What is Inflation?

What is Inflation?

In economics, inflation refers to the sustained increase in the price levels for goods and services in one country. This is measured as an annual percentage change. That’s the simplest definition, but there’s more to it that can be defined, as learned from the Online Broker Reviews. Let’s dig deeper and know what really inflation is to understand better why, as investors, we must pay attention to it all the time.

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Causes of Inflation

We can’t actually pinpoint a universal cause for inflation. However, there are a number of hypotheses that can attempt to explain this phenomenon.

Demand-pull Inflation

This one says that inflation is caused by the total increase in demand for goods and services. This increased demand can pull up the prices.

You can wrap your head around this theory by thinking too much money chasing too few goods. Simply, if the demand is growing faster than supply, prices will inevitably increase. This usually happens in economies with rapid growth. This theory is often supported and promoted by Keynesian school of economics.

Cost-Push Inflation

This one holds that inflation happens when companies’ production costs rise. When such a rise happens, they tend to increase prices so that they can maintain their profit margins. Higher costs may include wages, taxes, or increased costs of natural resources or imports, among other things.

Monetary Inflation

This one posits that an oversupply of money in the economy can cause inflation. Similar with any other commodities, the prices of goods are determined by the supply of and demand for such goods.

If the supply is too high, the price of those goods slides down. Now, if we’re talking about money, and if the excess of money makes its value go down, we can expect the prices of everything else priced in dollars must go up.

This theory is frequently promoted by the “Monetarist” school of economics.

How Does Inflation Affect Different People?

Surely, since this happens on a national level, inflation affects different people. Some benefit from it, while others surely lose out, depending on whether the changes were anticipated or unforeseen.

Creditors or lenders lose, and debtors gain under inflation. To illustrate, a bank issues a 30-year mortgage to buy a house with the fixed interest rate of 5 percent per year. You pay $1,000 a month. As inflation rises, the “cost” of you $1,000 per month decreases, and that benefits that homeowner. This would be extra good if the rate of inflation goes beyond the interest rate.

Meanwhile, inflation can be bad for those saving up some money. This is because the dollar they have saved yesterday is worth less today. These savers’ power of savings will certainly erode, and this is sometimes called “cash-drag.”

Workers with salaries that don’t adjust along with inflation will also be adversely affected. Their buying power from their income will still stay the same.

Landlords, on the other hand, will benefit. That is, if they have fixed mortgage. They’d be able to raise rent more each year.

Conclusion

It is important to thoroughly understand all the factors that affect the economy, and inflation is just one of those factors. What you have to remember is that whatever affects the economy affects your trades too, especially if you’re trading forex. Keep updated and stay in the loop.

Categories: Finance

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