Inflation
Inflation is important to understand as it depicts a rise in the
prices of goods and services. It is important to understand the characteristics
of an economy and in a free market; the economy tends to have highs and low. The
value of the dollar relates directly to the price that goods and services are
sold and how much purchasing power the dollar has. In times of inflation, the
prices of goods and services are much more than the value of a dollar and as
inflation rises the value of the dollar and its purchasing power decreases. When
deflation occurs, the value of a dollar is much greater than the price of goods
and services and negative consequences will result. Both inflation and
deflation
can have negative impacts on the value of money and the economy as a whole.
There are several tools or methods used to determine the current
inflation rate and these include the price index or the consumer
price index. Other price indexes include the producer price index
and the GDP deflator. A price index is described as the normal or
average prices of various goods and services in a consumer market.
The consumer price index measures the changes in the market basket
of consumer goods and services. Price indexes are used to determine
the purchasing power of money, and are an important way of measuring
the current economic climate.
Purchasing power is the amount of goods or services someone can purchase with a
specified unit of currency. It’s important to realize that increasing inflation
does not always indicate a decrease in the purchasing power of money. When
determining the amount of purchasing power related to current inflation rates
it’s important to determine a person’s real income.
Real income is the amount of money or income an individual has left after making
necessary calculations or adjustments for inflation. Real income levels are also
used to determine the value of currency for nations in addition to the finances
of individuals. If a person’s real income remains the same while inflation
increases, then it is clear that the individual has lost purchasing power. It’s
important to understand that banks will take just as many steps to stop
inflation as they do to prevent deflation.
Any time the purchasing power of currency is thrown off balance compared to the
prices of goods and services the potential for disaster in the economy occurs.
Increasing inflation prices mean that your currency will buy less goods and
services.
The Federal Reserve determines interest rates for those in the United States.
When the Federal Reserve meets to make these determinations current prices of
the consumer price index and the producer price index are often taken into
consideration. Inflation and interest rates are interconnected and during times
of high inflation it is important to watch how the Federal Reserve sets interest
rates. High interest rates can make it more difficult to obtain loans and many
may choose to save or hoard their finances during period of high interest rates.
This can have a negative impact on the economy and the Federal Reserve tends to
promote economic growth and consumer spending by lowering interest rates.
Another important aspect to inflation is that of hyperinflation. Hyperinflation
is when inflation is rising so quickly that it is out of control. Hyperinflation
indicates that prices are rising at an extreme rate. When this happens, currency
loses its value and the result can be devastating. Another aspect of inflation
is known as stagflation. During stagflation high unemployment combined with slow
economic growth. When there is both a high inflation rate combined with a high
unemployment rate stagflation occurs. This is a dangerous state for an economy
as steps usually taken to reduce high inflation often won’t help those who are
dealing with high unemployment. By lowering interest rates the stagnation of the
economy may continue.
It is best to have a steady, low inflation rate without any sudden deviancies
either way. Both inflation and deflation are dangerous and the goal is to is to
keep inflation at a low rate. It is believed that a steady, low inflation rate
is one of the greatest ways to prevent economic depression or collapse. It is
usually left to monetary authorities, such as the Federal Reserve, to balance
and monitor interest rates. The Federal Reserve monitors both price inflation
and monetary inflation to help maintain a balance within the economy. Inflation
has many detrimental impacts as it means that people cannot stretch their money
as far, those who live on a fixed income will no longer have the means of paying
for their daily needs, those who lend money will not see the expected value of
their return, those who invest their money in savings that earn interest will
not see the same return and when they obtain their money it won’t have the same
purchasing power.
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