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Introduction to the concept of Inflation 

For someone who dislikes having it technical, the impact of inflation reduces the purchasing power of a country’s currency. This is primarily due to the inequality of the demand and supply of money and the varying costs of production and distribution of goods. An increase in the VAT on goods also causes inflation.

Practical Example 

A car was marketed for $3,000 in January 2023, and a prospective buyer had $2,500 in his fixed savings account that would mature in January 2024 to be $3,000. 

This prospective buyer decides to wait until his savings account matures before buying the car. However, when he gets to the dealer, the same car brand now costs 12% (an extra 360 dollars) higher than it used to. 

This is because of Inflation, which has reduced the purchasing power of the money in the customer’s savings account. 

What is Inflation 

Inflation is simply the rise in the price of goods and services with a relative decrease in purchasing power. If a customer goes to buy some groceries in the store for 100 dollars and after a year, the exact grocery costs 110 dollars, then the price of the good has experienced a 10% inflation rate. The impact of the inflation rate is shown in the rising prices of selected goods or services. 

When people buy more sweaters instead of T-shirts during the winter season, the rising demand for sweaters can cause the price to rise. This is not always a typical example of inflation because this is just a change of buying interest due to the changed weather and not a currency’s value crash. Inflation, however, is majorly due to the downward trend of the value of a particular currency itself. Inflation is mainly traceable to irregularities in fiscal and monetary policies.

History behind Inflation 

Trade used to be by barter at a point in the history of buying and selling; however, the inequality in the barter system led to its evolution over several dispensations until governments began to issue currency notes. As money was introduced, the possibility for inflation emerged in the world’s economy, and a sample of one of the first recorded inflation was in the year 330 BC during the reign of Alexander the Great in the ancient European domination. 

During those times, metals were most people’s typical means of exchange. To increase the amount of money in circulation without increasing the amount of silver in the economy, the government would collect silver coins and smelt them into an alloy of silver by mixing the melted silver with a percentage of melted metals. As this continued, the amount of the pieces of coins in circulation increased, but its value began to decrease. This meant that a good that a piece of silver could buy was not more purchasable because of the crash in the value of the silver coin. 

In history, ancient Chinese kingdoms, African dynasties, European monarchies, and many others experienced inflation mainly due to victory or defeat in war. The Song Dynasty in China began issuing fiat currency by printing money, and the Yuan Dynasty began to print a lot of money to deal with the war they were in. This led to massive inflation because, soon, the value of money began to reduce drastically. 

Causes of Inflation 

The underlying cause of inflation is increased money pumped into the economy. This happens when monetary institutions like the central bank print more currency and also when the government gives citizens money, which played out during COVID when the government gave out money to citizens. When credit institutions like banks also give out more loans, this, at a point, can cause inflation because of the increased supply of money in the economy.

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Amidst all these, we can first classify the causes of Inflation into three categories; 

• Demand-Pull Inflation
• Cost Pull Inflation
• Inflation Projection 

Demand-Pull Inflation

Most people only spend beneath their paycheque or credit limit. However, when a situation increases the supply of money in circulation, and people can afford more than they have, they spend money sentimentally, and demand increases. This causes the demand for goods to increase beyond the nation’s production capacity. 

As this situation happens, the demand and supply margins increase. This instantly leads to an increase in the prices of goods, reducing money’s purchasing ability. This follows the underlying principle of economics: an increased demand will increase price. 

Cost Pull Inflation 

A bag that used to be produced for 100 dollars and sold for 150 dollars now costs 120 dollars to produce. This will immediately lead to an increase in the selling price without an increase in the cash available to prospective buyers. In this sense, the currency’s purchasing power has been reduced.

Cost pull inflation is most likely to happen when the central bank devalues a country’s currency. This is because the aggregate supply of locally produced goods and services will not be able to meet their aggregate demand. After all, export demands will increase due to the devaluation. This also will lead to a situation where raw materials imported will become more costly, and demand for them will reduce, causing an increase in the demand for local goods. 

Inflation Projection

This situation arises when producers and consumers panic about the rising inflation in the economy. When manufacturers can predict an increase in the inflation rate, they can rapidly increase the prices of goods because they know that this will lead to a rise in the cost of production and payment of staff in the long run. 

As this salary increase is effected, consumers also project rising inflation and an increase in their demand for goods. This then furthers the increase in the prices of goods, leading to a loop of inflation. 

Financial Impact of Inflation 

The impact of growing inflation on the economy is generally considered a threat to the financial capacity of the people and the country. However, this does not mean inflation has no advantage for individuals. Here are a few benefits and downsides of inflation. 

Benefits 

• The first benefit of inflation at its minimal percentage is that it allows money to be spent rather than saved since people know their money will be devalued after a while. This allows for stability in the supply and demand margin.
• Individuals with already fixed assets and stocked commodities will benefit from inflation because the prices of goods will increase, and they will be able to make more money from selling. 

Downsides

• The first downside of inflation is its impact on those who are buying. Buyers are always at the risk of inflation because they will spend more on goods that used to cost less. 
• During rising inflation, changes in prices are not always unitary. Some goods will go up before the others. This means that some will begin to spend a lot more than they earn because of these changes.