What is Inflation: Inflation is one of the most common topics under the Banking Awareness section of the BOI/PNB Credit Officer Exam 2022. A little knowledge about it can earn you a brownie point in your upcoming BOI/PNB Credit Officer Exam 2022. Therefore, in the following article, we are providing you an overview of inflation, its causes and types as part of the banking awareness preparation. We suggest you save this handy guide as a PDF for your effective preparation.
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What is inflation?
Inflation is a sustained rate at which the general level of prices of goods or services is increasing, and at the same time, the rate of purchasing power of currencies are decreasing. Inflation is measured as an annual change in percentage. Prices of things rise over time under conditions of inflation and as it does, every currency you own buys a smaller percentage of service/good. Therefore, when prices rise and currencies fall, you have inflation.
Purchasing power is the expression of the value of currencies. Purchasing power is the amount of tangible/real goods/services the money can buy at a moment in time. When there’s inflation, there’s the decline in the purchasing power of money.
What causes inflation?
There’s no single theory behind the cause of inflation that economists/academics agree upon. However, there are a few commonly held hypotheses:
1. Demand-pull inflation
According to the demand-pull inflation hypothesis, inflation is caused by an overall increase in demand for services and goods, which bids up their prices. If the demand for goods and services is growing at a faster rate than the supply, the prices will decrease. This usually occurs in economics that are rapidly growing.
2. Cost-push inflation
According to cost-push inflation, inflation is caused when production costs of companies rise. When production costs (taxes, wages, imports, etc.) increase, companies increase the prices of their goods/services to maintain their profit margins.
3. Monetary inflation
According to this theory, inflation is caused by the excessive supply of money in economies. Prices of commodities are determined by their demand & supply. When the supply is excess, the prices of commodities go down. If the commodity is money, excess supply of money reduces its value and the result is that the prices of everything else priced in currencies (dollars, rupees, etc.) must go up!
What are the different types of inflation?
Creeping is mild inflation, which occurs when there is a price rise of 3% or less a year. According to the Federal Reserve, when there’s a rise of 2% or less in prices, it benefits the economic growth. The creeping inflation makes consumers expect that the prices will keep increasing, which in turn boosts demand for goods and services, as consumers now want to buy a lot to beat the future prices. And this is how creeping inflation drives economic expansion. This is also the reason for Federal Reserve to set 2% as its target inflation rate.
Walking is stronger inflation, somewhere with a price rise between 3% to 10% a year. Walking inflation is harmful to the economy, as it accelerates economic growth (too fast). As a result, consumers start purchasing goods/services more than their requirements to avoid higher future prices. This further increases the demand so much that it’s challenging for suppliers to keep up with the demands. This results in common services/goods being priced out of reach of most people.
When inflation rises to 10% of more, there’s havoc wrecked on the economy. The currencies lose value so drastically that the incomes of employees and businesses can’t keep up with prices and costs. This leads to instability in the Economy and a loss in the credibility of the government leaders. This is the type of inflation that must be prevented at all costs.
An increase in inflation beyond the inflation range of 2 or 3%, could lead to hyperinflation, a condition where inflation quickly rises out of control. Hyperinflation occurs when prices skyrocket more than 50% a month. Hyperinflation is a rare phenomenon. Some examples of hyperinflation are Germany in the 1920s, Zimbabwe in the 2000s, and America during its civil war.
Stagflation is when the growth in the economy becomes stagnant, but there’s still price inflation. This seemingly contradictory phenomenon is rare like hyperinflation but can create havoc in the economy by combining high unemployment rate, severe inflation, and poor economic growth. Stagflation is a huge challenge to Central banks, due to the increase in risks associated with monetary policy responses and fiscal. Central banks usually increase interest rates to combat high inflation, but doing so during stagflation could increase unemployment further. Therefore, central banks need to keep a limit on their ability to decrease rates during stagflation. Possibly the most difficult inflation to manage.
This type of inflation measures the rising prices of all commodities except energy and food, due to the fact that gas prices increase every summer.
Wage inflation occurs when the wages of workers rise faster than the cost of living. Wage inflation occurs when there are labor unions demanding higher wages, when workers control their pay, or when there’s a shortage of workers.
Asset inflation refers to an increase in the prices of one asset class (gold, oil, housing, etc.). Asset inflation is often overlooked by inflation watchers when the overall inflation is low.
We hope the above notes on “What is Inflation”, its causes, and types help you in your Banking Awareness preparation for BOI/PNB Credit Officer Exam 2022.
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