Inflation

Inflation is the general rise is the price of goods and services. It is influenced by the value of the currency and the purchasing power of consumers. If the price of a good rises then fewer of these goods can be bought with a unit of the currency. As such it is related to price indexes.


There are several causes of inflation, the main situations are:


Demand-pull

This is where the demand for goods and services grows faster than the supply. Hence manufacturers and providers can increase prices without damaging the number of sales made due to the high demand


Cost-push

This is where the materials to produce goods (and services) increases in price and hence the final product price needs to be increased to ensure the manufacturer still makes their desired profit


Monetary

When more money is supplied into the economy the value of the money decreases resulting in increased prices to recover the value the manufacturer money


Expectations

Inflation has been a regular occurrence for centuries and hence consumers expect prices to increase, as a result they expect their wages to be increase annually to ensure they can keep consistent living standard. Ironically this causes inflation in itself as business payroll expenses increase and this increase will then be reflected in product prices.

Inflation can be both a positive and negative factor for an economy. At first glance inflation is seen as a sign of growth in the economy and this is normally true, however inflation can also lead to a decrease in the real value of money and hence discourage investment and savings, and a high inflation rate may lead to a shortage of goods as consumers bulk buy in fear that prices will vastly increase in the near future.

Deflation is when prices fall and money gains value. Both inflation and deflation have different effects on an economy and both, if sustained or if running at high levels, can be damaging. Deflation can be particularly so, because money gains value merely by being kept; there is no incentive to invest. For this reason, the goal of monetary policy is price stability – the target agreement has a floor as well as a ceiling.