How Does Inflation Work? - AstroWealth Skip to main content

What is inflation?

Inflation is the decline of purchasing power of a given currency due to a decrease in the value of that currency. Inflation occurs when prices increase across an entire sector or industry such as the automotive business, causing a decrease in purchasing power.

In contrast, deflation occurs when the purchasing power of money increases and prices decrease.

How is inflation calculated?

Most commonly, inflation is calculated using inflation indexes such as the Consumer Price Index (CPI) or Wholesale Price Index (WPI). To measure inflation using CPI, you subtract the former price of a good/service from the current price and divide the result by the former price. This will provide the rate of inflation, or percent price increase over that time period.

How does inflation occur?

The root cause of inflation is an increase in the money supply, which can result in a variety of ways. For example, the money supply can be increased by printing and giving away more money, legally devaluing the legal tender currency, and loaning new money into existence by purchasing government bonds from banks. There are three mechanisms that drive inflation: demand-pull inflation, cost-push inflation, and built-in inflation. Overall, inflation typically results from an increase in production costs or an increase in demand for products and services.

Is inflation good or bad?

Low, stable, predictable inflation is good for the economy and individuals’ finances. Stable inflation helps maintain the value of money and promotes growth in the economy. However, high inflation is often unstable and unpredictable. When inflation is high, consumers, businesses, and investors are unsure of their daily costs, causing the economy to not perform at its best.

How do you combat inflation?

Financial regulators are responsible for monitoring the level of inflation by implementing monetary policies. Authorities such as the central bank manage the supply of money and credit to keep inflation within the tolerable limits.

Individuals can beat inflation and increase their purchasing power by investing money in certain assets. For example, investing in the stock market can help you combat inflation. Stock market indexes rise over the long run despite fluctuations in individual stock prices for certain periods, helping beat inflation.

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