The whole economy is affected as oil prices, food, commodities, and other goods and services increase. Escalating prices, attributed to Inflation, influence basic cost of living, the cost of doing business, borrowings, mortgages, gains on corporate and government bonds, and any other part of an economy.
Inflation can be both positive and, in some situations, detrimental to economic recovery. The economy will struggle if Inflation becomes too high; conversely, if Inflation is regulated and at acceptable levels, the economy will thrive. Employment rises with regulated, lower Inflation. To purchase goods and services, customers have more cash and economic profits.
How does Inflation work?
Economic growth is calculated in terms of the gross domestic product (GDP) or the cumulative value of all manufactured finished products and services for a given period. The amount of growth or decrease is adjusted for Inflation relative to the previous year. GDP would therefore be registered at 3% if growth was 5% and Inflation was 2%. The value of the dollar decreases as prices increase, as its buying power erodes with each rise in the price of essential products and services.
The Interest Rate
Theoretically, low or no inflation can help an economy to recover from a recession or a depression. The cost of borrowing money for acquisitions or borrowing for the purchase of big-ticket items, such as vehicles or securing a mortgage on a house or condo, is also strong, with both Inflation and interest rates low. According to some economists, these low rates are supposed to stimulate consumption.
However, banks and other lending institutions can be reluctant to lend money to customers when the rate of return on loans is poor, reducing profit margins. Businesses can prepare their borrowing plans, recruiting, marketing, improvement, and expansion accordingly.
Investors also know what government and corporate bonds and other debt are going to return since most of these instruments are tied to Treasury returns.
Economists, however, notably vary in their beliefs. Some economists believe that by helping to address the US debt crisis, raising wages, and stimulating economic growth, a 6 per cent inflation rate for several years will benefit the economy.
The Index on Consumer Prices
The government’s consumer price index is the traditional inflation indicator (CPI). A ‘basket’ of some elementary goods and services, such as food, electricity, clothes, accommodation, medical care, schooling, and communication and leisure, are components of the CPI.
If, for instance, the average price of all goods and services in the CPI were to go up 3% over the level of the previous year, then Inflation would be pegged at 3%. This also suggests that the dollar’s buying power will have been decreased by 3%.
When the CPI increases, hard assets, such as a home or real estate, frequently increase in value; but fixed-income securities lose value because Inflation does not increase their yields. However, a notable exception is Treasury inflation-protected securities (TIPS). Interest on these securities is charged at a fixed rate twice annually as the principal rises in line with the CPI, thus shielding the investment from Inflation.
According to some economists, managed Inflation, no higher than 6% and may be somewhat lower, could have a beneficial effect on economic growth, whereas Inflation at or above 10% may have a negative impact.
If the US continues to raise its debt and, through Treasury problems, continues to borrow money, it will have to purposely inflate its currency to remove those obligations eventually. When their securities fall in value as rates increase, owners, retirees, or those with fixed income assets will in essence be paying down those commitments.
Considering the current scenario of the Indian economy, we can definitely predict that the Inflation seen in recent days may prolong until the economic growth or the GDP jumps back up from the floor it has touched. So hang tight, because the country is going through a phase of recession post-Covid 19, which shall yield into the boom period within a span of few years again.