The term Inflation refers to as when the purchasing power of a nation falls due to a rise in overall prices, it decreases the value of money and makes it more expensive to buy goods and services. Inflation is a normal economic phenomenon that should happen at a pre-determined speed anything above that should be a cause of concern. CPI or consumer price index is the most common gauge of inflation which measure the price increase and decrease of basic goods and services. Another very important tool to measure inflation is The GDP deflator it measures the price changes in goods that are produced domestically.
High levels of inflation hamper any country’s economic performance thus making it mandatory to indentify the causing factors. Following are some of the reasons that causes Inflation,
1) Excess printing of money.
2) Rise in production and labor costs.
3) High lending levels & Currency devaluation.
4) High level of taxes
Excess printing of money:
The general cause of inflation that has been agreed among most economists is when there is an increase in the money supply or a decrease in the quality of goods being supplied. Money supply plays a larger role in inflationary pressure, the more money injected in the economy the more will be the inflation. If the money supply is not adequately controlled by the Federal Reserve then it may actually grow at the rate faster than that of the potential output in the economy, or real GDP. As a result prices end up rising at a rapid pace to keep up the currency surplus. This is called the Demand-Pull, in which the prices are forced upwards because of the high demand. An increase in the quantity of money in circulation relatively to the ability of the economy to supply leads to increased demands, thereby fuelling prices. Low interest rates correspond with high levels of money supply and allow for more investment in big business and new ideas which eventually leads to unsustainable levels of inflation as cheap money is available. The credit crisis of 2007 is a very good example of this at work.
Rise in production and labor costs:
Another cause of inflation that should be kept in mind is a rise in the production cost that leads to an increase in the prices of the end products. Expensive Raw Material leads to an increase in the production cost that ultimately results in the company increasing prices of the final product to maintain steady profits. Rising labor costs can also lead to inflation. As workers demand wage increases, companies usually chose to pass on those costs to their customers.
High lending levels & Currency devaluation:
High lending levels are a curse to any nation and can result in an increasing level of Inflation as International lending and national debts have to be paid off with an addition of interest, which ultimately end up soaring prices in the country as a way to keep up with the debts. This causes the exchange rate to drop which results in more inflation, as government has to deal with the gap created between the import/export levels.
High level of taxes:
An increase in federal taxes either direct or indirect put on consumer products lead to inflation as suppliers transfer the burden to the consumer. A classic example of this cost-push or supply-stock inflation is the 1970s oil crisis after OPEC raised prices and as a result US saw double digit inflation levels during that period. As oil is used commonly a sharp rise leads to an increase in the prices of all commodities. Law & order situation and wars can often cause Inflation as the government has to repay the funds taken from the central bank. The impact of ways can be seen on everything from international trading to labor costs to product demand, so at the end it always inflates prices.
Conclusion:
Finally, a steady level of Inflation should be maintained as it shows the growth of an economy but any rise at an unsustainable level will certainly have a bad impact on the economy just as it happens in 2008 with a global price rise in oil, food, steel and other commodities.