What is Inflation and its Causes

6 Jul 2020 11:47 AM

What is inflation?

You’ve probably heard about it, but just what is inflation really? Inflation is a continuous rise in the general level of prices for goods and services in a country, calculated as a small percentage change annually. It also means rising prices over time. Consequently, when inflation is high the purchasing power of a country’s currency is falling, hence, goods and services cost more.

The real value of your money is expressed by its purchasing power, which means the amount of goods and services you can purchase. As a result of inflation, the purchasing power of a currency falls. For example, if the annual inflation rate is 2%, then any good that costs $1 will cost $1.02 in the next year. Therefore, the currency will not have the same value it had the previous year when the amount of currency required to purchase a certain good were lower, this means that the prices have risen or the currency’s value has fallen.

In recent years many developed countries have been trying to keep the inflation rate between 2 - 3% through the monetary policy tools of central banks.

Causes of inflation

There is no single cause of inflation, but there are a variety of factors, all which play some role in inflation:

  1. Demand – pull inflation: occurs when there is an increase in aggregate demand of goods and services causing a rise in prices. It can be summarized as “too much money to purchase too few goods”, in other words, if demand growth is faster than supply, prices will rise, usually in fast – growing economies.
  2. Production costs: occurs when companies are faced with increased input costs, they will increase prices to maintain the margins. These costs can include things like wages, taxes, or increased costs of natural resources or imports.
  3. The money supply: inflation is caused by an increase in the money supply. Like any other good, the prices are determined by supply and demand. More money supply will decrease the value of said money. For currency, if there is increase in the money supply the value of the currency will fall and will cause an increase in the price of goods.

You can learn more about inflation and other important economic concepts by reading the Equiti Newsroom articles.

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