Inflation

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. 

The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which are the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar can't buy the same goods it could beforehand.

So, Inflation can mean either an increase in the money supply or an increase in price levels. Generally, when we hear about inflation, we are hearing about a rise in prices compared to some benchmark.

Causes of Inflation

two theories are generally accepted for inflation.

Demand-Pull Inflation – This theory can be summarized as “too much money chasing too few goods”. In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.
Cost-Push Inflation – When companies’ costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

There are two main price indexes that measure inflation:

·         Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser.

·         Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.

General Inflation Rate (Household Income and Expenditure Survey (HIES)

Bangladesh Bureau of Statistics (BBS) computes National Consumer Price Index (CPI) of national general inflation by the consumers in their day-to-day life. The CPI has been constructed using 1995-96 as the base year. Later the government made financial year 2005-06 a new base year in the year 2012 after the previous base year of 1995-96 base year. (now planning-15-16). In order to construct the price index, the commodity and weight of the index basket from the Household Income and Expenditure Survey (HIES),  are used. All rural and urban price indices were compiled using the lists of consumer goods of rural and urban households based on the survey. And finally, the national price index has been computed by taking into account the weighted average of consumption expenditures of the two areas. All indices are shown separately in food and non-food groups which are again divided into a number of sub groups.

Non Food Inflation Rate

Rural and urban price indices were compiled using the lists of consumer goods of rural and urban households based on the survey. And finally, the national price index has been computed by taking into account the weighted average of consumption expenditures of the two areas. All indices are shown separately in food and non-food groups which are again divided into a number of sub groups.

Here is a brief account of the typical winners and losers from inflation:

·         Creditors (lenders) lose and debtors (borrowers) gain under inflation. For example, suppose a bank issues you a 30-year mortgage to buy a house at a fixed interest rate of 5% per year, costing $1,000 per month. As inflation rises, the “cost” of that $1,000 per month decreases, which benefits the homeowner, especially if the rate of inflation exceeds the interest rate on the loan.

·         Inflation hurts savers since a dollar saved will be worth less in the future. Unless the money is saved in an account that pays an interest rate at or above the rate of inflation, the purchasing power of savings will erode. This phenomenon is sometimes called "cash-drag."

·         Workers with fixed salaries or contracts that do not adjust with inflation will be hurt as the buying power of their incomes stay the same relative to rising prices. Similarly, people living off a fixed-income, such as those below the poverty line, retirees or annuitants, see a decline in their purchasing power and, consequently, their standard of living.

• Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.
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• ·         If the domestic inflation rate is greater than that of other countries, domestic products become less competitive.

Some points to remember:

·      Inflation is a sustained increase in the general level of prices for goods and services.

·      When inflation goes up, there is a decline in the purchasing power of money.

·      Variations on inflation include deflation, hyperinflation and stagflation.

·      Two theories as to the cause of inflation are demand-pull inflation and cost-push inflation.

·      When there is unanticipated inflation, creditors lose, people on a fixed-income lose,

·      Lack of inflation (or deflation) is not necessarily a good thing.

·      Inflation is measured with a price index.

·      The two main groups of price indexes that measure inflation are the Consumer Price Index and the Producer Price Indexes.

·      Interest rates are decided in the U.S. by the Federal Reserve. Inflation plays a large role in the Fed’s decisions regarding interest rates.

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·      Inflation is a serious problem for fixed income investors. It’s important to understand the difference between nominal interest rates and real interest rates.