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Inflation and Its Effects

June 15, 2011
Inflations and its Effects

Inflation Effects

Inflation is the measure of the general level of prices for goods and services in an economy over a given period of time.
Inflation’s impact on the economy is vast, varied and can be either positive or negative. Inflation is usually caused by the increase in money supply as well as a change in economic conditions. Most economic analysts agree that low to steady inflation can be beneficial, while hyperinflation is dangerous.

Inflation rates vary year to year, and currency to currency. Inflation explains why stamps cost less than 5 cents in the 50’s and are nearly 50 cents now. Rising inflation means that the value of a currency is decreasing or has less purchasing power. Here in the United States, we measure inflation with the Consumer Price Index.

The impact of inflation can be both good and bad for economies. Some of the negative results include the loss of value in real terms, rising prices, less capital investment and the hoarding of goods. Inflation can also be good in that it can show that a nation is prospering and that its currency is strong, which can encourage investment.

Causes for Inflation:
There are generally two causes for inflation: weak economic growth in a country or an excessive increase in the money supply due to accommodative fiscal policy. When you look at the hyperinflation in Brazil or Italy in years past, bad economic conditions coupled with a loose monetary policy are to blame. Things got so bad in those countries that people literally had to bring money in wheelbarrows to buy goods.

When countries experience economic growth, it is usually followed by an equal growth in its currency. As that country’s goods and services become desirable, the demand for their currency grows as well. This demand causes deflationary pressures at home, since their currency is worth more, making goods cost less. The opposite can happen as well. If a country’s economy is so bad and no one is willing to buy their currency, the value of that currency drops (until it finds buyers). This will make the cost of products soar just to keep pace, therefore causing inflation.

Another more direct way to impact inflation is by simply increasing the amount of money circulated. Sovereign national committees (such as the Federal Open Market Committee here in the U.S.) control the monetary policies for each individual country. These committees can also control the interest rates in their countries, therefore making their currency strong or weak. Excessive printing of money can lead to hyperinflation, which means prices can skyrocket.

Inflation: An Economic Indicator
Inflation is a measurable way to gauge the health of a country and their economy. Inflation can be good or bad for country, depending where they are in the growth cycle. When you look at the current situation in the U.S. dollar and commodities prices denominated in dollars, one can see that the decrease in the dollar has led to much higher prices for corn, cotton, coffee, gold, crude oil, wheat, and many other commodities.

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