What Inflation Means. Ultimate explanation.

What is the definition of inflation?

Inflation means the cost of living increases because of rising prices for goods and services. Inflation refers to a general increase over time in the prices of goods and services in an economy, which is consistent with the decline of the value of money. Inflation reflects either an overall increase in prices or a decline in the value of money.

How does inflation work?

Inflation occurs when prices rise, decreasing the purchasing power of your dollars. The cause is inflation, which describes a gradual increase in prices over time, slowly decreasing the purchasing power of your dollars. As inflation increases, consumer spending falls, because as prices increase, people cannot afford to buy as much.

Why does inflation happen?

Inflation may be contrasted to deflation, which occurs when the purchasing power of money increases while prices decline. Another reason inflation occurs is when the demand for goods and services exceeds the supply that is available at that point in time, which causes prices to go up. With demand-driven inflation, the economy’s demand for goods and services outstrips the economy’s capacity to produce them, and the shortages put upward pressure on prices, leading to inflation. When economies are experiencing inflation, i.e., when the price level for goods and services increases, the value of currency declines. Inflation usually results from too much demand for too few goods or services, which causes prices to increase.

This kind of inflation is mostly a result of higher prices to produce the product or service. This type of inflation starts when demand for services and products increases, and this exceeds the productive capacity of a firm. Cost-push inflation is the phenomenon in which rising prices for input goods and services raise the prices of final goods and services, causing inflation. In contrast to the Consumer Price Index, the Producer Price Index (PPI) measures inflation from a producers point
of view.

Which inflation rate to use?

The U.S. Bureau of Labor Statistics measures the rate of inflation using the Consumer Price Index (CPI). The rate of inflation measures the percentage annual change of the overall price level. Inflation measures the average change in prices of a basket of goods and services over time. An increase in value in a representative basket of goods indicates inflation and using the basket accounts for the way prices of various goods vary with varying rates while depicting a more general change in prices.

Both the types of goods and services included in a basket and the weighted prices used in the measure of inflation will vary over time to match changing markets. A quantitative assessment of the pace of the reduction in purchasing power may be captured by an increase in the average price level for the basket of selected goods and services over some time frame within an economy.

This serial shift of purchasing power and prices (known as the Cantillon effect) means that the inflationary process does not just raise the overall price level over time, it distorts relative prices, wages, and rates of return along the way. Inflation is defined as the rate at which prices for products and services change in a given period of time, typically one year. Expressed as a percentage, inflation takes a number of factors into account, ranging from broader measures such as the total cost of living in the country to more specific needs such as groceries, fuel, and heating costs–even the price of haircuts.

Can inflation be reversed?

You can. In very simple terms, by removing a certain amount of money from circulation (keep in mind that money, in this case, is not equal to cash) while keeping the amount of aggregate supply the same or increasing aggregate supply while keeping money supply.

However, that being said, small inflation is actually a good thing. You see, money, on its own, has no value. What gives it value are all the goods that you can exchange money for. Money is basically just a medium of exchange to avoid having to keep exchange ratios for every imaginable pair of goods (not to mention, how would you pay production line workers and such).

However, if the value of money is increasing (deflation) it has a tendency of killing the demand in the monetary zone (usually a country, or Eurozone in the case of the Euro) because why spend money today if you can get more for same money tomorrow. And because consumption is the main driver of the economy (no sane business will create goods for supply only), deflation tends to bring the local economy down.

So considering all this (which is very very simplified), you can reverse, but to an extent, it’s not really a good idea to do so. Unless you have hyperinflation, then you have big problems in politics AND the economy.

When inflation will go down?

Inflation can go down in different ways

1. Interest rate constant hike month after month, year on year to control inflation: bear market based on how steep the rate hikes are happening. Because money is getting poured out from share markets to money markets(debt instruments).
2. Interest rate same or maintain: consolidation phase, small Y-o-Y like 4–8% per year on major indices.
3. Policy changes, development work, government-driven changes for battling it: Now this is tricky as markets can do well in hope of euphoria and positivity in growth aspects, or sideways/bear trend if the market participants’ expectations are not met.