Inflation : Inflation and its impact
The most critical economic indicator is inflation’, which indicates the rate of rising prices of goods and services in the economy. Inflation causes a decrease in purchasing power parity. It is generally calculated in percentage form.
This quantitative economic measure is the rate of change in the prices of selected goods and services over a period of time. It basically indicates the rise in average price change in the basket of goods and services.
Inflation becomes a great barrier to economic growth due to the tremendous rise in prices. Financially, it is also called systematic risk, meaning that a company does not have a grip over it. Consider an example of an oil company that does not have control over the external factors that drive the oil price movement. During the Russian-Ukraine war, the oil price shot up to an approximately higher price of $135 per barrel, leading to a trickle-down impact on the prices of goods and services, so-called inflation. The short term impact (Israel- Palestine war) is already visible. The major impact is on crude oil prices that have surged over 5% since the declaration of the war.
Australian inflation rates
Source: Australian Bureau of Statistics.
Australia's inflation rate dropped significantly to 6% year-on-year in the second quarter of 2023, down from 7% in the previous corresponding period, which was below market estimates of 6.2%. The softening of inflation has resulted in lower prices since the third quarter of 2022.
Different types of inflation in economy
Inflation mainly occurs through three different types:
• Built-in inflation: Expectations of future inflation result in built-in inflation. A rise in prices causes higher wages to afford the increased cost of living. The higher wages result in an increased cost of production, which in turn has an impact on product pricing. The cycle continues.
• Cost-push inflation: It occurs when production costs rise. An increase in the prices of inputs such as raw materials, labor costs, etc. results in an increase in the end product cost.
• Demand-pull inflation: the increase in demand for specific goods and services when there is a supply chain bottleneck results in price appreciation. An example of a commodity price rise during the Russian invasion of Ukraine.
What are the main reasons behind Inflation?
The central government’s pivotal role in its monetary policy is to print money when the economy needs a growth boost. At the same time, excess supply results in surplus money flowing into the hands of the common public. The purchasing power increases, consequently impacting the rise in product and service prices. This is in economic language called inflation.
Fiscal policy: Fiscal policy takes control in borrowing and spending of the economy. Higher borrowing results in increased taxes and additional currency printing to repay debt.
Demands pull inflation: increases in prices due to the gap between the demand and the supply.
Costs push inflation: the higher prices of goods and services due to higher cost bases impact
Exchange rates: The fluctuations in the exchange rate have an impact on the rate of inflation.
Who benefits from inflation?
Inflation is a restrictive component of economic growth; however, it gives major benefits to investors. For example, investors investing in assets affected by inflation may hold them for a long time. Real estate investments increase yield faster due to the rise in housing prices. Therefore, those who would have invested long ago will most probably take advantage of capital appreciation.
How do we control inflation?
There are various ways the Reserve Bank of Australia (RBA) takes measures to tackle inflation. The primary strategy is to change monetary policy by adjusting interest rates. A higher interest rate decreases demand in the economy, consequently leading to lower inflation. There are some other ways to handle it, as follows:
Tightening the monetary supply in the economy may help to some extent. The cash crunch would help to cut down on spending and thereby reduce demand.
A higher tax rate can also reduce spending. And hence, it causes a lowering in demand and inflationary pressures.
Frequently Asked Questions (F.A.Q)
Is inflation bad or good?
Rising prices of goods and services have a negative impact on economic growth, as this will cause a rising interest rate and an overall slowdown in the economy. However, it has a positive impact as well. The older debt becomes cheaper to hold on to than current real dollars as inflation erodes the value of money.
What is the impact on gold during inflation?
Inflation impacts the price of gold because the demand for gold tends to increase during this time of high inflation. Investors prefer to shift towards safer asset classes to protect against the risk of an economic downturn.
What is the impact on equity during inflation?
The correlation between the value of stocks and the rate of inflation is directly proportional to each other. During high inflation, value stocks always tend to do better, while growth stocks will have less or no streaming in cash flows. The rise in the price of goods will have a significant impact on growth companies. For example, if the price of milk rises, so will the price of cheese, and thus product rates. Therefore, it is negatively correlated with the rate of inflation.
What is the inflation rate formula?
The rate of inflation = (initial CPI minus final CPI) * 100.
Initial CPI
CPI= Consumer Price Index
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