Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every Rupee you own buys a smaller percentage of a good or service.
The value of a Rupee does not stay constant when there is inflation. The value of a Rupee is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a Rs 10 pack of candy will cost Rs10.20 in a year. After inflation, your Rupee can’t buy the same goods it could beforehand.
Variations on inflation:
* Deflation is when the general level of prices is falling. This is the opposite of inflation.
* Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation’s monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!
* Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.
In recent years, most developed countries have attempted to sustain an inflation rate of 2-3%.
Inflation is a sustained increase in the general level of prices, which is equivalent to a decline in the value or purchasing power of money. If the supply of money and credit increases too rapidly over many months, the result will be inflation. With inflation, money buys less and less over time.
The effects of inflation include:
* Inflation might make people worse off if their incomes don’t rise as rapidly as prices.
* Lenders might lose because they will be repaid with money that isn’t worth as much.
* Savers might lose because the money they save today will not buy as much when they are ready to spend it.
* Businesses will find it harder to plan and therefore may decrease investment in future projects.
* Owners of financial assets suffer.
* Interest rate-sensitive industries, like mortgage companies, may suffer as inflation drives up long-term interest rates and Federal Reserve tightening raises short-term rates.
Friedman discusses the high inflation rate of the 1970’s and other periods in Free to Choose:
“Inflation is just like alcoholism. In both cases when you start drinking or when you start printing too much money, the good effects come first. The bad effects only come later…That’s why in both cases there is a strong temptation to overdo it. To drink too much and to print too much money. When it comes to the cure, it’s the other way around. When you stop drinking or when you stop printing money, the bad effects come first and the good effects only come later. That’s why it’s so hard to persist with the cure. In the United States, four times in the 20 years after 1957, we undertook the cure. But each time we lacked the will to continue. As a result, we had all the bad effects and none of the good effects.”
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