The decrease in purchasing power of a given currency over time is known as Inflation. An assessment of decline in purchasing power can be reflected in the increase in the average price level of goods and services in an economy over a specific period of time. A rise in the general price level, often expressed as a percentage, means that the currency is actually buying less than in the previous period.
Meaning
Inflation is the rate at which the value of a currency declines and, as a result, the general price level of goods and services rises. The most commonly used inflation indexes are the Wholesale Price Index (WPI) and Consumer Price Index (CPI). Inflation can be evaluated positively or negatively, depending on the individual’s perspective and the rate of change.
Inflation is intended to measure impact of price fluctuations on a diverse set of products and services, and individually represents the rise in price levels of goods and services in the economy over time.
When a currency depreciates, prices rise and you buy fewer goods and services. This loss of purchasing power affects the general living expenses of the general public and ultimately slows economic growth. There is a consensus among economists that inflation will occur when a country’s financial growth exceeds economic growth.
What are the causes of Inflation?
The increase in the money supply is the cause of inflation, which can be done through various economic mechanisms. The money supply gives new money as a reserve balance, either by legal depreciation of legal bids, or through the banking system, by printing more money and giving it to individuals. By borrowing, it can be increased by the financial authorities by buying government bonds from banks in the secondary market.
About Demand-pull Inflation: Demand-pull inflation occurs when the aggregate demand for goods and services in an economy grows faster than the economy’s capacity due to an increase in the supply of money and credit. This will increase demand and lead to higher prices. When people have more money, positive consumer sentiment drives up spending and this increase in demand drives up prices. High demand and inflexible supply create demand gaps and increase prices.
About Cost-push inflation: This is the result of rising prices that act through the inputs of the production process. If the money supply and credit supply is directed to the commodity or other asset markets, which is accompanied by a negative economic shock to the supply of particularly important commodities, the cost of intermediate commodities of all kinds will increase. These developments lead to higher costs for finished products or services, which impacts higher consumer prices. For example, if the expansion of the money supply leads to a speculative oil price boom, energy costs of all kinds can rise, which can contribute to higher consumer prices, which is reflected in various inflation indicators.
About Built-in inflation: This is related to the idea that people expect current inflation rates to continue in the future. As the price rises, workers and others come to expect that they will continue to rise in the future at a similar rate and demand more wages or costs to maintain their standard of living. Their higher wages raise the value of goods, and this wage spiral continues as one factor stimulates another.
About Consumer Price Index
CPI is a measure of the weighted average price of a basket of goods and services that meet the needs of key consumers. This includes transportation, food and medical care. CPI is calculated by taking price fluctuations for each item and averaging them based on the relative weight. The price considered is the selling price of each item offered for sale by an individual citizen. CPI changes are used to assess price changes in the context of living expenses and are one of the most widely used statistics to identify periods of deflation and inflation.
About Wholesale Price Index
WPI is another common inflation indicator that measures and tracks changes in commodity prices down to the retail level. WPI items vary from country to country, but most often include manufacturer or wholesale level items.
About Producer Price Index
This is a set of indices that measure the average change in the selling price received by domestic producers of intermediate services and goods. PPI measures price change from the seller’s perspective and is different from CPI, which measures price change from the buyer’s point of view. In all these variations, price increases for one component (such as oil) can offset some of the price reductions for another component (such as wheat). Overall, each index represents a weighted average price change for a particular component. This may apply at the sector, macroeconomic or commodity level.