Lately, we’re being inundated with talk and analysis about how inflation has been steadily climbing. Is it all bad news? Let’s first define inflation before we go into a bit more detail about it.
Inflation is the gradual loss of purchasing power, reflected in a broad rise in prices for goods and services.
As prices climb, this erodes purchasing power for both consumers and businesses. Basically, money will not buy as much as it did previously.
Here is a relatable example – The average cost of a cup of coffee increased from 25 cents in 1970 to $1.59 by 2019. If you had $5 in 1970, you could have bought 20 cups of coffee, but in 2019, you would only be able to buy about three cups of coffee.
How is the concept of inflation measured? Statistical analysts determine the current value of a “basket” of various goods and services consumed by households, referred to as a price index. Agencies calculate the rate of inflation by comparing the value of an index over one period to another, such as month to month or year to year.
“Inflation can be a warning sign of a struggling economy when inflation begins to surpass wage growth.”
There are two primary types, or causes of inflation:
1) Demand-pull inflation – The economy experiences this type of inflation when the demand for goods and services exceeds companies’ ability to produce them. For instance, a shortage in the supply of semiconductors made it hard for the automotive industry to keep up with demand after the initial drop in demand due to the COVID pandemic. A shortage of new vehicles resulted in a spike in prices for new and used cars.
2) Cost-push inflation – happens when the prices of the things that go into making a product go up, and so the price of the product itself goes up. For example, a radical shift in demand and buying patterns resulted in a sharp increase in commodity prices during the pandemic. industrial companies were forced pass on these increases to end consumers in order to offset inflation and minimize impact on financial performance.
Not all inflation is bad. Annual inflation in a healthy economy is typically in the range of two percentage points. When inflation is kept under control, it can help to stimulate spending and demand, and improve productivity when the economy is struggling.
However, inflation can be a warning sign of a struggling economy when inflation begins to surpass wage growth. The impact of inflation is felt most directly by consumers, but businesses can also be affected.
On the flipside, there is also deflation.
Deflation is a decrease in the level of prices in an economy, and it can be driven by a decrease in aggregate demand, a decline in the supply of money and credit, or by growth in productivity and the abundance of goods and services. It can be positive for consumers in the short-term, but it can also be a sign of a weakening economy.
Neither inflation nor deflation are inherently bad when they stay within lower single-digit ranges. But, if either trend gets out of control and goes to an extreme, both inflation and deflation can significantly and negatively affect consumers, businesses, and investors.
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