02 Apr 2021 · 3 min read

Inflation and it's effects

What is inflation?

Inflation is a rise in the general price cost of goods and services and a reduction in currency buying power. Currency value can decline if the government prints more money or if the currency is not in demand in the global market as earlier. Prices of goods can increase if there is less good produced in the country and buyers are more.

A certain level of inflation is required in the economy to promote expenditure, encourage the production of goods and services, and to demotivate hoarding money in savings. If your money will be of more value in the coming future, you will not spend money. That won't be good for the economic flow. (One of the disadvantages of bitcoin as a currency)

Who Measures Inflation??

Inflation is calculated by a central government body, which is responsible for taking steps to ensure that the economy runs smoothly. In India, the Ministry of Statistics and Programme implementation monitors inflation.

Why you should keep tracking inflation??

It is always eating your money without telling you. Let's take the example of Gopal who is saving 5000 in FD with 6% interest and want to buy a Saree for his mom that would cost 5300 now. He is very happy that after a year, he will get 5300 and he would be able to buy a Saree for his mom but when he reaches the shop, the shopkeeper told him that the price is 5500 now. So, his money increases by 6% but the price of goods also increased by 3.7%(For now we are not taking tax into the assumption that you have to pay for return gain on mutual fund according to your tax bracket).

Note - Always see net return in your investments.

Net return= return-Inflation 

Ex- If you invested Rs 100 in a mutual fund and you get 10% returns, 110 will be your return and if the inflation is 5% your net return will be 105.

How is inflation measured??

In India, inflation is mainly calculated by two major indexes, WPI (Wholesale Price Index) and CPI (Consumer Price Index), which respectively calculate increases in wholesale and retail price levels. 

The CPI measures the disparity in the price of goods and services that Indian customers purchase for use, such as food, medical treatment, schooling, electronics, etc. 

On the other hand, WPI gathers the products or services offered by companies to smaller enterprises for further sale. In India, inflation is calculated using both the WPI (Wholesale Price Index) and the CPI (Consumer Price Index).

Is inflation good or bad??

Depending on the type of assets you hold, inflation is viewed differently by all. Inflation ensures that the prices of their properties are poised for a hike for those with savings in real estate or stocked goods. They can be negatively influenced by inflation for those who own cash when the value of their cash erodes

Note - Inflation rate good for developing country - 2-4%

Controlling inflation

How RBI(Reserve Bank of India) controls inflation??

The initiatives usually taken by the RBI to counter inflation include an increase in repo rates (the rates at which banks borrow from the RBI), an increase in the cash reserve ratio, and a decline in the interest rate on cash deposited by RBI banks. 

How the Government controls inflation??

The government controls inflation by increasing taxes, decreasing their expenditures, and change in fiscal policy(fiscal policy is the use of government revenue collection and expenditure to influence a country's economy).

Causes of inflation

1) Deman Pull Inflation - The form of inflation that occurs when the aggregate demand of an economy surpasses its aggregate supply is demand-pull inflation. To put this in basic terms, higher costs easily follow when supply is not able to keep up with market demand. ex - There are 100 limited edition bikes in the world and 1000 people can afford the bike. So, Bike Company can increase its price.

2) Cost-push inflation - Inflation that stems from increased manufacturing rates and increasing raw material prices is cost-push inflation. Cost-push inflation happens because, because of an increase in manufacturing prices, the net supply of goods and services declines. For example, if the price of raw material(coconut) used for making coconut oil is increased, the price of coconut oil will also increase.

Inflation is good if it is 2-4% as it leads to growth in the economy but it also devours your capital. So, keep your money in different assets(Real Estate, stocks,mutual-fund,fixed-deposit, emergency fund) according to your risk capacity and age.  

3) Wage push inflation - Wage drive inflation is an average spike in the price of commodities due to an increase in incomes. Employers must raise the rates they charge for the products and services they offer to retain company income despite a spike in salaries.

4) Currency depreciation - When government start printing more money

Conclusion-

Inflation is good if it is 2-4% as it leads to growth in the economy but it also devours your capital. So, keep your money in different assets(Real Estate, stocks, mutual-fund, fixed-deposit, emergency fund) according to your risk capacity and age.