Inflation: Is it Really Bad for The Economy?

Arbin Aryal – General people always seek to increase the value of money in span of time but it is a universal phenomenon that inflation should exist in certain level to boost economic growth. Imagine you used to buy a gas cylinder in Nrs. 650 in 2004 having 14.2 Kg Quantity, Just in fifteen years later in 2019 you have to pay Nrs. 1400 for the same 14.2 Kg one cylinder gas. Though the quantity of the gas remain same 14.2 Kg and there is increase in price by more than 115% over the 15th year period. This simple example explains how money loses its value over time when prices rise. This phenomenon is called inflation. Somehow inflation is the determinant of time value of money. A rupee today is more worthy than a rupee we will get tomorrow.

Inflation is the numerical measure of the rate at which the average price level of goods and services increases over a period of time in an economy. In other words the constant rise in the general level of prices where a unit of currency buys less than it did in earlier. Often it is expressed as a percentage, which indicates a decrease in the purchasing power of a nation’s currency whether in national or international transaction. The situation when a rupee loses value as it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the general public which ultimately leads to a slowing in economic growth. Sometimes inflation occurs when a nation’s money supply growth overtakes economic growth.

However, it is not necessary that prices always rise with the span of time. They may remain stable or even decline. Deflation may cause by different factor like when supply exceed demand, higher production, government intervention and sometime technological change in production process and those cause decrease in the cost of production and market price too. The purchasing power of the same 1000 rupee note may increase over the period as the price of the commodity declined. This phenomenon is called deflation, and is the opposite of inflation. Deflation can occur in recessions, where the demand for most goods and services declines and the suppliers of these goods and services lower the prices to compete for fewer consumer. In extreme cases, consumers delay purchases in anticipation of further decline in price. This can often lead to a self-fulfilling prediction of lower prices.

Although less expensive goods and services may seem like a good thing for consumers, it only marks the beginning of deflation’s damaging downward spiral.

  1. Low price for goods and services.
  2. Smaller cash flow and profit margin for entrepreneur.
  3. Layoff and no new hiring, slow down production.
  4. Unemployment level hike.
  5. Less purchasing power of people.
  6. Oversupply of goods and services.
  7. Low price for goods and services. And continue the cycle 1 to 6 continuously.

 

We see how the dangers of deflation and the dangerous cycle it can create so deflation is not good we needs minimum rate if inflation at least to retain the existing investment. So we can say inflation is good somehow for nurturing economic growth which make investing motive for the new investor too it revert all the away that revel from deflation. We can classify causes/factors of inflation into three categories:

  1. Demand-Pull inflation
  2. Cost-Push inflation and
  3. Built-In inflation.

Demand-pull inflation occurs when the overall demand for certain goods and services in an economy increases more rapidly than the economy’s production capacity of the goods. It creates a demand-supply gap, with higher demand and lower supply, which results in price hike. For example, when the oil producing country decide to cut down on oil production, the supply diminishes. It leads to higher demand, which results in price rises and contributes to inflation. Further, an increase in money supply in an economy also leads to inflation. With more money available to individuals, the positive consumer sentiment leads to higher spending. This increases the demand and leads to price rises. Money supply can be increased by the monetary authorities either by printing and giving away more money to the individuals, or by devaluing (reducing the value of) the currency. In all such cases of demand increase and the money loses its purchasing power.

Theoretically, monetarism (a concept which contends that changes in the money supply are the most significant determinants of the rate of economic growth and the behavior of the business cycle) establishes the relation between inflation and money supply of an economy. The theory is governed by a simple formula, MV = PQ, where M is the money supply, V is the velocity (number of times per year the average dollar is spent), P is the price of goods and services and Q is the quantity of goods and services. Assuming constant V, when M is increased, either P, Q or both P and Q rise. General Price levels tend to rise more than the production of goods and services when the economy is closer to full employment. When there is relaxed in the economy, Q will increase at a faster rate than P under monetarist theory.

Cost-push inflation is a result of increase in the prices of production process inputs. Examples like increase in labor costs to manufacture a good or offer a service, or increase in the cost of raw material. These increases lead to higher cost for the finished product or service, and contribute to inflation. In other words cost-push inflation starts with an increase in the cost of production, which may be unexpected increase in the cost of raw materials, unexpected damage or shutdown to a production facility or mandatory wage increases for production employees, a rise in minimum wage automatically increases the compensation of employees who were being paid below the new standard. One common unexpected cause is a natural disaster. This can include floods, earthquakes, tornadoes or any other large disaster that disrupts any portion of the production chain and leads to increased production costs. Not all natural disasters may qualify, as not all of them result in higher production costs too.

Built-in inflation is another cause that links to adaptive expectations. It originates from either determined demand-pull or large cost-push (supply-shock) inflation in the past. It then becomes a “normal” aspect of the economy, via inflationary expectations and the price/wage spiral. In other words, inflation which evolve from the past events and continues to affect the current economic conditions of a nation sometimes it may also be termed as Hangover Inflation, so this means that inflation happens now simply because of subjective views about what may happen in the future or past experience with inflation. The adversarial nature of bargaining about wages in modern capitalism supported by the conflict theory of inflation. Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages from falling in response to inflation by pushing for higher wages. If they are successful, this raises the costs faced by their employers. To protect the real value of their profits (or to attain a target profit rate or rate of return on investment), employers then pass the higher costs on to consumers in the form of higher prices which encourages workers to push for higher nominal wages because these price hike raise their cost of living; so the inflationary cycle continues as one factor induces the other and vice-versa.

Effects of inflation:

Inflation can be viewed positively or negatively depending upon which side one takes. Individuals with tangible assets, like property or stocked commodities, may like to see some inflation as that raises the value of their assets which they can sell at a higher rate. However, the buyers of such assets may not be happy with inflation, as they will be required to shell out more money. In other words, people holding cash may not like inflation, as it decomposes the value of their cash holdings. Inflation promotes investments, both by businesses in projects and by individuals in stocks of companies, as they expect better returns than inflation rate in near future.

In my opinion, an optimum level of inflation is required to promote spending to a certain extent instead of saving. If the purchasing power of money remains the same over the years, there may be no difference in saving and spending, also the interest rate on saving should not be more than the return on investment in real sector.  It may limit or decrease spending, which may negatively impact the overall economy as decreased money circulation will slow overall economic activities in a country. High, negative or uncertain value of inflation negatively impacts an economy. It leads to uncertainties in the market, prevents businesses from making big investment decisions, may lead to unemployment, promotes people collect to stock necessary goods at the earliest amid fears of price rise and the practice leads to more price increase, may result in imbalance in international trade as prices remain uncertain, and also impacts foreign exchange rates too which ultimately hamper the nation’s economy as a whole. So a balanced approach is required to keep the inflation value in an optimum and desirable level of range.

Governing body should focused on implementing measures through monetary policy, which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money There should be linked between Fiscal and monetary policy to promote new investment supply, and moderate long-term interest rates, price stability and maximum employment, each of these goals is intended to promote a stable financial environment, further the implementation part should be clear and hassles free which is not seen in Nepalese economy time and again, we lack in implementation part or individual describe the situation that favor the one only in a particular situation whether from demand side or supply side. The monitory policy should clearly communicate long-term inflation goals in order to keep a steady long-term rate of inflation, which in turn, maintains price stability, which allows businesses to plan for the future, since they know what to expect. It also allows to promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change supported by fiscal policy to control the inflation and hyperinflation. Stocks are considered to be the best hedge against inflation, as the rise in stock prices are inclusive of effects of inflation but it do not promote the employment and supply side economy.

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