One of the biggest factors, which causes inflation is the sudden drop of supplies that don’t meet the population demands. This is evident when buying meals at restaurants. It is either the portions get smaller at the same price or the price increases with the same portions of food.
A healthy economic cycle naturally rises and falls in prices so that the demands for goods can balance the supply of raw materials. However, this does not stop economists from thinking that inflation is the biggest enemy of the market. The sudden increase in prices decreases the consumption power of the general public and translates to slow returns of money.
However, inflation does not stop from there. Ending the explanation with mere supply and demand alone is not enough to cover everything there is to know about inflation.
Lax Monetary Policies
Inflation is often the result of lax monetary policies that have not been reversed. Lax monetary policies, or easy money policies, lower interest rates to allow new cash to flow. While this is an ideal solution to increase employment and make loans more accessible, it will eventually lead to a lower monetary value, then eventually inflation, if not controlled properly. There’s a perfectly good reason why it is not a good idea to make everyone become billionaires.
When a bank makes too much money, the monetary value of the currency itself decreases as time passes by. In short, when there’s more money there’s less power to spend on more goods. The prices will quickly adjust to the increase of currency causing what’s called a hyperinflation.
Japan almost had this problem back in WWII, but addressed it through intentionally devaluing the yen and changing their limit of deflation, or a sudden decrease of prices. In turn, this led to a stable economic development that has helped Japan throughout the years. Despite the yen being considered the cheapest form of currency, Japan’s exchange rates fare better than most Asian countries.
However, not all countries were able to address the problem.
Zimbabwe faced the worst poverty problem in 2009 because it experienced the worst kind of hyperinflation. The interest rates were so low, it’s calculated that 175 quadrillion Zimbabwean dollars were the equivalent of just one US dollar in exchange rates last 2015. This indirectly caused a shortage of goods that led to a multi-currency system that allows other currencies outside of Zimbabwe to be used.
Increase of Commercial and International Loans
Lax monetary policies can also explain the sudden increase of loans across the globe, especially commercial and international loans.
Commercial and international loans are ideal for corporate transactions and offshore businesses. However, the foreign exchange involved in these transactions can sometimes have an indirect effect to inflation rates in the economy because inflation rates decrease a currency’s value.
In other words, people borrow too much money because they spend too much. This can take a toll on so many commodities that it would be almost impossible to spend on anything.
As of 2004, prices in different commodities such as oil, food, fuel and water rose to record levels in various parts of the globe. The supplies of raw material had roll back to a point that it hasn’t met the demands of the rapidly growing population. Even highly economic countries such as US and China are experiencing a slow but steady decline both in their business revenues and work forces. Factories are losing steam, gas prices are hiking up and more people are finding themselves unemployed.
There are just too many loans.
Having lax monetary policies can either solve the loan problems or make them worse since the relationship between inflation and interest rates are often too complicated to balance. Increase interest rates from one country to another and it would result to less loans but a higher chance of having an inflation of prices. Decrease interest rates, on the other hand, and this will result to more loans and the prices deflating bit by bit.
Apparently, this isn’t the case in the field of investment, which concerns non-consumer related things. Since foreign exchange investments are basically bets to see which prices go lower or high, intentionally altering the exchange rates sometimes has a negative impact with investors. Investors sometimes root for high exchange rates because money often comes back tenfold.
There are cases when a country’s lax monetary system causes the inflation rates to go way out of hand that the government resorts to fiscal policies.
A fiscal policy is another word for a tax cut. It basically tries to take money out of the economy in the belief that an increase, or decrease, in tax would lower the risks of inflation.
How do taxes curb inflation? It decreases the amount of money people spend on without having a large impact on their power to spend. It would make sense that taxes can decrease inflation rates since inflation is caused by too much flow of money. Instead, the extra currency would be put back in government banks for later use. This controls the monetary value of currency and their distribution at the same time.
Is Inflation All Bad?
Despite the indication of supply shortage, inflation is not that big of a problem unless it severely limits the people’s spending power
Inflation is inevitable because economy isn’t always fixed. A healthy inflation of prices not only sets quality on certain goods. It also keeps cash flow in moderate rates at the same time. A rise in prices only indicates the overall progress in a country’s economy. Keeping a track of prices would highlight the strong and weak points of a country’s currency system.
If there is anything worse than hyperinflation, it is severe price deflation. Investors would not put their money on something that lowers in price. While it does grant more spending power, it indicates that the demands grow weaker and the economic progress of a country would slow down eventually.
The key to a good economy is to find a balance between inflation and deflation of prices, and knowing exactly what to do in a given time frame when things get out of hand.