Question

What are some of your current concerns about inflation? What actions should be taken to minimize your concerns? The term inflation has been loosely thrown around for years. Economists clarify what kind of inflation they are talking about - at least the accomplished economists do this. So for us here in class, let's use these terms to make sure we are all talking about the same thing: Price Inflation - the general increases in overall prices in the economy. This is usually measured by use of the GDP Deflator or the Consumer Price Index. Monetary Inflation - the increase in the money supply. This is done through the Federal Reserve's Open Market Committee, or through bank lending (fractional reserve lending). When talking about "inflation" for this question, please use these terms.

Answer 1

Inflation can be described as a prolonged increase in domestic prices of an economy. It can be inferred as a decline in the purchasing capacity of a commodity that is, as the prices increase, the commodity becomes less affordable given a defined nominal income of an individual.

Inflation is an injury to an economy. It causes the aggregate level of demand to fall along with a fall in the productive capacity of the economy.

It is a cause of concern for the financial markets as well. The persistent increase in prices makes the value of money as a currency to decline, making it difficult for the borrowers to repay the amount borrowed.

Inflation also damages the trade balance and the wage structure in markets. An increase in domestic prices makes the domestic goods less competitive against the world commodities. As a resul, the world demand for domestic goods fall, causing the trade balance to decline as well as a fall in the wages of workers in the domestic country due to low demand for their work.

Controlling inflation becomes an important issue to be dealt with in an economy as a result of the injury it causes to economic growth. Inflation can be controlled by using a contractionary monetary policy. A decline in the nominal money supply causes an increase in domestic interest rates.

Also, the bond prices fall and eventually the general price level declines due to reduced spending by individuals. This is the result of less money in circulation which causes people to save money instead of spending it. As the interest rates increase, borrowing becomess costlier and thus, the demand for funds falls leading to a fall in general price levels.