The Effects of Inflation - Research Paper Example

There are different economic variables that affect the lives of people. One of those variables is inflation. Inflation can be defined as a persistent substantial rise in the general levels of prices (Dictionary). The reason inflation is so influential is because inflation affects the purchasing power of money. For example, if a person is able to purchase $1 of goods today and a year later the national inflation rate is 10% that person would only be able to purchase 90% of the goods a year later with a $1.

The effect of inflation is that it makes your money be worth less. Inflation affects poor people because this group of individuals has limited resources. Inflation affects the consumer markets as well as the money markets. The money market is where the government sells treasury stocks and bonds and where corporations sell corporate bonds. The interest rate influences the money markets because when interest goes up companies are forced to offer higher bond coupon rates in order to attract investors.

The bonds of corporations are rated by agencies such as Moody’s. Take for example a company that sells bonds. The company is offering bonds that pay 8%. The inflation rate of the nation is 5%. The investor gets a net return of 3% after deducting inflation from the coupon rate. Suddenly the interest rate of the nation goes up to 9%. Based on those circumstances the corporation cannot sell bonds at 8% because nobody would buy them since the bonds have a net loss of 1% after inflation is deducted.

The inflation rate in a country affects the amount of interest that people earn in their savings and checking accounts. When inflation goes up banks are forced to pay higher interest rates to provide value to their customers. Different age demographics are affected more than others by inflation. The elderly are affected a lot by inflation. The reason that the elderly get hurt more than others is that most pension funds pay fixed payments. If a person gets $600 for the rest of their life as time passes that pension becomes less valuable because inflation is deducing the buying power of the $600.

The federal government realizes the impact inflation has on the elderly and in their social security system there is a safeguard protocol that protects the beneficiaries. The payments of social security are adjusted each year to offset the effects of inflation. Another reason the elderly are affected a lot by inflation is that the elderly spend a lot of money on medical expenses. The inflation rate in the medical field is approximately 10%. The inflation varies by goods and industries. When inflation occurs in food prices the lower class is affected the most because poor people have limited income to pay for their food necessities.

The amount of inflation in an economy depends on the country. In the United States, the inflation rate as of February 2011 was 2.1% (Trading Economics). Historically the United States has always had a low inflation rate. There are parts of countries in this world that have been completely destabilized by the effects of inflation. A phenomenon in economics known as hyperinflation can destroy an economic system. Hyperinflation can be defined as extreme or excessive inflation. A country that is currently going through a hyperinflation crisis is Zimbabwe.

Two other countries that have suffered through hyperinflation in the past are Argentina and Russia. In the past, the cost of living was much lower. We have heard stories of how our grandparents used to pay a few pennies for a can of Coke or a pound of bread. Through the passage of time, things have gotten much more expensive. Despite lower wages, our ancestors had great wealth because they could buy more goods and services with less money. During those years owning land and homes was more accessible because prices were much lower.

When inflation goes up in the United States the Federal Reserve can take measures to control inflation. This is called monetary policy. The current chairman of the FED is Ben Bernanke. Inflation is an economic variable that affects the lives of everyone. When inflation is low people enjoy a better standard of living in the long run because their money is not getting diluted due to inflation. In the United States inflation is currently low at around 2%. When inflation is low it is a good time to borrow money from banking institutions.

People should invest money in the equity and money markets in order to offset the effects of inflation. The interest paid by banks is simply too low to offset inflation.