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Inflation Meaning

What do you mean by inflation?

Hello, Everyone!

If I gave you a hundred rupee note in the year 1950 and you kept it hidden under your bed for 50 years And if you took out that note today and used it in the market, then the value of that note would have reduced to a mere 1 rupee 25 paise in comparison to 1950.

Let me explain it from another angle if you do not understand ……

If you buy something worth 100 rupees today, it would have cost 1 Rupee 25 paise back in 1950, That is 100 rupees of today is equal to 1 rupee 25 paise of 1950. This is because of inflation.

Inflation means inflation of things that make things expensive for all of us every year.

  Why is inflation and what are the reasons behind it?  Is this really a bad thing?  

And how is inflation related to unemployment and other economic factors?

  Where I will explain to you this "terrible" inflation.

What causes inflation?

 First of all, a very important question - Why does inflation happen and what is causing it?  Are some government officials arbitrarily increasing the prices of things?

It is not so...

There are many reasons for inflation but I want to discuss 4 main reasons for an inflation in this blog.

The first reason is very simple- An economic boom.

That is, good economic development when economic development is good, then people have more money in their hands, who can spend it on various items.  When people have more money in their hands, they can spend it on various items.

That is, the demand for everything in the economy will increase.  When demand rises, businesses and companies manufacturing these products want to raise prices to bid to earn more profit because many people are ready to buy.  Hence they increase the price of goods which will later give rise to inflation.

With an example illustrating- Imagine that an aeroplane has 100 seats and 100 passengers have to board that plane but only 10 first-class seats and 90 economy class seats.  Now if the passengers are given more money.

If all of them are given enough money to bear the expenses of the first-class seat, they will all want to book the first-class seat.  But the number of seats is not only 10. All of them can have first-class seats.

So what would happen as a response?

In response, the airline will increase the prices of its first-class seats.  So that only those who have more money can book first-class seats.

So basically there is inflation. This type of inflation is called "demand-pull inflation"

"Demand-pull inflation" is when inflation rises with the rise in demand. The second reason is the increase in the prices of raw materials due to different reasons.

For example, if wheat and rice prices rise due to a bad monsoon season, a government-imposed oil price increase or a new tax increases the price of one of the raw materials, then manufacturing companies  Products using these raw materials.

they'd have to hike the prices of the products to make profits since manufacturing them would become costlier, which would ultimately lead to inflation. This inflation is called "cost-push inflation"

The third reason is an increase in the salaries

No, I'm not kidding: When companies or governments increase their employees' salaries, they have to increase the price of their products and at the same time still be able to make profits.

This inflation is called "wage push inflation"

There can be other reasons for this if the unemployment level in a country is at a very low level, then it is very difficult for companies to change their employees and if they are not replaced, their salary will have to increase, and then it  Triggers inflation from.

And finally, the fourth reason is "currency depreciation"

This can happen for many different reasons, one of the most important reasons is the printing of more notes by the government which causes the currency to lose its value and this is a very important reason.

It could also possibly trigger the hyperinflation that is happening today in Venezuela and in 2008 in Zimbabwe.

If the inflation rate in our country even touches 10%, it would be a reason for people to comment that things are becoming very dear, but in Venezuela, between 2016– 2019, the inflation rate to take per example  Zimbabwe was more than 5 crores,

Around 2008, the Zimbabwean currency was losing its value at such a rapid pace that the government started printing 1 million dollars and 1 billion dollar notes!  And a 1 trillion dollar note also existed in Zimbabwean dollars.

 And do you know what the value of that  1 trillion Zimbabwean dollar note was?

Just 1 US dollar!

This is the extent to which money can lose its value in the case of hyperinflation. because there are several political reasons behind it, apart from the economic ones. Talking about the present, the inflation rate in most of the countries today is going down

Think about why this is happening...

It is because of the shrinking demand in the wake of the lockdowns that have been imposed around the world. People are buying fewer things and travtravellings. The people do not have money to spend because their businesses have shut down And so, there has been a decline in overall demand

And the opposite of the "demand-pull"(which I told you about as the first reason) is happening Since the demand is going down, so is the inflation.

As a response to this, some countries have decided to transfer cash to the people- distribute it for free. Now, some people state that doing this would cause inflation to increase.

What do you think will happen?

I discussed the same logic in this blog on Universal Basic Income that the biggest criticism of the Universal Basic Income and the free distribution of money is that it will cause inflation to spike.

Is inflation necessary? What if there was 0% inflation?

Observing superficially, you could think that this would be great as things would stop becoming costlier and that it is good for you as you will be able to afford it for cheap. You would be able to save up more and over time, the value of money would not depreciate either.

So this would be another great thing!

Analyzing deeply upon the reasons that lead to inflation, then you would understand that 0% of inflation is actually not a good thing. This would mean that companies would not raise your salaries. Your salary would remain constant.

And since salaries never go down, therefore, in general, inflation always stays positive and there is a third reason as well.

If there is deflation, that is, the prices of things keep decreasing every year, then the people would not want to spend money. They would want to save up.

First of all, the value of money is increasing, If deflation continues to happen, then five years on, the item that one wishes to buy would come for cheaper.

So they would want to buy it five years later instead of buying it now. This would cut down the overall public expenditure. Lesser expenditure would mean that the businesses would start incurring losses. The businesses incurring losses would translate to people losing their jobs.which would then cause unemployment to rise.

I've told you about a very long and convoluted connection- You might wonder if it actually happens so

Yes, it does...

There is a very interesting relation between unemployment and inflation. This graph is called the "Phillips Curve"

This shows us the inverse relationship between unemployment and inflation. If there's economic growth, there will be an increase in inflation and unemployment would go down and unemployment will rise if inflation goes down.

And this is a very interesting explanation because one would not expect this to happen, but it does in reality. But as obvious, there are some extreme limits where this graph is not valid.

For example, in the case of hyperinflation

It isn't that Venezuela today has 100% employment and 0% unemployment. Some other factors come into play there. For instance, political factors that cause inflation to spike.

But generally, this graph is valid

A question arises- Excessive inflation is bad because it would cause hyperinflation and increase dearness. Nominal inflation is also bad because it would cause unemployment to rise.

So, what is the optimum level of inflation that a country should maintain?

What could it be?

This figure is 2% for the developed countries.

The central banks and the governments of the developed nations have decided that they should maintain an inflation rate of about 2% If it is more, then they would try and reduce it.

And if it is less, they would try and increase it

For India, this rate is 4% with a margin of  ±2%. So the ideal inflation rate in India should be around 2-6%. This keeps the prices stable and keeps the levels of unemployment at their lowest. It ensures maximum employment.

So, if a government wants to control inflation, how can it do that?

There can be several ways to do this

Generally, the central bank of a country is responsible for controlling the inflation rate, and normally, the central bank- RBI, in the case of India controls the inflation rates by increasing/decreasing its interest rates.

If RBI increases its interest rates (which are called repo rates) which are charged on loans given to other banks, Then fewer banks would want to take loans these banks, in turn, would increase their interest rates as well, which would reduce the number of people wanting to take loans.

This would result in lesser money being circulated in the economy and if this happens so, then inflation would go down and if RBI slashes its interest rates, then indirectly, through other banks, more people would want to take loans and this would push the inflation up.

So the inflation rate can mainly be controlled by increasing or decreasing the interest rates But there are other ways as well- Inflation can also be controlled by the printing of more notes.

Printing of more notes would obviously cause inflation to rise. The government can control inflation by imposing more taxes as I had explained in the reasons earlier in this blog.

The government can also control inflation by spending more or spending less. As read in this blog, you might've noticed that there is a direct relationship between inflation and economic growth.

If the economic growth of a country increases, then so would inflation, And if there is a recession in a country and there's no economic growth, then inflation would also decline. This happens on a general basis, but not always.

Sometimes, it also happens that a country's economic growth is going down and the country is going into recession but inflation is going up. This situation is called "Stagflation"

This is a disastrous thing indeed. Why does this happen?

The reason for this is- Assume that there is a recession within a country, but the cost-push factors- the second reason for the rise of inflation that we talked about The cost of the raw materials is rising.

For example, the rise of oil prices all across the world, so the oil imported would then cost more.

so the inflation would rise because of cost-push factors but there is a recession within the country.

There is another exception from the other side- If there is deflation in a country, but simultaneously,  there is economic growth in the country.

This happened in the USA between 1870-1890. This period is referred to as "The Great Deflation".

The cost of the goods was falling by around 2% every year and there was deflation, but there was also an economic boom. Both the people and the businesses were making more money and employment was on the rise.

The reason behind this attributed to the rise in productivity. This was a time when there was technological progress at such a rapid pace and new technologies were being developed that it compensated for the deflation.

Reverting to our original question- if people are given money for free in today's times during this recession then would it lead to a rise in inflation?

In my opinion, the answer to this is no.

Inflation would not rise because handing out money wouldn't amount to such a huge increase in wealth that people become capable to buy things that are not being supplied. It would not be so. Because it would push up the demand vary slightly.

And demand has fallen so low that giving out paltry sums of money would not alter the demand drastically. So I do not think that the distribution of money for free would trigger any sort of inflation.

No matter how much importance inflation holds for the entire economy, but if we come down to personal consequences and how it personally affects you, then you could say that it has a negative consequence.

The money that you save up would lose value over time the prices of the things keep going up and dearness would always be on the rise this is why people invest their money in different things rather than stashing it under their bed.

For example, they buy gold with it. Because the price of gold rises over time the value of money keeps diminishing due to inflation but the value of gold keeps rising.

 You might wonder about the ban imposed by India on cryptocurrencies. This happened in September 2018. when RBI brought out a circular banning cryptocurrency in India.

But on 4th March 2020, the Supreme Court has overturned the decision of RBI by its judgment and the ban on cryptocurrencies on India has now been lifted.


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