Inflation is a sustained increase in the general level of prices for goods and services in an economy over a period of time. It is measured as an annual percentage change in a price index, such as the consumer price index (CPI). A rise in the CPI indicates that inflation has occurred, and that the purchasing power of the currency has been reduced. In economics, inflation is a rise in prices and fall in the purchasing power of money. It is measured by calculating the percentage change in a price index, such as the consumer price index (CPI). A rise in the CPI means that inflation has occurred and that the purchasing power of the currency has been reduced.
Inflation can be caused by a number of factors, such as an increase in the money supply, an increase in government spending, or an increase in taxes. When more money is available, people have more buying power. Then, demand for goods and services increases. This can lead to higher prices as businesses try to cover their increased costs.
Current events have led to a spike in inflation. The COVID-19 pandemic has disrupted supply chains all over the world creating more demand for products as never witnessed by our generation. Think back to the beginning of the pandemic when it was near impossible to find toilet paper or hand sanitizer on a shelf in a grocery store. Demand exceeded supply. Many industries were influenced. For example, many meat packing plants were unable to ship out enough meat as the industry experienced a serious labor shortage due to workers being impacted heavily by COVID-19. The farmers had nowhere to ship the cattle. This is another instance where consumer demand exceeded supply. Let’s fast forward to holiday season 2021. Products were being manufactured, but the labor shortage inhibited unloading freight into shipping ports. Again, the supply chain was negatively impacted. This created chaos in the economy as shoppers were worried about not receiving packages in time for the holidays. The government tried to manage the pandemic by helping impacted people with liquidity, otherwise referred to as cash injections or stimulus pay. Notably, beginning in July 2020, the government sent monthly checks to households ranging from $250- $300 per child to get more money into circulation. Most recently, Russia’s war against Ukraine halted export of oil out of Russia. With gas prices hiking, manufacturers are seeing higher costs to deliver goods and services resulting in higher costs to the consumer. The inflation we are currently seeing in today’s economy is a compounding event of both the the supply side struggling to deal with the high demand all while being amplified by the extra liquidity.
There are two types of inflation: demand-pull inflation and cost-push inflation. Demand-pull inflation is caused by increases in aggregate demand, while cost-push inflation is caused by increases in the costs of production. When prices are rising, people may hold off on purchases in the hope that prices will continue to rise. This can lead to an increase in the general level of prices known as inflationary spiral.
It should be stated that governments sometimes try to increase inflation in order to reduce the value of their debt. By inflating the currency, the government can make it worth less in terms of goods and services. This makes it easier for the government to repay its debts, since they will be able to buy more with the same amount of money.
However, at other times, inflation needs to be managed. Governments and central banks can try to deal with inflation by using a variety of tools, such as monetary policy and fiscal policy. Monetary policy is the use of the money supply to influence economic activity, while fiscal policy is the use of government spending and taxation to influence economic growth. Inflation can also be reduced by increasing the efficiency of the economy, such as by increasing the production of goods and services.
Policymakers have different methods for dealing with inflation. If the economy is overheated, central banks can implement contractionary measures to rein it in and ensure that prices stay stable by raising interest rates or fixing their exchange rate against another country's currency - this was seen recently when China did just that due too high levels of growth. In general, the main ways to prevent or reduce inflation are raising interest rates, decreasing government spending, increasing taxes, and by selling assets.
Individually, there are a few ways that you can protect yourself from inflation. One is to keep your money in cash, which will still have the same purchasing power over time. Another is to invest in assets that are expected to increase in value faster than the rate of inflation. Make sure your income is keeping pace with the rate of inflation. This can be done by diversifying your investment portfolio, including assets such as stocks and bonds that are not tied to the rate of inflation. One can protect their money by investing in assets that are not affected by inflation, such as gold or real estate. Gold tends to hold value even when the price of currency trends down; however, a limitation of gold is that it does not offer a yield. On the contrary, real estate investment trusts offer high yields, but the limitation to investing is that there is a high rate of taxation on the dividends. You could consider placing your money in short-term investments, such as treasury inflation-protected securities. In this type of investment, the principal value changes based on the inflation rate so your rate of return is guaranteed protection against inflation. Advisably, you could invest in stocks or mutual funds that provide a higher return than short-term investments. There seems to be a correlation between which industries grow and prosper during times of inflation. For example, technology businesses benefit from increased price levels because their products don't require much capital investment; whereas natural resources-based companies suffer losses due to rising costs for inputs such as oil or metal prices.
Inflation is a complex economic phenomenon, but with the right knowledge you can make informed decisions that will help you protect and grow your capital. Whether you decide to invest in assets that are traditionally seen as inflation hedges, like gold or real estate, or find new ways to generate income outside of traditional investments, remember that taking action is better than sitting on the sidelines. With so much uncertainty in the world economy, it’s more important than ever to have a plan for protecting your money against rising prices.