M RahmanAdvantages and disadvantages of inflation
This article offers a detailed analysis of the key advantages and disadvantages of inflation. Inflation is an economic phenomenon that can have both advantages and disadvantages. It is usually a negative word; however, it does not always have to be viewed in this light. It actually has some advantages, which is why it is very common in modern economies.
What is inflation?
According to Groves (2022) the term ‘inflation’ is used to describe the increase in prices over time. The rate of inflation measures how rapidly prices of goods and services are increasing in a country.
According to IMF (2022) inflation is the rate of increase in prices over a given period of time. It is a general indication of rising prices. It is usually a broad measure that can show the overall increase in prices or the increase in the cost of living in a country. However, a narrower approach can also be pursued to explore the price increases for certain goods/services.
Inflation occurs when the general level of prices in an economy increases. Economists have different opinions on what is causing the inflation. Some say that there is too much money in circulation, while others say that it is due to rising demand in the market.
How to measure inflation in the USA?
In the USA, the Bureau of Labor Statistics (BLS) produces the Consumer Price Index (CPI) which is usually used to calculate price changes faced by urban consumers. It collects spending data from tens of thousands of consumers from up and down the country. The data collected concerns the prices spent by them to purchase items such as food and drink, energy services, holidays, computers, medicine, mortgage payments and many more to measure how prices have increased over a period of time (Lavie and Curry, 2022).
How to measure inflation in the UK?
In the UK, the Office for National Statistics (ONS) checks the prices of a wide variety of products and services in a ‘basket’. This is called the Consumer Prices Index (CPI) which measures the prices of over 700 items including everyday items such as food and drinks and less frequently purchased items such as cars, mortgages, and holidays (Bank of England, 2022).
The ONS compares the current prices of items with those a year ago to determine the rate of inflation. The UK government has an inflation target of 2% to keep the inflation low and the economy stable. However, if the rate goes up or down by more than 1 percentage point from the set target of 2% (e.g. 1% or 3%), the Bank of England must explain to the government as to why it has happened (Bank of England, 2022).
Advantages of inflation
Economic growth
The are several advantages of inflation. For instance, moderate inflation is desirable as it helps promote the economic growth. That is why the UK government has set an yearly inflation target of 2%.
Helpful for planning
If prices are affordable and predictable, it is easy for consumers to plan how much they can spend, save, or invest in a month, year etc.
Disadvantages of inflation
When it comes to the disadvantages of inflation, most people only think about savers losing money. However, there are other negative effects of high inflation that need to be considered as well.
Reduced purchasing power
High inflation reduces the purchasing power of people’s income. This means that people have to work more to receive the same amount of money they used to get before.
Reduction in investments
When the general level of prices increases, the value of investments goes down. This is why people with savings generally lose value of money as time goes on. High inflation can cause other economic problems that can be harmful to the economy.
Increased interest rates
If there is high much inflation in an economy, the government and central bank might decide to raise interest rates to control it. This is not good for businesses and people who have loans.
Decreased gross domestic product
An excessive amount of inflation can lead to a decrease in gross domestic product. Many people may find it difficult to buy everyday items because of their high prices, particularly when their wages/salaries have not gone up in line with the inflation rate.
How to control the effects of inflation?
Inflation is generally an uncontrollable phenomenon; however, there are certain steps that governments and central banks can take to control the effects of inflation. They can often be seen doing this in the form of interest rate hikes or a reduction in money supply.
There are also certain steps that ordinary people can take to control the effects of inflation. First and foremost, they must try to live within their means. This means spending less than they earn, if possible, at all. This can be achieved by cutting down on the purchase of luxury items.
It is important to save money for the future, and therefore, people should try to save as much as they can. Finally, they need to be fully aware of the long-term effects of inflation, and plan accordingly. For example, they must know that if they have a long-term loan, they will have to pay back a higher amount when there is high inflation.
Summary of the advantages and disadvantages of inflation
It is impossible to have a perfect economy. Every economic system has its own pros and cons, and no system is perfect. Inflation is a natural occurrence in all economies; however, it can sometimes get out of control. If this happens, there are steps that can be taken by the governments, central banks, and consumers to control the effects of inflation.
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Last update: 09 December 2022
References:
Bank of England (2022) What is inflation, available at: https://www.bankofengland.co.uk/knowledgebank/what-is-inflation (accessed 29 November 2022)
Groves, J. (2022) What is inflation – and how does it destroy your money? available at: https://www.forbes.com/uk/advisor/investing/what-is-inflation/ (accessed 28 November 2022)
IMF (2022) Inflation – prices on the rise, available at: https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Inflation (accessed 27 November 2022)
Lavie, D. and Curry, B. (2022) How to calculate Inflation: PCE & CPI, available at: https://www.forbes.com/advisor/investing/how-to-calculate-inflation/ (accessed 29 November 2022)
Author: M Rahman
M Rahman writes extensively online and offline with an emphasis on business management, marketing, and tourism. He is a lecturer in Management and Marketing. He holds an MSc in Tourism & Hospitality from the University of Sunderland. Also, graduated from Leeds Metropolitan University with a BA in Business & Management Studies and completed a DTLLS (Diploma in Teaching in the Life-Long Learning Sector) from London South Bank University.
