Why does inflation occur
Technically inflation is, in pure dictionary definition terms, an overall or specific rise in the cost of services and/or goods. Effectively then, in relation to everyday life, it basically means that the price you pay for a certain thing now will have changed from what that thing would have cost you in the past. Inflation in the US has generally been reasonably steady despite a few high inflation periods. Generally speaking, however, inflation levels remained at around 3% over periods of some three decades and provide a constant regular increase in costs. By contrast, during the same periods of time some countries have seen their levels of inflation top 1000% in the course of a single year.
There are a number of factors that can lead to fluctuations in the level of inflation. First, an increase in government levels of taxation and fees can result in inflation – and this is particularly the case if businesses are taxed. At this point when the costs incurred by doing business rise this has a trickle down effect that pushes the prices of the goods and services business offer up. The further trickle down effect of this is that the price increases inevitably mean that people’s incomes effectively drop as their expenditure rise to cover the higher price costs from businesses. At this point people are squeezed and hope for new, better-paying jobs or pay rises. If this occurs the effect is that business costs rise still further (to cover the cost of higher salaries) which contributes even further to higher prices, and right on and on as the cycle continues round and round. It is the passing on of these extra costs of doing business to customers that we refer to a “inflation”.
Scarcity of product in relation to demand can also result in price inflation. For example, take the case of a hypothetic children’s toy at Christmas that ties in with the latest animated blockbuster. Once the hit film stokes demand for the toy – especially during the Christmas peak buying periods – the item inevitably becomes scarce and more and more people want the toy. At this point the price will rise exponentially, another prime example of inflation. Also, as in the mad cow epidemic in the UK of a decade or so ago when an industry destroys a large amount of its stock resulting in less stock on the market the price of that commodity is certain to rise.
Inflation can also result as a trickle down effect of a rise in interest rates as well. The reason for this is that if the cost of borrowing rises it means that the cost of conducting business has also risen also which, as we saw earlier, will push prices of products and services up. On the bright side, inflation is usually a sign that an economy is growing, so all is not particularly negative. Controlled inflation has acted as the key to managing a successful economy for countries for decades and, if possible, deflation may even occur. While this is rare is may actually occur and push the currency’s value up even further, particularly if the currency is traded on the world foreign exchange market, thus helping international business deals in general.