Inflation is a one-word tale that has got the best of the best economists twisted in a good knot. Its Janus-faced nature has got people scratching their heads in search of answers to the question - is inflation a fair-weather friend? Be it a billionaire or someone that is trying to make ends meet, inflation affects everybody. That is why the government monitors it scrupulously. 

Inflation is a term used in economics, to indicate the generally rising prices of goods and services within a particular economy. The periods of inflation or deflation are measured using a popular statistic called Consumer Price Index or CPI. CPI is defined as a measure that determines the weighted average of prices of a basket of commodities. It is estimated by considering the change in the price of each item in the predetermined basket of goods and averaging them. 

Let's look deeper into why the rise and fall of inflation have been one of the most contested topics in economics. Through the course of this blog, we'll look at what inflation means, its causes and effects, and what too much or too little of it could do to any global economy.

What Is Inflation?

Inflation is defined as a general increase in prices and a fall in the purchasing value of money. This means that if it cost you $5 to go to the movies in the 1990s, you will now have to shell out $15 in 2020. This surge in price is the effect of inflation. 

The inflation rate is defined as an overall increase in the Consumer Price Index (CPI), which is a weighted average of prices for different goods. In layperson's words, the inflation rate is the rate at which inflation rises or falls. 

What Causes Inflation?

Financial experts have sought to find the causes of inflation.  They have found that an increase in money supply faster than the growth in real output, causes inflation. Simply put, the money supply is the total money circulating within a particular economy. The reason this happens is that, with an increase in the money supply, there is more money chasing the same amount of goods.

Inflation also has an impact on the national debt, and exchange rates. In fact, inflation makes it easier for the government to pay off a national debt as they now have a higher reserve. However, in the case of exchange rates, an increase in an exchange rate results in slower growth of real GDP. 

Experts have coined two theories explaining the causes of inflation; Demand-Pull Inflation and Cost-Push Inflation (National debt, money supply, exchange rate).

Demand-Pull Inflation: 

When the number of goods and services demanded far outweighs the supply of them, it is called demand-pull inflation. Producers are unable to meet the swell in demand, and so, compensate by increasing the price of the goods and services that they offer. This forces people to spend more money, having a positive impact on the economy. With an increase in salaries and wages, there is more money being circulated in the economy as people tend to better their lifestyles. That means buying better quality goods, which again, results in spending more money. In due time, this causes inflation. 

Cost-Push Inflation: 

This is when the cost of businesses rises and is forsworn on to consumers. There are several reasons why this could happen, one of which is the cost of raw materials. The cost of crude oil, for instance, could increase exponentially as a result of progression in countries. An increase in wages is an added reason that causes cost-pull inflation. Businesses then compensate for this increase in cost, by relinquishing it to their customers. Ultimately, this too yields an increase in inflation.

Why Is Inflation Important?

Although inflation may sound like an economy's worst nightmare, an optimum amount of it has proven to not only be required but also welcomed. Experts have deduced the optimum range of inflation to be between 2-2.5%.

Case 1 - China:  

A country that has held fairly appreciable inflation rates is China with 2%, 1.56% and 2.1% in the years 2016, 2017 and 2018, respectively, representing growth and a blossoming economy. What separates China from other countries is that the government, instead of the market, sets the interest rates.  By setting the cost of money artificially low, on both loans and deposits, the government transfers the wealth from borrowers to savers. What also works for China is its monetary policy. As it gets looser for producers, it simultaneously gets tighter for consumers. China is also considered to be the manufacturing hub of the world - meaning lots of exports. All of these factors have contributed to giving China an appreciable inflation rate.

Some may argue that the lower the inflation, the better it is for the economy. That argument fails to hold. Zero or very low percentages of inflation indicate a stagnancy in the growth of the country.  On the other hand, too high inflation rates have served to be ruinous to many global economies. A country that proves that statement like a theorem is Venezuela. 

Case 2 - Venezuela:  

Venezuela's economy crumbled around the year 2017 and is not doing very well on the recovery front. With the sky-rocketing inflation of 438.12% (as of 2017), when compared to previous years, Venezuelans struggle to put food on their table.  The country's debt peaked, the Venezuelan bolivar started to lose its value and people started hoarding which led to an increase in prices, hyperinflation and, eventually, the collapse of the economy. The inflation has continued to swell through an unfathomable measure and reached a jaw-dropping 9585.5% (as of December 2019)

How Can You Fight The Effects of Inflation?

• Invest in long-term returns: Shelling out money on investments that yield long-term returns can aid greatly in combating inflation. As the date of maturity nears, the inflation rate will have less of a blow if you are prepared with some money in reserve. 
• Saving is everything: Save, save and save. You will need money for when retirement strikes. And the truth is, it will probably be a lot more than you have roughly anticipated.  To keep up your current lifestyle or augment it, without an active source of income, is no joke. This is when your savings come into the picture. Make sure you keep enough money stashed aside for a comfortable retirement lifestyle. 
• Invest in real estate, art and precious metals: Investments of these sorts come in handy when life throws you a curveball. Real estate can be an active source of income. Putting up your house on rent can fetch you a good sum of money every month. Investing in painting, sculptures and exotic art prove to be good assets and can yield large sums of money when sold. Precious metals, like gold and silver, also give fairly large sums of money when sold in the market. Investing in precious metals is considered a strategic investment as it has positive returns on investment. 

Inflation has been studied by countless experts over the years, most of whom round it up accurately. As we conclude, we have dug deeper into what inflation means, CPI as a measure to estimate inflation, causes of inflation, its significance, and lastly, measures you can take in fighting the effects of inflation. Milton Friedman famously said, "Inflation is the one form of taxation that can be imposed without any legislation".

Do you think inflation is merely a fair-weather friend?