Inflation is defined as the sustained rise in the general prices of Goods and services. It is expressed as a percentage and measured each month. It devalues any monetary unit and means the holder has less purchasing power. A key point to remember first of all, is that as long as the inflation figure is positive prices are increasing. For example, if the rate falls from 5.2% to 2.5% prices HAVE NOT fallen. They are still rising but at a slower rate.
The opposite to inflation is deflation - where the prices of goods and services are decreasing. In other words the deflation figures are basically "negative inflation" values. For example, if the inflation rate for August was -1.5% prices are decreasing.
Is Inflation a bad thing?
To an extent inflation is a bad thing for those who have savings. They will find that when they choose to spend these savings, their buying power is less. For example I saved $100 in my Savings Account. That could buy me 10 car magazines in 2010. Now as inflation occurs the price of magazines increases from $10 to $15. Now obviously with my $100 (even with the small amount of interest) I cannot afford as many. I can afford 6 or 7 depending on the interest received so the conclusion is that my money doesn't go as far.
Also those with fixed incomes lose out. This is because if their rate of pay rise is under the inflation rate e.g. 2% and inflation is 3%, your buying power actually decreases as your wages buy you less. This means that your real income has fallen when considering the increase in prices of goods and services.
However those with debts such as loans, credit cards etc. benefit in that the loans do not increase with inflation. Therefore each dollar paid back is worth less and although the amount payable stays stable it will seem to be worth less.
Deflation
There are two types of deflation:
- Good Deflation results from excess supply of goods from advancement in processes and technology. Hence you will know from basic economics that if supply goes up and demand is the same prices will fall ceteris paribus.
- Bad deflation results from decreased demand for products in the market. Consumers save their money for uncertainties or think that prices will drop even lower so wait. This sounds a bit like the Stock Market where anticipation of how low or high the price of a stock will go is key. So, in the markets prices have to be lowered to attract buyers.
How is Inflation calculated?
Consumer Price Index (CPI) is a weighted index which measures monthly changes in the price of popular goods. Think of it as a basket of groceries. The Family Expenditure Survey (FES) decides which items are to be included in the index based on popularity. However it is only an average so considers only the typical household and no the people at the extremes if the scale.
Retail Price Index (RPI) is an alternative. The main difference is that it includes housing costs that aren't in the CPI. These include mortgages, Building Insurance and Estate Agency fees. The rate is therefore different to the CPI. If RPI was higher than CPI we can infer from this that these housing costs are obviously rising at a faster rate if it makes the RPI higher.
Controlling the Inflation rate is one of the Government's key economic objectives.
Why not read:
Causes of Inflation , Effects of Inflation
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