How Does Inflation Affect The Economy

By Max. D Gray. Updated: June 5, 2018
How Does Inflation Affect The Economy

When you listen to news about the economy it can be difficult to understand some of the key terms used and what they actually mean in terms of their impact upon the economy. One of the factors which affects the economy and is often discussed is the current rate of inflation and its impact on the economy.

In simple terms, inflation simply means an increase in the price of goods and services, but what does this look like in reality and how does inflation affect the economy? If you want to know the answer to this question and understand more about the effects of inflation then keep reading this OneHowTo article where we explain the impact of inflation in more detail.

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What is Inflation?

Inflation is a term used to describe the increase of prices in goods and services over time, or to put it another way, the devaluation of a currency. The rate of inflation of a currency is normally measured using a Consumer Price Index (CPI) which tracks the changing cost of everyday items such as milk and bread, and can be used to estimate the cost of living.

Inflation can be due to various factors, for example macroeconomic conditions in a country, the price of basic commodities such as oil affecting costs of others goods and services, and a myriad of other factors which make up a modern economy.

How Does Inflation Affect The Economy - What is Inflation?

How Does The Inflation Rate Affect The Economy?

The next question is, what effects does inflation have on economic growth and stability? It sounds like a simple enough question, but the answer is not so easy. It really depends on the rate of inflation (which also affects interest rates) and how it compares to the Gross Domestic Product. It should also be mentioned that there is no consensus on the ideal rate of inflation or even the effects of different rates of inflation among economists.

For example, if inflation rate is low (close to 0%), this can theoretically help to boost an economy, as it means the cost of borrowing money will be lower so businesses and individuals will be more likely to make significant purchases and investments because borrowing the money to do so is cheaper. Conversely however, interest rates that are too low can also discourage banks from lending money and investors from investing because the rate of return is too low.

If inflation rates are too high, at say 10% or more, this will decrease purchasing power, meaning people have proportionally less income available to spend on goods and services. The obvious effect of this is that people buy less which has a knock on effect in "slowing down" the economy. Businesses will also be less able to plan pricing and investment strategies and will incur higher costs. As a currency becomes less valued, so too will savings and debts be devalued.

To summarize then, different rates of inflation have different effects, some good and some bad. Combine this with how hard it is to measure the exact rate of inflation, and you can see why there are so many different perspectives on the question of what is the ideal rate of inflation.

How Does Inflation Affect The Economy - How Does The Inflation Rate Affect The Economy?

What Is The Best rate of Inflation?

Modern economies are incredibly complex and national economies are still becoming increasingly part of an international, global economy. With all the variables involved, to define a universal, ideal rate of inflation would be very difficult if not impossible.

However, the closest thing to a consensus currently in existence is that some slight inflation is good and that zero inflation is bad. This is because a moderate rate of inflation (3%-6%) can help to encourage investment and therefore promote employment and growth.

If you want to read similar articles to How Does Inflation Affect The Economy, we recommend you visit our Economy & business category.

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