Connect with us

Business

What is Inflation and How do economists deal with this problem?

Economic inflation ? What is the ? Have you ever heard of economic inflation ?? Has your country been exposed to any type of inflation before or at the present time?

الإعلانات

Many questions lie on the mind of the reader when he reads the word “inflation.” And that is out of curiosity to know whether this person will be exposed to certain financial losses or will his work be affected if the region or country in which he lives is exposed to one of the types of inflation. In this article, I will discuss with you the most important changes that occur when inflation occurs, and I will show you realistic examples of economic inflation of all kinds over the passage of years with the method of treatment.

What Is Economic Inflation … Simple Explanation To Understand It

Economic inflation is one of the most common economic terms, but despite the popularity of this term, there is no agreement among economists on a specific definition of economic inflation.

الإعلانات

This is due to the use of this term to describe many cases:

  • Excessive rise in the general price level.
  • Inflated monetary income or an element of monetary income such as profits or wages.
  • Higher costs.
  • Create excessive cash balances.

But it is not necessary for these different phenomena to move in one direction or at the same time. Meaning that a rise in prices may occur without being accompanied by a rise in money income. Or there could be a rise in costs without an accompanying rise in profits. Pay attention to this point

In other words, the different phenomena that each of them is called (inflation) are phenomena independent of each other to some extent. It is this independence that causes confusion in defining the concept of inflation. We conclude from this that inflation is an error resulting from accumulations that were not addressed in time.

الإعلانات

You might be interesting to read this also: Mutual Funds

Economic inflation is characterized as a phenomenon that consists of a group of terms, namely:

  • Price inflation : That is, an excessive rise in prices
  • Income inflation: That is, monetary income inflation such as wage inflation and profit inflation
  • Inflated costs
  • Monetary Inflation: That is, the excessive issuance of monetary currency
  • Bank credit inflated

8 months leading to economic inflation

Follow the following reasons that lead to the occurrence of this anomaly in the economy:

Reasons of high or low Economic Inflation

1- The money supply
Inflation is mainly due to the excess of the money supply over economic growth.
– The higher the money supply and the more money the government decides to print, The value of the coin decreased, Because that means more money with the same amount of goods.
This increases the demand for goods. Hence the price rise.
2- The national debt
– the national debt leads to inflation, This is due to the fact that governments have no choice but to pay the national debt by increasing taxes, Or print more money.
When taxes are raised, companies will be forced to raise their prices. To offset the tax rate imposed on it, Thus inflation occurs.
– And in the second case related to printing money, It will increase the money supply, Thus inflation occurs.
3- Inflation resulting from higher wages
– the higher the wages of the workers, Enables people to spend more money on purchasing consumer goods, Which leads to an increase in demand.
– The companies will raise the prices of goods in this case to the level that the consumer will bear, To achieve a balance between supply and demand.
There are other reasons for the increase in demand, among them the decrease in income taxes. This provides more income to the consumers and motivates them to spend more.
– Monetary stimulus policies such as lowering interest rates may also increase demand. This may encourage people to get more loans. Or it leads to higher housing prices.
4- Cost-related inflation
– When companies face an increase in the prices of the raw materials they use in manufacturing. It will increase the price of the commodity to the consumer. In order to maintain the percentage of its profits.
5- The exchange rate
The currency exchange rate affects inflation significantly. The higher the value of the local currency is less than the value of foreign currencies. The prices of imported goods and goods will be very high, And expensive for consumers in the state.
6- Inflation arising from the pursuit of profits
This type of inflation occurs when companies raise their prices in order to obtain more profits.
7- Low productivity
When firms are less productive, The supply of goods decreases and the prices increase.
8- Increase taxes
– When the government imposes more taxes such as value-added tax or customs duties, This will lead to higher prices.

Types of inflation and examples of them:

Inflation is the rise in the prices of goods and services. There are four main types of inflation, categorized by the speed at which prices rise. There are also specific types of inflation such as asset inflation as well as wage inflation and some economists classify demand inflation. Cost inflation is in a separate category and so is inflation resulting from higher money supply.

What are the Inflation Types

Creeping inflation
Also called moderate inflation, it occurs when prices increase by 3% per year or less.

According to the Federal Reserve, when prices increase by 2% or less, it achieves economic growth, as this pushes consumers to increase their purchases now in an attempt to overcome the rise in prices in the future, which boosts demand, That is why the Federal Reserve sets its inflation target at 2%.
Accelerating inflation
This type of strong inflation occurs when prices grow by 3-10% per year.

The economy is hurt by increasing economic growth too quickly.

Consumers just start to buy more than they need to avoid rising prices in the future, which pushes demand to levels that suppliers cannot keep up with, and most importantly, wages also cannot keep pace.

as a result, Prices for goods and services are rising beyond most people’s reach.



Hyperinflation

The rise in inflation to 10% or more, Which causes chaos in the economy.

Money is losing its value so quickly that the income of workers and employees cannot keep pace with the rise in prices.

Foreign investors avoid the country suffering from this type which reduces capital inflows.

The economy becomes unstable and the government loses credibility.





Hyperinflation

This type is characterized by a price increase of more than 50% per month.

It’s rare for it to happen as it only happened when governments printed money to pay for wars.

Germany experienced hyperinflation in the 1920s. And Zimbabwe in the first decade of this century, And the United States during the Civil War in the mid-nineteenth century.
Stagflation
This type appears in light of stagnant economic growth and rising prices at the same time.

This type occurred in the 1970s when the United States abandoned the gold standard, causing the dollar to decline and the price of gold to rise.

This inflation did not end until the Federal Reserve raised interest rates until they reached 20% in the early 1980s as part of its attempts to curb the rise in inflation.
Core inflation
Core inflation measures the rise in the prices of all goods and services except food and energy, because their prices tend to fluctuate greatly due to multiple seasonal factors.

The Federal Reserve uses the core inflation rate to determine its monetary policy in order to avoid adjusting it too much due to seasonal changing factors.




Price deflation

Deflation is the opposite of inflation and it occurs when prices are continuously falling.

The housing market in the United States in 2006 suffered from a downturn as house prices plummeted causing huge losses to those who bought their homes in 2005.

The Fed was concerned about deflation during the economic recession that followed the global financial crisis, because deflation could turn a recession into an economic depression.

During the Great Depression in 1929, Prices have fallen by 10% annually and once deflation starts it is hard to stop it like inflation.
Wage inflation This type indicates that workers’ wages are rising at a faster rate than the rise in the cost of living. This type occurs in three cases: The first is when there is a shortage of workers, And the second when trade unions negotiate to raise wages to a higher level than ever before, And the third when workers effectively control their own wages.

A labor shortage occurs when unemployment falls below 4%. Trade unions in the United States negotiated ever higher wages for auto workers in the 1990s.

CEOs effectively control their own pay by serving on various corporate boards of directors especially their own companies.

Because wages are among the cost components, their rise leads to a rise in the prices of goods and services provided by companies.
Asset Inflated
An asset bubble or asset inflation occurs in one asset class like housing, oil, and gold.

Central banks and other inflation watchers often neglect this type when the overall rate of inflation is low.

The mortgage crisis in the United States and the global financial crisis that followed demonstrated the damage this kind could cause.
Gasoline price inflation
Gasoline prices usually rise in the spring season and before the driving season in the United States during the summer vacation.

Political uncertainty in oil-exporting countries led to a rise in gasoline prices in 2011 and 2012, and prices reached a record high of $ 4.17 a gallon in July 2008.

In fact, oil contributes about 72% of the price of gasoline and the rest is due to shipping costs and taxes.
Inflated oil prices
Crude oil prices hit an all-time high of $ 143.68 a barrel in July 2008.

Oil prices are set by commodity traders and this includes speculators and firms that hedge risks.

Traders raise oil prices in two cases: The first is if they believe there are threats that might affect the show, The second if they see an increase in demand.
Food price inflationFood prices increased by 6.8% in 2008. Causing protests in India and other emerging markets.

Prices rose again in 2011 by 4.8%. Food price inflation usually leads to protests, as food prices rise beyond the reach of most citizens.
Inflated gold prices
An asset bubble occurred when gold prices reached an all-time high of $ 1,895 an ounce on September 5, 2011.

Although many economists do not consider the rise in gold prices to be a form of inflation, However, it is also where prices rise without a change in supply or demand because investors are embracing gold because it is a safe haven.

In August 2011 the US jobs report showed no improvement in the labor market at all. And with the eurozone debt crisis, Economic uncertainty dominated the world and led to higher gold prices.

Gold is being acquired as a hedge against inflation as well as deflation.

How to treat economic inflation and what are the methods used?

Inflation is one of the economic problems that most (if not all) suffer from. Economies, whether developed or developing. And it is increasing, and as a result of the effects that inflation leaves on the course of life in general and the economy in particular. This is what pushed economists to place inflation as one of the main economic goals that macroeconomics seeks to address or at least reduce. Inflation is generally defined as a general and continuous rise in prices. Based on this definition, the rise in the price of a commodity during a specific period cannot be considered inflation, because it is not continuous and includes one commodity, not all goods and services.

The important issue with which inflation arises is the increase in demand for goods and services as a result of an increase in population, for example without being matched by an increase in the production of goods and services that meet what increased demand The increase in cash liquidity in excess of the increase in goods and services also leads to inflation. As the increase in the demand for goods and services with the stability of supply or the increase in cash liquidity more than the increase in the production of goods and services It will lead to an increase in the prices of those goods and services, A rise in the general price level means a decrease in the value of the local currency and a decrease in the value of the local currency means a decrease in purchasing power.

A rise in the general level of prices

That leads to a decrease in the value of the local currency and thus a decrease in purchasing power, It leaves great and numerous impacts on all members of society, including producers and consumers, importers and exporters, As a large part of the rise in commodity prices is a reflection of the prices of the factors of production, which means higher production costs and lower profits, the factor encouraging producers to produce, which is profit, decreases, so production decreases, and this makes the matter worse. The increase in the prices of goods and services will move to the side of exports, and exports will decrease due to the increase in prices.

The rise in the general level of prices will also affect consumers, since before the rise, the consumer had a better standard of living than after the general price increase. Because the rise in prices by half, for example, will lead to a decline in the standard of living of consumers by almost half. As for the importers, they will be better off. Because the prices abroad are cheaper than at home, so they import the cheapest from abroad, and they are sold at home, so they get the difference.

Inflation can be treated through the two most important policies, which are fiscal policy and monetary policy, as follows:

Fiscal policy

The inflation problem is addressed through the use of fiscal policy tools, which are government spending and taxes.

When inflation occurs, the state can deal with it by increasing the size of taxes, regardless of their details. As the increase in taxes will lead to the deduction of a part of the income of individuals. This is reflected in a decrease in the demand for goods and services, so prices will decrease and inflation will decrease, on the one hand.

On the other hand, government spending can be used to treat inflation, as the government can pressure government spending.

This means reducing the volume of spending, especially consumer spending because it leads to increased demand and thus inflation. As for investment spending, it may lead to lowering inflation because it leads to an increase in prices for capital goods in the beginning, but later on, it leads to lower prices. And the decrease in inflation because it led to an increase in the production of goods and services in exchange for stability or an increase in demand in the same proportion.

Monetary policy

Fiscal policy has also been used by its spending and tax tools to tackle inflation. Monetary policy can also be used through its tools represented by the interest rate and the monetary reserve ratio. And open market operations, To address the problem of inflation.

We mentioned previously that inflation could occur as a result of an increase in cash liquidity with the stability of the supply of goods and services. Or, there is an increase in liquidity at a faster rate than the increase in the production of goods and services. This is what drives an increase in the demand for goods and services, so prices rise, and what is known as inflation occurs.

In order to deal with inflation, the state resorts to using monetary policy tools. For example, it works to raise the interest rate, which leads to the withdrawal of liquidity from the markets because everyone is looking for profits and since a higher interest rate achieves profits with uncertainty about future market conditions. Then investors will deposit their money in banks to obtain the interest rate, So cash liquidity, demand and inflation are reduced.

The Central Bank May Also Resort To The Monetary Reserve Ratio Policy

This means the amount of money that banks must keep with the central bank, and the latter is the one that decides the proportion of money that the bank must pay with it, according to economic conditions, If inflation occurs, the central bank raises this percentage, and the banks’ ability to grant credit decreases, and then demand decreases, prices decrease, and then inflation. And vice versa in the case of deflation.

The central bank can also resort to a policy of open market operations to address inflation, When inflation occurs, the central bank enters the stock market as a seller of securities. As the sale of securities in exchange for the money obtained means the withdrawal of liquidity from the markets, and thus a decrease in demand and inflation; Because entering the central bank as a seller to individuals, commercial banks and financial institutions, It will reduce the cash reserves of commercial banks and reduce their ability to grant credit. Demand will decrease as a result of lower spending, and inflation will diminish.

What are the specific tools used in monetary policy to treat it?

The monetary policy tools discussed above are called quantitative tools, and in the event that they do not lead to a desired result, they can be resorted to. Plus quantitative tools. To the use of specific tools, some of which can be referred to as follows:

  • Regulating consumer credit, such as if the central bank raises the value of the first installment. Or shortening the repayment periods, in both cases the demand for credit will decrease, thus spending and then inflation will decrease.
  • Moral persuasion, such as if the central bank in the event of inflation, by sending an invitation to the administrations of other banks to exercise caution and caution in their lending and investment policies.
  • Direct influence through imposing sanctions on banks that adopt inappropriate practices from the point of view of monetary policy. For example, the central bank refuses to carry out a re-deduction process in favor of commercial banks upon declaring its disagreement with their investment policies. Or he refuses to provide commercial banks with additional cash reserves in the event that their loans exceed the prescribed upper limits.

These are the most prominent inflation solutions that the decision-maker can resort to to address the inflation problem. Certainly, the use of these solutions is the opposite of what was discussed above, It will address the deflationary problem of recession and declining economic activity.

Inflation Calculator

Advertisement
Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Advertisement
Advertisement