Inflation is the sustained rise in the general price level. In this essay I will be discussing how inflation positively or negatively impacts the economy depends on a number of factors:
Whether inflation is anticipated,
Whether inflation is not anticipated,
An individual persons situation,
The cause of inflation.
Inflation is an increase in prices we pay for goods and services. As inflation occurs it costs more for consumers to buy these products and services. The ‘Purchasing Power’ of individuals decrease, when there is an increase in inflation rates it means that for each pound you spend you will only be able to buy a smaller amount of a particular product or service. If we assume that the inflation within the economy is 2% per year this means that a product that currently cost £2 will cost £2.04 at the same time next year. Inflation increases the price and you can’t buy the same goods with a £1 as you previously could.
Inflation is good at low levels if it matches the growth in GDP and wages are increased (or decreased unemployment rate) to accommodate the increase in prices. This is the sign of a healthy economy. If inflation outpaces GDP or if there is a decrease in wages (increased unemployment rate) then the economy is becoming less healthy and it is bad. Likewise deflation (lower prices) can be bad if it is a result of a shrinking economy. Deflation is another variation of inflation in reverse in that it is the decrease in prices of goods and services of time. This occurs when people cannot afford to buy things and companies have to sell goods for a lower price and less profit to get rid of inventory.
There is no accepted cause for inflation; however there are two theories as follows:
Demand-Pull inflation occurs in situations where the demand for goods and services is increasing faster than their supply. In this instance there is a lot of money and not enough goods to satisfy the demand. This pushes the price up and generally occurs in economies that are experiencing growth, hence the argument that inflation can be a sign of a healthy economy.
Cost-Push inflation occurs when the cost to produce goods and services increases; companies increase their prices to maintain a profit margin.
The impact of inflation will be different for different people depending on whether or not it is anticipated. When the inflation rate is anticipating (meaning that it matches the rate that most people expect) then it will not have a large impact. In these situations people can take certain steps to compensate for the expected increase, for example:
A consideration of the rates can be incorporated into wage increases such as professional people and those in trade unions with strong bargaining power may be able to negotiate real pay rises. However the negative impact in these instances is that if an agreement is not reached this could lead to strikes or widening wage differentials.
The interest rates that are charged by banks. Inflation rate updates are usually linked with updates regarding interest rates. The interest rates that are sent are very important as they have a direct impact on the credit market. When interest rates are high, obtaining a load costs more and borrowing is less appealing. When interest rates are lower people tend to borrow more, spend more and this results in a higher level of economic growth. Therefore the way that the government changes interest rates can have a dramatic implication for employment levels and economic stability. When the economy grows rapidly it has an increased likelihood of suffering hyper-inflation. On the other hand when there is no inflation the economy will generally stagnate. The