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Inflation is defined as a sustained increase in general level of prices for goods and services. It is usually measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller quantity of goods or services. The values of a dollar do not stay constant when there is inflation. The value of a dollar is always 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 purchasing power of money. For example, if the inflation rate is 2% per year, then theoretically a $1 pack of gums will cost about $1.05 in a year. After the inflation, your dollar cannot be used in buying the same goods it could beforehand.
Anticipated and unanticipated inflation
Inflation affects different individuals in different ways. It also depends on whether the inflation is anticipated or unanticipated. Anticipated inflation arises when people and businesses can be able to make accurate predictions of inflation, they can take steps to protect themselves from its associated effects. Unanticipated inflation occurs when the economic agents such as people, businesses and governments make errors in their inflation predictions.
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When the inflation is perfectly anticipated, it can be taken into account in the various economic transactions. In a situation where the inflation rate is known, all the contracts would build in the expected inflation. The loans, labor contracts, and tax brackets would be able to take the inflation into an account, because it is known. In this case, the inflation has no real costs. The savings accounts, insurance etc. have their purchase power being transferred to those who issue those financial assets. Unanticipated inflation also moves the public into higher tax brackets and this raises the real value of tax payments and thus decreases the real disposable income. The unanticipated inflation has some negative repercussions through the redistribution of wealth which is why it's necessary to understand the inflation rate and its causes.
What role expectation plays on inflation and Central Banks policies?
Inflation expectations play a critical role in the monetary policy process. Central banks regularly monitor and analyze information regarding inflation expectations, as reflected in the financial markets. The inflation expectations receive much attention at central banks because the policymakers at central banks in many other nations have long recognized that the monetary policies can be more successful when inflation expectations are well anchored. Given the existence of a very substantial monetary policy lag, it makes sense for policy decisions to be based on the expected future conditions. Also, the inflation forecasts may be useful in policy deliberations and decisions, because they summarize a wide variety of information that is related to the past and anticipated economic developments. The monitoring and responding to the public's inflation expectations, in addition to the monitoring the evolution of the actual inflation, leads to the improved policy outcomes. Accordingly, the inflation expectations are embodied in state-of-the-art macroeconomic forecasting models used by central banks and other economic think tanks. The well-anchored low inflation expectations are widely regarded as an important indicator of the central bank's credibility regarding its price stability commitment.
Why money is the main cause inflation?
The aggregate production possibilities, consumer preferences (willingness to work and save), and government policies combines to influence the values of output, employment, and the rate of interest. All of these variables were real: the relevant wage rate is the ratio of the wage measured in money to the price of goods measured in money and the relevant interest rate measured the rate of return are adjusted for changes in the purchasing power of money. Inflation can happen when governments print an excess of money to deal with a crisis. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. This is called the demand-pull, in which prices are forced upwards because of a high demand.
Also inflation comes as a result of the rise in the production costs, which leads to an increase in the price of the final product. For example, if the price of raw materials increases, it leads to the cost of production increasing, which in turn leads to the company increasing the prices to maintain steady profits. Inflation can also be caused by international money lending and national debts. As nations borrow money, they have to deal with the associated interests, which in the end cause prices to rise as a way of keeping up with the debts.
Discuss the relationship between inflation and interest rate. Does an international relationship exist, yes no HOW?
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Whenever we hear the latest inflation update on the news, chances are high that the interest rates are mentioned in the same breath. In the United States, interest rates are decided by the Federal Reserve which holds meetings eight times a year to set short-term interest rate targets. During these meetings, the consumer price index and producer price index are significant factors in the Federal Reserve's decision. The interest rates directly affect the credit market because higher interest rates make the borrowing more costly. By changing interest rates, the Federal Reserve tries to achieve the maximum employment, stable prices and good level growth. As the interest rates drop, the consumer spending increases and this in turn stimulates the economic growth. Contrary to the belief that excessive economic growth can in fact be very detrimental. The international relations do not exist because the most researches in the U.S shows that the majority of the investigations for other nations or countries find a coefficient on anticipated inflation below unity. This indicates that in some situations the nominal interest rates do not adjust sufficiently to maintain the expected the after tax rates in the face of anticipated inflation.
Going through this paper, we obtain some insight into inflation and its effects and like many other things in life, the impact of inflation depends on our personal situation. The following inflation aspects should be always remembered.
i. Inflation is a sustained increase in the general level of prices for goods and services in the economy.
ii. When inflation goes up, there is always decline in the purchasing power of the money.
iii. When there is an unanticipated inflation, creditors lose, people on a fixed-income lose and uncertainty reduces spending.
iv. Lack of inflation is not necessarily a desirable thing.
v. Inflation is measured with a price index.