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7 Facts About Inflation That You Need to Know


7 Facts About Inflation That You Need to Know. Is it possible to live in the modern world without money? The question is rather philosophical. If you do not live on a desert island or in the jungle, then the answer is unequivocal – it is impossible to live without money.

Problems of inflation and money in the modern world

What is inflation?

Inflation is a steady increase in the general level of prices for goods and services. At the same time, certain goods can significantly increase in price, others may become cheaper, and still, others may not change in price at all.

Basically, prices for goods and services depending on supply and demand in the market, and some prices are regulated by the state. For example, if the farmers had a good harvest of vegetables, the prices of tomatoes and potatoes will fall. If the state increased excise taxes on alcohol at the same time, the price of alcohol will go up sharply. At the same time, the general price level can grow only a little.

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How is inflation measured?

In Russia, inflation is measured in the same way as in most countries of the world. They take the so-called consumer basket – a set of products, goods, and services that the average person or family regularly buys. About 500 goods and services fall into it – for example, products, clothes, utilities, household appliances, cars.

It should be understood that someone never eats meat and does not drive a car. And someone, on the contrary, cannot live without meat and changes cars every year. Consumer basket reflects the average consumption of all residents of the country.

People often buy some of these products: bread, vegetables, meat, gasoline. And others, such as a car, are rarely purchased, but these costs are very large compared to spending on the same bread, vegetables and meat. Thus, when calculating a consumer basket, a car occupies a larger share in it than bread.

The cost of this conditional basket varies from month to month. This change is inflation.

Why is it said that inflation goes down if prices go up?

Inflation is always a rise in prices. With low inflation, prices rise very slowly but still rise. When they say that inflation is declining, this means that the consumer basket rises in price more slowly than in previous years.

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What is inflation?

Low  – up to 6% per year. Such inflation is comfortable for both consumers and entrepreneurs. And at the same time allows the economy to grow. It is at this level that inflation is being sought in most countries.

Moderate  – from 6 to 10% per year. It is dangerous because it can get out of control and go into high inflation.

High (galloping)  – from 10 to 100% per year. It creates market instability; people and companies cannot plan their future.

Hyperinflation  – prices rise by hundreds and thousands of percent, in especially severe cases, people give up money and switch to barter. Hyperinflation usually occurs during severe crises and wars.

In post-Soviet Russia, record-high inflation was recorded in 1992 – more than 2500% per year.

Deflation is negative inflation. That is, prices do not rise but decrease. Deflation stops the development of the economy. Consumers stop buying goods in the hope that they will become even cheaper. And because of this, companies are curtailing production.

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Why is inflation rising?

Inflation can arise for many reasons:

  • Increase in demand. It happens that people suddenly start to buy more certain products. For example, when mobile phones became affordable, everyone wanted to use cellular communications. Cellular operators did not have time to immediately adjust to high demand: there were not enough towers and free frequencies. Therefore, the prices of mobile communications were very high. Any shortage causes a rapid rise in prices. But when the operators got the extra capacity, prices began to decline.
  • Supply reduction. The deficit can arise for another reason – if demand remains the same, but goods and services become smaller. This can happen due to crop failure, restrictions on the import of foreign goods, the actions of a monopolist in some market. This also accelerates price increases.
  • The weakening of the national currency. If the exchange rate of foreign currencies grows, then imported goods automatically rise in price. This also leads to higher inflation.
  • High inflationary expectations. When people and companies expect prices to rise strongly, they often begin to change their consumer behavior: they buy goods for the future and save less. It is more logical to buy today cheaper than overpaying tomorrow. Companies, for their part, are starting to raise prices for their products. For example, a cheese maker expects milk prices to rise. To cover his future expenses for raw materials, he begins to raise the price of his goods in advance. All this spurs inflation. It turns out a vicious circle: everyone is waiting for prices to rise and prices are rising precisely because people are waiting for this.
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Why is high inflation bad?

High inflation is always bad. And for the economy, and for business, and for financial markets, and, of course, for the inhabitants of the country. People make obvious financial decisions: they get rid of money, spend it as soon as possible, investing in valuable goods, real estate, and buy foreign currency. It becomes unprofitable to make savings, open deposits, bank customers withdraw money from accounts.

Typically, high inflation is also unpredictable – it accelerates or moves in leaps and bounds. Due to the growing instability in the financial markets, it becomes unprofitable for entrepreneurs to take long-term loans. It is impossible to plan ahead – and this is the most important condition for the growth of investment and the economy as a whole.

Inflation is especially hard on poor people who live on fixed incomes. Indeed, more affluent people have ways to fully or partially protect themselves from inflation – for example, by receiving interest on deposits or investing in the financial market. That is why inflation is sometimes called the tax on the poor.

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But is it possible to simply freeze prices so that they do not rise?

It may seem that fixing prices at a certain level is a good solution. But such artificial intervention in the economy will lead to an increase in the imbalance between supply and demand. Manufacturers will not understand how much goods to produce, shops – how much to buy, and as a result, buyers will have to stand in lines at empty counters.

With frozen prices, there will be a shortage, part of the goods will not have to be bought, but taken out. In addition, the goods will become worse: in order to stay afloat and keep unfavorable prices dictated from above, manufacturers will sacrifice quality.

It is for these reasons that in a market economy, prices should be dictated by the market, not the state.

Who and how holds back inflation?

The movement of money in the economy is regulated by central banks (in our country it is the Bank of Russia). With the help of monetary policy instruments, central banks can curb inflation in the country.

For example, the Bank of Russia plans to keep inflation near that same 4 %. But a specific figure is not an end in itself, it can change. The main thing is that the economy develops at this inflation rate.

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