Japan, France, Canada, Singapore and China use CPI to measure inflation.

WPI does not measure the exact price rise consumers will experience because; it is calculated at the wholesale level.

Another issue with WPI is that more than 100 out of the 435 commodities included in the Index are no longer important for consumers. Even commodities like livestock feed are considered to measure the WPI. In India, inflation is calculated on a weekly basis.

Types of inflation

“Inflation is like sin; every government denounces it and every government practices it.” Frederick Leith-Ross .

 There are different types of inflation:  

 Deflation: It refers to a general falling level of prices. 

 Disinflation: This is a decrease in the rate of inflation.  

Hyperinflation: When prices zoom and inflation goes out-of-control, it is called hyperinflation. 

 Stagflation: It is a combination of inflation, rising unemployment and stagnation in the economy.  

Reflation: This refers to move to hike prices to fight deflationary pressures.

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2 Responses to What you MUST know about Inflation

  1. […] What you MUST know about Inflation In the short term, it encourages spending and borrowing and also encourages long term investments. […]

  2. Kat says:

    I understand that inflation affects retirees and people who live on fixed incomes, but HOW does it affect them? In terms of healthcare, housing, leisure, etc?

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