Inflation Is Here to Stay, as Prices Will Always Go up - Term Paper Example

Topic: Inflation is here to stay, as prices will always go up Introduction Inflation is considered as a currency occurrence and not an economic occurrence, with monetary inflation always resulting in higher prices (Carson, Thomas & Hecht, 2005). Typically, inflation results from growth that is not proportionate in terms of the supply of money with consequences being increased prices and a weakened economy. Central banks that have sufficient autonomy from political dealings are typically associated with lower rates of inflation. Up to the twenties, the US used gold standard where people owned coins and the nation’s currency had fixed value in it, therefore, even if money was saved without using the banking system, it could purchase almost the same amount of goods fifteen to twenty years later compared to the time when it was first saved. Inflation started being experienced when the US decided to start using gold standards. Presently, when the government experiences shortfall in terms of cash, it purchases some from the Federal Reserve (Gosling & Eisner, 2013). The additional money that is put into circulation results in an imbalance between money and goods and consequently prices increase and inflation is experienced. There have been instances when inflation has been considered as invisible tax, as it is seen as the means used by the government to get free money from the public. The amount of commodities available might also drive the prices upwards, for instance, oil prices continue rising as a result of war in the major oil producing areas. The increase in prices is not entirely attributed to the war, but to the damage on the infrastructure including damaged pipelines and incapacitated refineries because of the war, which have led to a reduction in production, by almost fifty percent. Inflation and increasing prices The effects of inflation have thrown nations in to prolonged periods of instability and central banks always seek to be watchers of inflation. Numerous politicians have won elections through promising the electorate that they will fight inflation but they lose their positions when they are not able to achieve this (Perry, Serven & Suescun, 2008). At some point, President Gerald Ford made a declaration that inflation was public enemy number one in 1974. It is therefore important to understand that inflation denotes the rate of upsurge in prices through a specific time and is usually a wide measure like a universal intensification in prices or an upsurge in costs of living in a nation. However, it can also be narrowly calculated, for instances of particular commodities like food and tuition fees in schools. Regardless of the context, inflation denotes the degree of increase in price to the relevant collection of commodities through a particular period, typically a year. The costs of living of consumers are dependent on the prices of numerous commodities they use and the share of each commodity in the budget the each household uses. In order to measure the cost of living of the average consumer, agencies of the government conduct surveys in the households so that the commonly purchased commodities can be identified in order to monitor the costs of these commodities over a specified amount of time. The commodities that are tracked may include housing expenses such as rent and mortgages as well as food, which is usually the largest part of the household budget in the comparatively poor nations. The costs of commodities used by the a household at a specific time expressed in comparison to a base year produced the consumer base index, while a percentage changes in CPI over a particular period produces consumer price inflation which is the most broadly utilized measure in inflation. However, there are other significant measures of stability of prices such as core consumer inflation that does not include prices set by the government and the volatile price of commodities like energy and food, which are typically impacted by seasonal dynamics or impermanent supply conditions. It emphasizes on the fundamental and tenacious trends as far as inflation is concerned and is also carefully monitored by the policymakers (Beetsma, 2004). The general rate of inflation for all the commodities that are produced in an economy may be calculated using an index with a wider coverage compared to the CPI, the GDP deflator. The CPI basket is usually remains constant through time so that it can be consistent, but goes through occasional tweaks in order to reflect the consumption patterns that keep changing. For instance, these changes are instigated to include new innovative commodities and to replace the commodities that are not purchased broadly anymore. On the other hand, the components of the GDP deflator vary every year as it monitors the prices of all the commodities that are produced in a specific economy. This puts the GDP deflator in a position that is considered as more current compared to the fixed CPI basket while at the same time incorporating non-consumer commodities, like military spending, making it a good approach to measuring the cost of living. To the extent that the nominal income of households that they get in current monetary form does not increase at the same rate as the prices of commodities, they become worse off as the amount of purchase decreases. Their power of purchase decreases as income falls since real income is significantly affects the living standards. In the event that real incomes increase, the living standards also increase and vice versa, but in the real world, change in prices occurs at varying paces. Some prices, like the price of traded products, vary on a daily basis; while others like wages that are established through contracts, take a longer time to change. In an inflationary setting, prices that rise unevenly certainly decrease the purchasing power of a section of the consumers making this decrease in real income the sole largest cost of inflation. Inflation also has a capacity to misrepresent purchasing power through time for those who receive and pay fixed interest rates like the pensioners receiving a fixed five percent annual increase on their pension. In the cases where inflation is more than five percent, the purchasing power of the pensioner decreases, while a borrower paying a fixed mortgage rate of five percent may benefit from five percent inflation since the real interest rate will be zero. Consequently, servicing the debt will be more simplified in the event that inflation is higher only if the income of the borrower matches the rate of increase of inflation; however, the real income of the lender suffers. When inflation is not included on the nominal interest rates, there are gainer and losers of purchasing power. Without a doubt, numerous nations have faced high inflation, while others have experienced hyperinflation, which is an inflation of more than one thousand percent or more in a year. Zimbabwe faced one of the most severe occurrences of hyperinflation in 2008 when the yearly inflation reached five hundred million percent at some point. These high rates of inflation have disastrous ramifications and nations experiencing them have been forced to instigate difficult and painful changes in policy as they seek to bring inflation back to reasonable levels, in some instances through giving up the national currency like Zimbabwe (Somanath, 2011). Regardless of the fact that quickly increasing prices have a negative effect on the economy, deflation is not appropriate either. This is because when prices fall, consumers are not eager to make purchases with the hope that prices will be lowered in future. This consequently implies decreased activity for the economy, less income realized by the producers and slower growth of the economy. Japan is an example of a nation that experienced a lengthy era of zero economic progression as a consequence of deflation. Prevention of deflation during the global financial crisis is among the main reasons the Federal Reserve as well as other central banks all over the globe maintained low interest rates for a longer time while at the same time instituting policy measures to make sure that financial systems continue to have sufficient liquidity. Majority of the economists have confidence that low, steady and anticipated inflation has a positive effect for the economy, as it is easier to capture it in regards to price-adjustment contracts as well as the rates of interest, which decreases its effects of distortion (Agénor, 2004). Furthermore, being aware that prices will be marginally higher in days to come encourages consumers to increase their rate of purchase sooner, eventually boosting the economy. Maintaining low and steady inflation has become the main policy objective for most central bankers through a policy they refer to as inflation targeting. Prolonged episodes of high inflation usually result from sloppy monetary policies, for instance, if the supply of money becomes too high in comparison to the size of the economy, the unit value of the economy will diminish as the purchasing power will decrease and prices will rise. The connection between the supply of money and the magnitude of the economy is referred to as quantity theory of money and is among the oldest assumptions in economics. Pressure on the supply or demand aspects of the economy may result in inflation and supply shocks that have a disrupting effect on production, like natural disasters, or increase the costs of production, such as escalated oil prices, may reduce general supply and result in cost-push inflation, whereby push for increase in prices develops from disturbances in supply. Fuel and food inflation incidents that occurred in 2008 and 2011 were examples of such cases for the global economy as they were characterized by suddenly increasing prices of fuel and food that were transmitted from one nation to another through trade. The comparatively poor states experienced further negative consequences compared to the economies of the fairly more industrialized states. The correct forms of anti-inflation policies, which seek to reduce inflation, are reliant on the causes of the inflation (McEachern, 2012). Various central banks have chosen, with different degrees of success to enforce monetary discipline through fixing exchange rates through tying their currencies to that of another nation and thus its monetary policy to the nation it has been connected to. Nonetheless, when inflation is pushed by global instead of domestic aspects, this kind of policies may not be helpful. When inflation rose in 2008 in the entire globe as a result of high prices of food and fuel, numerous nations allowed the high prices to go through their domestic economies. In some instances, the government may openly determine prices but this form of administrative price setting typically results in the governments accumulating large subsidy bills in order to compensate the producers for the losses they have incurred. Conclusion Demand shocks like stock market rallies, or expansionary policies like instances when central banks decrease the rates of interest or when the government increases its spending, may momentarily increase general demand as well as economic growth. Nonetheless, in the event that this increase in demand is larger than the production capabilities of the economy, the subsequent strain on resources leads to demand-pull inflation. Therefore, policymakers must strive to achieve the correct balance between increasing growth when required without over-stimulating the economy and triggering inflation. Expectations also greatly influence inflation in that if people or companies anticipate increased prices, they develop expectations to become wage negotiations or adjustments in contracts. These actions partially determine future inflation and when people’s expectations are based on recent expectations, inflation is likely to follow a similar pattern through time thereby leading to inflation inertia. References Agénor, P. (2004). The economics of adjustment and growth. Cambridge, Mass.: Harvard University Press. Beetsma, R. (2004). Monetary policy, fiscal policies, and labour markets. Cambridge, UK: Cambridge University Press. Carson, R., Thomas, W., & Hecht, J. (2005). Economic issues today. Armonk, N.Y.: M.E. Sharpe, Inc. Gosling, J., & Eisner, M. (2013). Economics, politics, and American public policy, second edition. Armonk, N.Y.: M.E. Sharpe. McEachern, W. (2012). Economics. Mason, OH: South-Western Cengage Learning. Perry, G., Serven, L., & Suescun, R. (2008). Fiscal policy, stabilization, and growth. Washington, D.C.: World Bank. Somanath, V. (2011). International financial management. [Place of publication not identified]: I K International Publish. Read More