The Effects of Inflation on a Financial Situation of People

Have you ever thought about how inflation can affect us in a financial sense? This paper will go in-depth and explain the causes of inflation and how it affects consumer behavior, income, investment, and business. In this paper we will go over the methods on how inflation is usually managed and what standards it meets to raise alarm about the economy. It will also provide explanations to understand news of inflation in an effective way.

Inflation is an economic term that has been used in many of the business and economic reports that are presented throughout the media today. Some people do not understand inflation in a clear way on how it works and how it affects our living, resulting people to simply ignore the importance that inflation has in the society. Inflation is the general increase of prices due to increasing consumers demand for goods and services that surpasses what businesses can produce. A cause to this is when employers concede wage increases that surpass profits in productivity, and then these employers would make up for these wage increases by charging consumers with higher prices to their products. In some cases, there could be an increase in the cost of products due to environmental or physical factors, such as, for example, the cost of eggs had risen because a virus had killed many egg-laying hens in poultry factories.

When the cost of goods and services rises, the buying power of the dollar declines significantly. During a period of inflation, a certain amount of money can purchase less than it used to. For example, an employee may receive a salary increase of 20 Twenty percent. If prices remain steady, the employee can buy 20 (Twenty) percent more goods and services. However, if the prices increase 20 (Twenty) percent, the employee’s purchasing power has not changed, but if the prices increased even more, the employee cannot purchase as much as he or she formerly could. This is especially difficult for workers with fixed incomes. There are also different kinds of inflation: mild, moderate, severe, and hyperinflation.

Mild inflation is when the price level increases from 2 to 4 percent a year. If a business can pass the increases along to the buyer, the economy flourish; jobs are plentiful, and unemployment rates go down. “A risk in a growing economy is that it may grow too fast.” (Prentzas, 31) If incomes increase faster than prices, workers would have better purchasing power. Unfortunately, this would last for a while. Employers seek out for larger profits through periods of economic growth, and unions seek out higher wages. This would result to prices rising even further, meaning increasing inflation. Moderate inflation happens when the price level increases from 5 to 9 percent. During moderate inflation, prices increase more rapidly than wages, making the purchasing power to decline. Most individuals would buy more then because they want more goods and services before the prices would increase even further. The increase in demand would eventually make the prices to go up more.

Severe inflation (or double-digit inflation) is when the yearly rate of inflation is 10 percent or higher. Expectantly the prices go up even more higher than the wages, so, it is expectant for the purchasing power to decline even more. It can also decrease a country’s output of goods and services by decreasing demand from foreign and domestic consumers since the products have become more expensive. Demand for exports decline because other countries would seek out for cheaper alternatives and so would the domestic consumers.

Hyperinflation is the worst, with uncontrolled and rapid inflation. It usually happens when a government coins money to back a level of spending much larger than what it collects in tax revenue, usually because it can no longer back its budget deficit by selling bonds. The huge amount of money being distributed would initiate a huge decline in its value. When money loses value, it would not be in much use because many people would trade goods and services, not currency. Hyperinflation had caused downfalls in the economies of some nations during or after war. Knowing what you hear about inflation is quite nice. The inflation rate in the United States is usually measured by the Consumer Price Index (CPI), a monthly measure, done by the Bureau of Labor Statistics. It tracks price changes of a representative group of goods and services that are regularly purchased such as food, clothing, housing, medical care, etc. The total price of these items is compared with their total price during a base period (an earlier period.) As a consumer, the lower the calculated number is, the better.

To control inflation, the government would reduce its budget deficit (the amount by which a government’s spending surpasses its revenue) or reduce the money supply. Most governments use their money supply to try controlling inflation, the practice being labeled monetary policy. The monetary policy of the United States is managed by the Federal Reserve System. The Federal Reserve can try to reduce the rate of inflation by increasing interest rates on loans; encouraging people to spend less money and loaners will not have to keep increasing prices, so that inflation calms down. The government may also follow along with the fiscal policy, which involves its spending and taxing programs. The government can use these programs to reduce the demand of goods and services. It can reduce its spending by buying less from businesses, causing a reduction in sales and people would have less money to spend. It can also reduce the income of consumers by raising taxes, making them to spend less money, easing the demand for goods and services, which leads to inflation leveling off.

Another way to fight against inflation would be wage and price controls established by the government to limit wage and price increases during an inflationary period. Some economists assume that if a government limits these increases, wages and prices would level off, and others believe that controlling them would be ineffective, while others think that trying to control them would interfere with the natural rise and fall of wages and prices. However, implementing wage and price controls have been proven ineffective in advanced economies.

An increase in inflation can lead to erratic investments. Usually prices give out signals that help individuals and businesses make the economic choices that break down the factors of production. With inflation, people would have a distortion of that process and begin to speculate (to buy things of huge value thinking they would increase in value later on.) People would not invest as much as before and would continue to speculate, giving a bruise to the economy. With wage increases being slower than the rising inflation, one might feel down as the cost of living increases. By looking at the long term, one should at least start saving for future needs. Currently we are experiencing mild to moderate inflation but it is not too late or too early to start investing in your savings or retirement.