Category: Inflation

The Consumer Price Index

Consumer Price Index is defined as the average change in consumer goods and prices that occurs over time in the prices that urban consumers pay for goods and services. In other words, the goal of the CPI, when prices change, is to measure the percentage change if the spending by the consumers to be as well off as they were before. For example, suppose the prices of all the goods went up by 5%. Consumers would have to increases the spending by 5% for keeping themselves on the same living standard, assuming everything else constant (Greenlees, J. S. & McClelland, R.B 4).

CPI as Inflation Gauge

Inflation is often defined as the trend rate of change in the prices. The change rate of prices of products, excluding energy and food prices, is common proxy for this basic definition of inflation. This definition reflects the idea that energy and food prices have more volatility than the other goods. Therefore, we can conclude that such prices show less signal of the trend rate of inflation. With regard to these findings, two trend rates are utilized to measure inflation. The two are overall consumer prices and consumer prices. It is notable that energy and food prices are not included (Dye, R. A. & Sutherland, C. 2009).

The CPI and perceived inflation

There has been criticism on CPI from a writer’s perspective in the words that the CPI is inconsistent with the research. There have been complaints for the many commentators have shown the concern that measured inflation is lower in the U.S. than another country. This shows the evidence that the growth rate of U.S. CPI is understated. One important point to remember is that one can easily gauge the accurate values of the U.S. CPI with inflation rates in the other countries is wrong as each nation has its own inflation experience. It is result of its unique economic conditions.

CPI is the most widely used measure of price level in the U.S.; however, it implicitly assumes that the expenditure function is related to a static expenditure minimization problem. The research has shown that the assumption, mentioned above, has some problems. If the consumer is active for more than that particular period, the price index should reflect the prices of future goods too, along with the prices of today. Researchers have been trying to solve the problem. A Dynamic Price Index has been proposed the recognizes the monetary cost of goods included in the cost of both, the future good and current goods (Shuhei, A. & Minoru, K, p. 959).

Among all the criticisms on CPI, the most understood and mischaracterized is its use of the geometric mean formula. Economists are agree to the fact that the price index formula of basic CPIs, used before 1999, has been overstated the changes in the cost of living, particularly the change in taxpayers index. It predates the decision of BLS to switch off to geometric means formula for the computation of most to basic CPIs (Greenlees, J. S. & McClelland, R.B, p. 6).

It has to be released in a timely manner and Bauru of Labor Statistics uses it. The CPI is used as a parameter for consumer cost of living demographics. Inflation is an upward movement in prices. Often it is observed as rather a movement in the prices of goods and services. Moreover, the CPI is a fixed weight index and overestimates the changes in cost of living. When comparing both models the Personal Consumption Expenditure Price index (PCEPI) suffers less stress from the overestimation. In fact, Consumption Expenditure Price index (PCEPI) is favored by changes in consumer prices (Richard, D, p. 2).

In short, the use of CPI as indicator of inflation has been source of controversy and misconceptions. Journals and other interested observers have been questioning the use of CPI as the operational guide and trend measures of inflation. Some countries have experienced that the core inflation trend deviat4e persistently from total CPI inflation and, therefore, is not reliable measure of inflation pressure.

Does the CPI understate Inflation?

The criticisms on CPI have been believed to be a result of misunderstanding of the methods used for the construction of the index. The attempts to make improvements are asked on the sound economic theory and research by academicians and BLS economists. The outside commissions have been reviewing the methods and statistical agency has been using them. Some writes have attributed to the changes in the methodology of CPI. A widely cited alternative is the estimate that is based on the change to CPI since 1983. This development has resulted in the lowering growth rate o inflation, by addition 4%, approximately (Greenlees, J. S. & McClelland, R.B., p. 14).

Many writers have contributed to the changes fin methodology of CPI. The use of geometric mean is one of the proposed models. It has lowered the CPI growth by 3% points. Furthermore, the use of hedonic models and OER knave lowered the growth rate of CPI by 4% points. However, it is important to note that these proposed models have been inconsistent with empirical evidence, according to BLS. The indexes computed by BLS show that the use of the geometric mean has reduced the growth rate of inflation by only -0.28% point per annum. We can also make a number of other points. Industry experts single out size and effects of the changes implemented by BLS as overestimates. The introduction to geometric mean formula has resulted in the decrease in the rate of change by 0.3 percentage points per year. On the other hand, some critics have proposed it to be 3-percentage point. Second, the changes that have been implemented by BLS have been considered the result of analysis and recommendations made over a decade, and are consistent with the international standards of statistics. It is being widely used by OECD countries and Euro stat. Third, the BLS has been publishing the details about its methods and changes to the models. In ‘Handbook of Methods’ of BLS the chapter on CPI contains information about the methods of construction of index and its history, uses, perceptions and related topics. In addition to these facts, the CPI website has included a wide variety of specialized information, for example, articles on hedonic regression models, new vehicle quality adjustment methods, fact sheet of the methods utilized in the generation of selected CPI components. The use of intervention analysis in the seasonal adjustment and the comparison of the CPI and PCE price index, are also included. The BLs also maintains the information at the both national and regional offices to respond to the questions from people (Greenlees, J. S. & McClelland, R.B, p. 16).

Basic statistical model of inflation

Empirical exercises to evaluate CPI as a measurement of inflation have been developed in the recent past. For example, Dye, R. A. & Sutherland, C. (2009) has presented the same with quietly data for prices and consumer prices without energy and food prices. The study utilized two measures of consumer prices: the Personal Consumption expenditure Price index (PCE) and the consumer price index (CPI). Both measures differ from each other in various ways. How the model aggregates the construction of an aggregate price level differs with each model and this should be noted. Trend inflation = expected value of inflation. However, the value is measurable over the next four quarters.

Dye, R. A. & Sutherland, C. 92009) have used the univariate IMA model of inflation to a bivariate model of inflation in consumer prices excluding food and energy prices and consumer prices. Consumer data, collected to pitch credible differences between both methods, the outcomes show that the relationship among overall consumer prices and consumer prices without energy and food over time has changed. To evaluate this trend properly, gauging it using recent data on price trends and consumer reaction becomes principal. The analysis is based on prices excluding energy and food price.

In short, we can conclude the simple CPI can be best utilized if the food and energy prices are excluded.

Alternative Inflation Gauge

Dye, R. A. & Sutherland, C. have presented an improvement on the CPI index that has been used to quantify the economic stress of households that they have been feeling in the days of high inflation. In the stress days of present economic situation, most of the economic stress of households is the result of decline in the household wealth. The reason for this decline is the fall in prices of housing sector. Therefore, it is appropriate to use the housing prices change in addition to CPI index. The first three quarters of 2008 have seen the bad economic conditions in most of the U.S. regions. As such, deterioration of economic condition has a down ward effect. Macroeconomics suffers a depression that is replicated on households. This is how the Household Economic Stress Index has increased. The rate of unemployment across a range of set clusters/areas is a parameter vital in context. Rate of change in the consumer price index is one parameter. Rate of unemployment act also is a parameter and work well when used along the latter. Both are core data sources. Rate in change of house prices is used as a parameter of Stress index. The study concluded that the Stress Index is useful for the analysis of the mortgage delinquencies, regionally and nationally.

Researchers have proposed a new price index ‘Dynamic Price Index’ (DPI). The DPI recognizes that the products’ monetary cost includes the cost of current goods as well as the cost of future goods. Shuhei, A. & Minoru, K. has argued that how DPI presents the inflation rate that is more volatile than CPI (p. 959). They ignored durable and multiple goods and focused on the two modifications: a focus on the Epstein-Zip utility and considering total wealth that include both human as well as financial components. These modifications resulted in more stable measures of inflation than those of the previous research.

An Integrated System of Accounts for Measuring Inflation

At present, the discussions of public, about inflation, are centered towards a very few indexes. Important among them are CPI, the index of producer prices and GDP defaulter. There is need for integration of eh system in order to measure inflation. The set of indexes, mentioned above, must b most informative. The CPI, for example, must show annual rates of inflation. Another account is to present the corresponding price levels that start from a value of some base year unity. This will show the cumulative amount of inflation and allow a quick comparison of the price levels of two periods. All price levels would deflated with a general price level system of relative prices accounts would be a genuine novelty and increase in economically meaningful information (Hillinger, C, p. 24).

Roger, M. & Zheng, D. (2010), has presented another model, recently. This model is renowned as ‘regime-switching model.’ The objective of the model is to capture the structural changes of inflation dynamics to get valid estimates. Using an advanced EM algorithm can help identify optimal parameter estimates of the model of the discrete time finite Markov chain. This governs the switching of regimes from one form to another. They implemented the model to measure the CPI data of Canada. Comparing real data with predictions helps estimate performance. They found that the used data set was sufficient to capture the dynamics of CPI series of Canada.

Works Cited

1. Anderson, Magnus. “Using Intraday Data to Gauge Financial Market Responses to Federal Reserve and ECB Monetary Policy Decisions.” International journal of Central Banking (2010): 117-146.
2. Dye, Ryan. & Sutherland, Ian. “A New Metric to Gauge Household Economic stress: Improving on the Misery Index.” Business Economics 44 (2009): 109-113.
3. Greenlees, John. & McClelland, Robert. “Addressing misconceptions about the consumer price index.” Monthly Labor Review 13. 8 (2008): 3-19.
4. Hillinger, Claude. “Measuring Real Value and Inflation.” Economics 2 (2008): 1-26.
5. Kiley, Michael. “Estimating the common trend rates of inflation for consumer prices and consumer prices excluding food and energy prices.” Finance and Economics Discussion Series.
6. Richard, Dennis. “The ‘inflation’ in Inflation Targeting.” FRBSF Economic Letter 17 (2010): 1-5.
7. Roger, Enoka & Zheng, Daniel. “A Self-tuning model for inflation rate dynamics.” Communication in Nonlinear Science & Numerical Simulation 15. 9 (2010): 2521-2528.
8. Shuhei, Aoiki. & Kitahara, Minoru. “Measuring a Dynamic Price Index Using Consumption Data” 42 (5): 959-964

Ever since the US economy started feeling the effects of the recent economic crisis, the Federal Reserve (Fed) has been using stimulus packages to try and rectify the money demand and supply associated with inflation. The most ambitious stimulus was the 2009 two trillion worth of bonds at the height of inflation. Most recently, the Fed is again planning to buy long-term US Treasury bonds to the tune of hundreds of billions of dollars. The rationale for this controversial decision is to stimulate public spending. The effect of this is that inflation will be slightly adjusted upwards from the current 1% to 2%. The fed officials believe that this will have long-term positive effects on the economy. When people anticipate higher future prices, it is expected that they will increase expenditure today to avoid the extra expenses of the future (Hilsenrath and Cheng 1). This relationship can be shown in a demand-supply curve as illustrated below.

The equilibrium point is a point where the value of is money adjusted thereby creating an equilibrium in the quantity of money supplied and that of the quantity of money demanded. When the Fed adjusts the quantity upwards, it results in the increment of price levels consequently pushing down the value of money. The process of regulation of the money supply as explained above is made possible by one of the Fed’s tools of monetary policy which is known as the Fed fund markets. This is a policy that is carried out by the central bank (Brannstrom 26).

The QE policy is aimed at regulating long-term interest rates rather than short-term interest rates. The main reason for this is that they believe if they can set a threshold of an increasing interest rate in the long run, it will encourage people to make money from their savings and use it to spend. for example, if the inflation rate is to be fixed at 2% per annum from the current 1% and one was planning to take a bank loan the following year, chances are that he would prefer to take the loan today as the loan repayment of the same loan in the next year will be higher. This will increase investment and it will therefore spur economic growth.

Hilsenrath (1) underscores the importance of pushing down inflation rates as well as the interest rates. This is a concept widely taught by economists. But the experiment conducted reveals that the fed is doing exactly the reverse of this; they are taking the risk of pushing the inflation up. While the inflation has been on a steady 1%, they argue that it is not a good enough percentage to spur growth and so they suggest pushing it up to 2%. The Fed to cause a good panic in the market that will cause people to spend more and save less. This, they believe will increase the investment thereby helping in checking on the inflation.

One notable effect of inflation is the redistributive impacts associated with inflation. As explained by Hilsenrath (1) as well as by Brannstrom (26), a high rate of inflation drives up the wage levels thereby making it easier and cheaper for the borrower to pay back his loan. For instance, if a student took a loan today to pay his fees, and the loan was due ten years later within an economy that had undergone hyperinflation, the student will have a lot of money as the wage level will have also gone higher and he will easily pay back the loan. The only problem is that the value of money will have gone down and so the bank may not make a profit out of this scenario.

Works Cited

Brannstrom, Tomas. Money Growth and Inflation. Stockholm: Economic Research Institute, 2005.

Hilsenrath, Jon and Cheng, Jonathan. fed gears up for stimulus. Wall Street Journal. 2010. Web.

Hilsenrath, Jon. Why the fed wants a tad more inflation. Wall Street Journal. 2010. Web.

The UK economy was once characetrised by high inflation, which affected the economic stability of the country (Bank of England, 2004). Inflation is defined as the change in consumer prices index (CPI) from the exact period the previous year. The CPI on the other hand is defined as a measure used by governments to measure the change in prices of specific goods and services. Some of the products and services included in CPI measurements include cost of transportation, food, electricity and housing among others.

In the 1970s, inflation was at an average of 13 percent a year and reached its peak in 1975 when it hit the 27 percent mark. In the 1980s, the prices were fairly stable and inflation was at an average of 7 percent a year. Though this is not the case anymore, the country is yet to come up with a macroeconomic policy that will ensure that prices remain stable within set inflation targets.

According to the bank, the target inflation is 2.0 percent, while the prevailing rate is at 3.0 percent. In February 2010, inflation rose to 3.5 percent and the Bank of England explained that government’s action to restore value added tax to 17.5 percent influenced and led to an increase in inflation. The government had reduced VAT to 15 percent in a bid to encourage consumer spending during the 2008-2009 recession.

Causes of inflation

According to the Bank of England (2004), inflation occurs when the demand exceeds the ability by the economy’s capacity to produce goods and services. When this is the case, the prices rise in response to the increasing demand. With an increase in the supply of money, this automatically leads to inflation. According to Sloman (2007), excess demand in goods and services leads to demand-pull inflation.

The main causes of demand-pull inflation in the UK includes: 1) depreciation of the sterling pound’s exchange rate; 2)reduction in taxation, therefore allowing consumers to have more money to spend;3)increased liquidity in the market especially when banks increase their lending to people and institutions; 4)a rise in consumer confidence especially in the real estate industry; 5) increase of asset prices ; and 6) economic growth in UK trading partner economies thus providing a ready market to the UK exports.

A different kind of inflation is the cost-push inflation (Sloman, 2007). Such is caused by external shock to the UK economy, such as fluctuations in commodity prices; depreciation of the sterling pound exchange rate; and /or the increase of unit labour costs or wages. When cost-push inflation occurs, firms usually respond by raising prices for goods and services in order to protect their bottom lines.

Effects of inflation

One of the most notable consequences of inflation is that money loses value (Sloman, 2007). As a result, people no longer have as much confidence in their currency, and usually this leads to a reduction in savings as people opt to invest in assets hoping that such will give them real value.

As one would expect, when the prices of goods and services increase, people have to find a way of maintaining their living standards. Usually, this leads to wage increase demands. Employees who cannot bargain wage increases usually end up living in poorer conditions, or working extra jobs in order to survive the inflation.

Unlike savers who are usually on the receiving end of the inflation when their savings loose value, inflation tends to favour people who borrow money since it erodes the value of their debts. This then means that inflation is less equitable and unsustainable. Economic analysts argue that a market economy such as the UK cannot survive a process where wealth is arbitrary allocated to the borrowers due to inflation effects, while the savers and people with fixed incomes loose out.

The Bank of England (2004) states that inflation increased the risks associated with borrowing and saving. This then calls for some form of insurance against the uncertainties that money may loose value. The risk premium usually results in higher interests’ rates, which drives the costs associated with borrowing higher and eventually, the high borrowing costs discourage investments.

According to Sloman (2007), inflation can further lead to disruption of business planning thus leading to lower investments in the long-term. It is also touted as one of the leading causes of unemployment because as employers try to keep up with the higher wage demands, they lay off some of the staff members. More to this, inflation makes it hard for business expansion thus meaning that employers cannot recruit at a high rate.

Inflation also leads to reduced global competitiveness because the basic measures of production, most specifically labour is costly. This then means that the overall price of products and service are high compared to those produced where inflation is lower. Financial institutions usually respond to inflation by instituting higher interests rates, which consequently affects the growth trend in a country.

According to the Bank of England (2004), inflation hampers long-time planning and development as business prefer to restrict spending to projects that hold the promise of high-returns in a shorter period or those that allows a quick payback. This in turn affects the economic stability of the country.

The effect of inflation on the economy is pegged on the quantity theory of money, which indicates that “if the quantity of money in the hands of purchasers increase or decrease, they will be able to buy, with the same money, a lesser or a greater quantity of goods and services “(Gosh, 1996).

Allen (1997) holds the opinion that the ultimate objective of the UK’s economic activity is to satisfy the consumer. As such, he argues that the Consumer price Index (CPI) should be able to measure the monetary cost of achieving specific levels of utility. Notably, the UK disclaims any intention of having a specific cost in order to maintain customer satisfaction.

The cost of inflation is always high for an economy. This is regardless of whether the inflation was predicted, stable or high. While predicted inflation may be helpful because it assists economists in planning the appropriate monetary policy to use in the future, it still does not shield the economy from the overall effect brought about by the increase of prices.

This mainly is the case because businesses need to keep re-adjusting their prices. Buyers on the other hand cannot budget in advance because of the price uncertainties. Further, there are economists who argue that there is no full proof way of predicting inflation especially when the prices are volatile.

According to the Bank of England, inflation undermines the value of money as a unit of exchange and eventually leads to economic players misdirecting resources, which then leads to wasteful allocation of capital and missed opportunities for growth. According to the Bank’s observation, high inflation makes the messages that prices send to economic analyst vague.

Ideally, the prices of goods and services provide specific signals to the economy on the most likely profitable areas to direct resources. When inflation is high however, the signals are unclear since no one understands whether they are as a result of inflation or related to the individual product.

Monetary Policy

According to the Bank of England (2004), interest rates have always been used to control inflation rates in the UK. But how exactly does the bank do this? Well, according to its 2004 report, changing the interest rates influences the overall amount of expenditure in the country.

When the interest rate is increased, it makes saving attractive and borrowing less attractive. A reduction of interest rates on the other hand makes saving a less attractive economic venture, while appealing to the borrowers. The latter stimulates spending, while the former restricts spending. Ideally, the government observe prevailing trends in the market before either increasing or reducing the interest rates.

The use of interest rates to regulate inflation also affects the currency exchange rates. When the interest rates in the UK rise, investors who have assets in the country get increased returns for their investments. A reduction of the interest rates would also reduce import prices while making UK based assets more appealing to the international market. Unfortunately however, the Bank of England (2004) notes that interest rates do not always affect the exchange rates.

A monetary policy would stabilise the value of money by keeping inflation at low levels. This does not however mean that such a policy would permanently raise growth or output in the economy. However, the fact that the monetary policy creates a better business environment means that individual players can exploit the benefits of low inflation by concentrating on the quality and competitive production of goods and services.

A different monetary policy proposal would be for the UK to adopt a fixed exchange rate. According to Gosh (1996), there is a strong link between inflation and fixed exchange rates. This mainly stems from the discipline and confidence effects that fixed exchange rates give to an economy. However, seeing that exchange rates are affected by various economic variables, this does not look like a very suitable option.

Conclusion

Achieving low inflation rates is touted as the foundation for economic stability of the UK’s economy (Bank of England, 2004). The current target inflation rate is at 2 percent, which the bank argues that it takes into account the change in quality that happens overtime in product and services. This then means that prices cannot remain constant if improvements are made on them.

Overall however, the Bank estimates that if the 2 percent is attained and maintained, the UK government will be able to set economic objectives for investments and job creations.

The 2 percent interest rate is part of the governments monetary policy intended to deliver a more certain economic environment where businesses can make long-term predictions and plans. By delivering monetary stability into the UK economy, the Bank of England will give businesses the room needed to concentrate on competitively producing goods and services for the consumer market without having to worry about inflation and the consequences that it has on their businesses.

References

Allen, W. (1997) Inflation Measurement and Inflation Targets: The UK experience. Bank of England review, 179-185.

Bank of England. (2004) Low Inflation and Business. Web.

Gosh, A. (1996) Does the exchange rate regime matter for inflation and growth? New York: IMF.

Sloman, J. (2007) Essentials of Economics. 4^th edition. New Jersey: FT Press.

Prices have never been a solid and constant quantity because of a large number of aspects that affect this field. Different factors like competition, the elasticity of demand, the economic environment, or government policy can all become the reasons for price change. Massive changes in prices for products in a country are called inflation. There are two types of inflation: demand-pull and cost-push. The demand-pull inflation happens when demand for services or products grows faster than supply.

To understand the operating principle of inflation hypothetical new strain of COVID-19 will be considered. That version would be even more infectious and deadly dangerous than previous versions of coronavirus. In that scenario, the Government would need to impose another lockdown to secure American citizens from the virus. Gyms are forced to close, and that way, people who are members of gyms could not visit them like before. People to equip gyms at their homes because of not knowing how long the lockdown will take. This creates an unaccustomed demand for exercise equipment because of people’s massive ordering online and the increased supply because of the inability of training equipment manufacturers to provide enough goods. In that case, the aggerate demand shifts to the right and causes the price level to grow while not enough products are produced. The mentioned type of inflation can stimulate the economy and increase demand for jobs, but at the same time, it raises the prices and is usually more expensive than cost-push inflation.

When the economy is well-balanced, demand-pull inflation means that the population has more money to buy more goods. Consumers spend money in peace when they do not have problems with their jobs, and the market is competitive and growing. The circular flow model helps to understand the system of inflation better. Tsoulfidis et al. (2019) describe “productive activity as a never-ending circular flow of capital activated to produce use values for the purpose of profit-making on an expanded scale” (p. 54). The global market gets its resources from households to sell them for a higher price to companies that produce goods and sell them to people using the goods market. In the same way, money goes in circles from the global market to households, the goods markets, and companies and ends up returning to the global market.

Every basic American perceives inflation as a short-term discomfort, while it needs to be considered more seriously because of its possible long-term impact. Inflation can severely impact the worth of people’s income and savings. The consequences of inflation can change the situation of every person’s spending and revenue drastically, even retired people. The inflation numbers are used by Government to understand which field needs the raise more. That is why inflation can cause the enlargement of pensions or vice versa. However, the main problem of the pensioners is their purchasing power in terms of their health, rest, and other vital necessities. Studies show that “a wide majority of older retirees depend on Social Security benefits, as ninety-three percent of retired individuals aged 65 and older claim it” (Lake, 2022). At the same time, social security’s crucial influencing factor is the inflation index which is used to calculate the price of living.

There is another factor that affects retirees’ payments negatively, and it is connected with the last years of pensioners’ employment. Most of the time, pension payments depend on their salary during the previous years of their career before retiring. That way, if inflation happens during these years, it can affect the amount of money the person gets. However, an outdated salary can distort the actual market rate if inflation happens after retirement. That means that even the shortage of not vital objects like exercise equipment can cause bad changes in their income and savings.

There are many ways that the Government can use to fight inflation and its negative consequences. Price control as a method was used in the past, but it turned out to be unusable and failed. In 1971 Richard Nixon closed the gold window, and “over the next decade, the dollar lost more than half of its purchasing power” (Lowenstein, 2021, p. 24). However, contractionary monetary policy works the other way around, raising interest rates by reducing the money supply in the economy. They can also use the discount rate to make discount windows that are short-term loans. Unfortunately, inflation cannot be easily stopped, but still, Government has its pressure levers. A contradictory monetary policy remains the best way to control inflation because price control can worsen the situation.

To conclude, in the modern world, inflation is inevitable, but it can be controlled. Most of the time, this phenomenon negatively affects people’s lives. Still, it can also be a sign of the growing economic situation in the country, especially the demand-pull type of inflation. However, inflation is a common problem and not a temporary one. Still, even though it can destroy savings or cut salaries and other payments, it is important to understand its core to be able to control it.

References

Lake, R. (2020). How inflation impacts your retirement income. Investopedia.

Lowenstein, R. (2021). 1971 and the undermining of Fed independence. The International Economy, 35(3), 24-25.

Tsoulfidis, L., & Tsaliki, P. (2019). Classical political economics and modern capitalism: Theories of value, competition, trade and long cycles. Springer.

White, J. (2022). Demand-pull inflation: Definition & causes. Seeking Alpha.

Inflation refers to a general increase in the prices of basic commodities and services, usually taken to represent an average spending pattern (Mankiw, 2012). In simpler terms, inflation is the rise in the cost of living due to an exaggerated increase in commodity prices. As inflation sets in, both individuals, corporations, and the government usually feels its impacts. However, a significant increase in the level of inflation will cause numerous impacts on me as an individual.

Since inflation means a rise in prices of common and basic goods, my purchasing power will reduce since the income shall remain constant as prices rise up (Sexton, 2007). This is because the rate of inflation affects the currency’s purchasing power. As inflation rises, the value of the currency reduces proportionately or even at a higher rate pattern (Mankiw, 2012). Generally, the prevailing rate of inflation dictates the number of goods that I will be able to afford. As the cost of basic such as fuel prices, its trickle-down effects are manifold. The energy prices will increase the prices of foodstuffs such as grains since the machinery costs used in production shall have increased.

Because of a rise in the cost of living, it will lead to lower standards of living since inflation negatively influences the comfort of life. To demonstrate this impact, clearly, there shall be a shift from spending on leisure activities toward basic commodities.

Inflation influences budgeting and planning for investment. Ordinarily, inflation is a phenomenon that happens without the prior and perfect knowledge of an individual, and as such, planned budgets are affected. The confusion created by an uncertain increase in both costs and prices eventually hampers the planning process (Sexton, 2007). Similarly, the amount planned for investment will reduce hence causing a detriment in my overall investment base.

Inflation causes money to lose its value due to a rise in the price level. Since I am a regular saver, the rising inflation will affect me in the sense that I will lose confidence in the currency as a measure of value. This is because the rate of savings will be lower than the inflation resulting in a negative real interest rate on savings (Madura, 2006). For instance, if the per year inflation rate is at 6% while the nominal rate on savings is 3%, it means that the real interest rate on my savings is -3%.

The other effect of inflation will be tendencies of food shortages on the market occasioned by hoarding by sellers. Market analysis shows that an anticipated increase in inflation stimulates hoarding since sellers withhold goods with a view to selling at a higher price. Sellers will begin to cause physical scarcity of food and other products on the market since they would be anticipating better prices in the future (Sexton, 2007). As an individual, it will become difficult to access basic items, and if available, their prices will be excessively farther than what I can afford.

However, I will also be able to benefit from the government intervention plans and policy adjustments geared towards addressing inflation (Madura, 2006). The government’s policy to amend the nominal rates in order to cushion the savers will automatically be advantageous to me. As such, I will be motivated to increase my savings and investment in order to meet my future investment objectives.

Reference

Madura, J. (2006). Introduction to business. New York, NY: Cengage Learning.

Mankiw, N.G. (2012). Principles of macroeconomics (6^th.). Mason, OH: South-Western, Cengage Learning.

Sexton, R. L. (2007). Exploring Economics. New York, NY: Cengage Learning.