Inflation: the enemy of your economic freedom

Don’t let rising prices hold you hostage – fight back against inflation and protect your economic freedom!

What is Inflation

In simple terms, it’s a stealthy thief, slowly diluting the value of your money. 

Inflation is the increase in prices over time. With the price increase, we see a decrease in the dollar value, known as purchasing power. With the drop in your purchasing power, we can see this reflected in the increase in the price of goods and services. The rise of prices, reflected as a percentage rate, is a loss of real value in an economy’s medium of exchange.

While inflation and deflation can seem like an ever-shifting tide for the everyday person, it does have both a negative and positive impact.

It’s time to stay ahead and the advantages and disadvantages of an inflated economy.

Key Takeaway

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• There are three main types of inflation: demand-pull, cost-push, and built-in.
• Inflation can benefit those who own tangible assets such as real estate or commodities.
• Inflation can be viewed positively or negatively depending on one’s perspective and the rate of change.
• The rate at which prices for goods and services rise is referred to as inflation.

Stay informed and protect the value of your hard-earned cash.

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Understanding Inflation

Many factors can pose an impact, including an increase in the supply of money, a decrease in the value of money, or an increase in the cost of goods and services. Monetary policy is used by central banks, such as the Federal Reserve, to try to manage inflation and keep prices stable.

The effect on the economy due to inflation can be positive and negative. On the one hand, it has the potential to stimulate spending and investments. However, it can cause uncertainty and discourage saving. Inflation can be difficult to predict, and it varies significantly between countries.

Keeping an eye on inflation data can be helpful, such as the annualized percentage change in a general price index and the consumer price index. These indexes will give you an idea of the current inflation rate and how it has changed over time. It is also critical to keep current on economic developments and policy changes affecting inflation and consider how they may affect your finances.

A good understanding can assist you in making sound financial decisions and protect your money’s value. It is essential when saving, investing, and making long-term plans.

The cause of inflation

The increase in money supply is a frequent cause of inflation rates. We can see this happen in various ways, including the printing and distributing more money, the legal devaluation of a currency, or the creation of new money through the monetary authorities’ purchase of government bonds. These can decrease today’s dollar value, thus impacting purchasing power.

We see three types of inflation with the increased printing of us dollar: demand-pull, cost-push, and built-in inflation rates.

Demand-pull effect

One of the three main types of inflation, the demand-pull effect, can result from an increase in the money supply. This happens when there is a high demand but an insufficient supply to meet that demand. As a result, prices may rise to ration scarce goods.

Several factors, such as increased consumer spending, government spending, or exports, can cause the demand-pull effect. Businesses can raise their prices when there is high demand because customers are willing to pay more for what they require. Demand-pull can result in a general increase in the price level, directly impacting our purchasing power.

Cost-push effect

When we see an increase in the supply of money, this can cause the cost-push effect. It happens when production costs rise, forcing businesses to transfer the increased costs onto customers in the form of higher prices. Cost push can increase the overall price level of consumer goods.

For example, a rise in the cost of raw materials or energy may cause businesses to raise their product prices. Similarly, wage increases may cause companies to raise the prices of their goods and services to cover the higher labor costs. A company’s overall return on investment needs to grow, regardless of the operational price for production.

Built-in inflation

Built-in inflation is another type that can occur due to a rise in the money supply. It refers to individuals’ and businesses’ expectations about future inflation, which can contribute to actual inflation.

Individuals and businesses who expect future price increases may be more likely to demand higher wages or prices for goods and services. Higher salaries and prices contribute to actual inflation, which may then lead to even higher expectations of future inflation.

A history of high inflation and the expectation of future price increases due to economic or policy changes causes built-in inflation. It is one of the factors that can contribute to less purchasing power and can be combined with the demand-pull or cost-push effect.

Investing during inflation

During times of economic decline, it can be difficult to think about investing with inflation depreciating the value of money. However, some investment strategies can help during negative economic trends.

• One strategy is investing in assets that perform well during inflation, such as stocks, real estate, and commodities. These assets can keep up with, if not outperform, the inflation rate, potentially providing a positive return on investment.
• Another strategy is to invest in assets that have the potential to provide a real return, which is the return on an investment after inflation has been taken into account. For example, investing in a company that can increase its profits over time may provide a real return even if the value of money decrease due to inflation.
• Inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS), may also be considered by investors. TIPS are designed to provide a return linked to the inflation rate.

Investing in general, let alone during inflation periods can be risky, and no investment strategy can guarantee success. Before making any investment decisions, it is always a good idea to diversify your portfolio and consult a financial professional.

Types of price indexes

Price indexes are statistical measures of price changes over time for a specific basket of goods and services. The various types are used to measure inflation and track changes in the cost of living.

CPI is a standard price index that measures changes in the price of a basket of goods and services.

The CPI is frequently used as an inflation measure and benchmark for adjusting wages and other financial instruments.

PPI is another price index that measures changes in the prices received by domestic producers of goods and services. The PPI is frequently used to track production cost changes and forecast future inflation.

These indexes are a helpful tool for economists and policymakers because they provide insight into the cost of living changes and can be used to make informed decisions about monetary and other economic policies.

The consumer price index (CPI)

The CPI is a statistical measure of the weighted average for a basket of goods and services. Transportation, food, and medical care are examples of what is included.

CPI is calculated by averaging price changes for each item in a predetermined basket of goods based on their relative weight in the overall basket. The prices take into account are the retail prices of each item as they are available for purchase by individual citizens.

CPI changes are used to assess price changes related to the cost of living, making it one of the most commonly used statistics for identifying periods of inflation or deflation. The Bureau of Labor Statistics (BLS) in the United States publishes the CPI every month and has calculated it since 1913.

The wholesale price index (WPI)

The wholesale price index (WPI) measures changes in the wholesale or producer price level of the price of goods.

The WPI is calculated by comparing the price of a fixed basket of goods and services at a given time to the same basket at a previous point in time. The WPI then uses the percentage change in the cost of the basket over time.

WPI is published on a monthly or quarterly basis. It is widely used as a measure of wholesale inflation and is frequently used to adjust wholesale prices of goods and services. Although WPI is used by many countries and organizations, many other countries, including the United States, use a similar variant known as the producer price index (PPI).

The producer price index (PPI)

The Producer Price Index (PPI) is a group of indexes that track the average change in selling prices received by domestic producers of intermediate goods and services over time. The PPI measures price changes from the seller’s perspective, as opposed to the CPI, which measures price changes from the buyer’s perspective.

A rise in the price of one component (say, oil) may partially offset a decline in another (say, wheat). Each index represents the average weighted price change for the given constituents, which may be applicable at the economy, sector, or commodity level.

PPI cannot accurately reflect changes in production costs for all goods and services. PPI typically only includes finished goods costs. It may only capture a portion of changes in raw material or energy prices. It may also need to recognize changes in the availability of discounts or other special offers.

Advantages and Disadvantages of Inflation

Inflation reflects a decrease in the purchasing power of money – a loss of real value in an economy’s medium of exchange and unit of account. The inflation rate, the annualized percentage change in a general price index (typically the consumer price index) over time, is a crucial measure of price inflation.

Benefits

1. The real value of debt can be reduced by inflation. When prices rise, the purchasing power of money falls. The actual value of debt will also fall because purchasing the same goods and services will cost more. Borrowers may benefit from this because it allows them to repay their debts with money worth less than when they took out the loan.
2. Inflation has the potential to stimulate economic growth. People are more likely to spend money pre-inflation rather than wait if they expect prices to rise in the future, which can boost demand for goods and services, thereby stimulating economic growth.
3. Inflation has the potential to redistribute wealth. When prices rise, people on fixed incomes (such as pensioners) tend to lose out because their income stays in lockstep with prices. People with variable incomes (for example, those on commission or with a salary linked to inflation) benefit because their income rises in tandem with prices.

Disadvantages

1. Uncertainty can be caused by inflation. People may be less likely to make long-term plans, such as investing in a business or purchasing a home, if they are still determining how much prices will rise—having the potential to cause economic instability.
2. Savings can lose value due to inflation. If the rate of inflation exceeds the rate of interest on your savings, the actual value of your savings will decline over time.
3. Wage-price spirals can occur as a result of inflation. Companies that attempt to protect their profits by raising the prices of their products may face higher wage demands from employees. If these wage increases are granted, further price increases may follow, creating a vicious circle of rising prices and wages.
4. Hyperinflation can result from high inflation. If the rate of inflation becomes uncontrollable, it can lead to a situation known as hyperinflation, in which the price of goods and services rises very quickly. This can be highly damaging to an economy, leading to a loss of confidence in the currency and the financial system collapsing.

Controlling inflation

Inflation control keeps an economy’s overall price level stable or within a specific range. Governments and central banks can control inflation in a variety of ways.

Setting interest rates: Setting interest rates is one of the primary tools used. When the central bank (for example, the Federal Reserve in the United States) raises interest rates, borrowing money is more expensive for individuals and businesses—helping to keep prices stable by reducing demand. If the central bank lowers interest rates, borrowing money becomes less expensive, stimulating demand and potentially leading to higher prices.

Fiscal policy: Governments can also use fiscal policy to try to keep inflation under control. For example, raising taxes or cutting spending by the government can reduce the amount of money in circulation and help to keep prices stable. On the other hand, lowering taxes or increasing spending by the government can boost demand and potentially lead to higher prices.

Monetary policy: Central banks can also use this policy to control inflation. They can, for example, increase the money supply by printing more currency or lowering bank reserve requirements and having the potential to stimulate the economy and raise prices. On the other hand, the central bank can reduce the currency supply by selling assets or increasing bank reserve requirements, which can help reduce demand and stabilize prices.

Price controls: Governments can also attempt to control inflation by establishing maximum and minimum prices for specific goods and services. Yet, price controls can be challenging to implement and have unintended consequences such as shortages or black markets.

Expectations: Finally, one of the most important ways to control inflation is to manage people’s expectations. If people expect prices to rise in the future, they may be more likely to spend money now rather than waiting, which can stimulate demand and lead to higher prices. On the other hand, if people expect prices to remain stable, they may be more willing to make long-term plans, such as investing in a business or buying a house, which helps keep demand and prices stable.

Hedging against inflation

Hedging against inflation is investing in assets expected to retain or increase in value over time to protect against rising prices. Hedging aims to preserve the purchasing power of money and the actual value of an investment.

There are several ways to hedge against inflation:

1. Invest in assets whose value is expected to rise over time: Stocks, real estate, and commodities such as gold and oil are examples. The idea is that as prices rise, these assets’ value will also increase, helping to offset the impact of inflation.
2. Invest in assets with a high real rate of return: These are assets with a return that exceeds the inflation rate. For example, if the inflation rate is 3% and an asset returns 5%, the real rate of return is 2% (5% – 3%).
3. Invest in inflation-protected securities: These are financial instruments whose returns are linked to the inflation rate. Treasury Inflation-Protected Securities (TIPS) are a type of bond in the United States that provides a return linked to the inflation rate.
4. Diversify your portfolio: By investing in various asset classes, you can spread your risk and potentially mitigate the impact of inflation on your portfolio.

It is critical to understand that hedging against inflation does not guarantee that an investment will retain its value. Investing involves risks, and it is vital to consider the potential risks and rewards before making any investment decisions.

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