Understanding causes of inflation

Zeeshan Wasim

Surviving the various financial crises in the recent past, the investors and companies have grown accustomed to fluctuating inflation rate. In terms of profitability, the unwanted variations in the inflation rate mostly results in low interest rates in the economy.

For a period, inflation rate seemed to have stabilized in terms of the global economy. However, in the year 2021, a sudden financial turmoil disrupted the state of normalcy. Today, the topic of inflation is trending and while most people don’t understand the entirety of inflation, they are aware that it results in the gradual loss of purchasing power.

At its core, inflation is a rise in the prices of commodities and services. As the prices increase abruptly, our hard-earned money loses value and with time we are able to make lesser purchases as we did in the past with the same amount of money. Employees demand a raise in salaries in such a scenario and this leads to further inflation. Hyperinflation is when prices rise at such a rapid pace that an economy breaks down. This is because every person rushes to spend his/her money the moment he/she receives it, because every minute makes the prices go higher.

The central banks set an inflation target and utilize the interest rates to keep the rise in prices as steady as possible as per the pace that was pre-determined to be the best. Minor inflation is harmless and everyone expects it, however, since 2021, prices are increasing at a pace that is considered to be ‘out of control’. This can induce recession and decreases the speed of economic growth.

For the purpose of understanding, one should know that inflation is driven when there is too much demand relative to the supply in a market. The question is: how does demand possibly outpace the level of supply?

Firstly, supply shocks, which is disruption to an essential economic input such as energy. If key oil fields are not able to produce oil, price of energy will rise and as energy is used in production of goods, the price of goods will increase as well.

Secondly, a case where the money supply increases, more cash in the pockets of people will make them buy more things, but unless the supply of goods and services increase as well, the sudden spike in demand will bid up the prices, thus invoking inflation. Too much money chasing few goods is bound to cause financial instability.

Then there are expectations of the people that can lead towards unexpected and unwanted inflation. Due to any reason, workers in an economy might think that there will be a sudden period of inflation. This can cause them to ask for high raises in their wages or salaries. When a company is forced to pay the workers more, it compensates for it by increasing the prices of its products or services in order to maintain a good percentage of profit. Thus, the economy can dwindle in such a scenario. 

As inflation affects everyone, from major industries, the leading companies to the household in an economic system, therefore, a proper understanding of the concept is essential. Currently, the high rate of inflation is causing countless problems for businesses and individuals, so managing the everyday affairs successfully during such an unstable period is the priority of all businesses, hence, gaining and understanding economic knowledge can benefit us.

The writer is a digital marketer, entrepreneur, columnist, freelance content writer and a graduate of the Institute of Management Sciences (IMSciences), Peshawar in business administration. He can be contacted at: srkgothambat@gmail.com. He also tweets @ZeeshanWasim8.

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