Major Issues in Inflation - Essay Example

Inflation Inflation is defined as the rise of the level prices of goods and services in a given economy over a certain period of time. In the event of an inflation or the rise of prices of goods and services in a given economy, the purchasing power of a given currency is diminished to the effect that it will now require more units of money for the same goods and services purchased or the number of goods and services purchased with the same amount of money is reduced. In effect, inflation is the loss or the diminishing of value of money in a given economy (Blanchard 45). In plain language, inflation is the instance where goods and services get expensive or the phenomena where people complain that the price of commodities is rising. Concretely, if one unit of bread costs $1 before and it now costs $2 for the same unit of bread, the increase in price can be attributed to inflaction. Inflation is typically measured by comparing the annual change in Consumer Price Index (CPI) or the basket of goods that people normally buy over time. The effect of inflation can either be good or bad. Inflation has the effect of decreasing the net value of money because of the rise of the price of commodities. For example, the $1,000 savings this year may only have the purchasing power of $900 next year due to rising prices caused by inflation. This is not good for investors and consumers alike. For investors, this meant that the inputs for production will increase substantially over a short period of time and this could make the business uncompetitive because it has to pass the increase of the price of its inputs to its selling price making it more expensive than its competitors. For the consumers, it makes their lives difficult because their money cannot buy much goods and services and in extreme cases, excessive inflation, such as the case of hyperinflation can drive consumers to hoard goods to shielf themselves from excessive increase of prices causing shortage of goods. Inflation is generally caused by several factors. In the case of hyperinflation, it is typically caused by too much circulation of money or excessive money supply (Barro and Grilli 139). This meant that more money are printed and circulated for the same amount of goods and services that it now requires more money to buy the same goods and services. The classic example for this is the phenomena of the Mickey Mouse money in the Philippines during the Japanese occupation whereby the Japanese government issued Japanese peso in excess. The amount of money that was circulated was just too much that the currency was Mickey Mouse Money or play money because it became worthless that buying a mere loaf of bread requires a bag or case of money (Dijamco). Another common factor of inflation is the change either in demand or supply of goods and services. A sudden increase in demand of a certain goods or services can drive the price up given the same unit of supply (law of supply and demand, prices go up when demand goes up). In the same vein, a contraction in supply can also result in inflation or the increase in price of commodities. The classic example for this is the decision of Organizationof Petroleum Exporting Countries (OPEC) to increase oil price in October of 1973 where the the increase of the world price of oil shot up as much as much as five times and backed by a selective embargo which was directed against the industrialized countries, Latin America and developing countries (Street, 1978). OPEC’s decision to increase the price of oil contributed to the recession of the US economy in 1974 to 1975. Another common cause of inflation is the excessive growth of money supply compared to rate of real economic growth (Mundell 280-283). For example, if an economy only produces an amount of goods services to $100 a year and yet it continues to print and circulate money to the amount of $150, it will naturally cause prices to go up because there are too much money circulating in the economy. Inflation however can also be good when its increased is low and predictable. Inflation can reduce the ill effect of recessions such as what happened during the 2008-2010 financial crisis where the government intervened by putting in more money in the circulation either by easing interest rates, bail out or pump priming the economy. Inflation also also prevents liquidity trap or the phenomena where government intervention to stimulate the economy through its monetary and fiscal policy no longer works. Thus, economies and their governments always desired to have a low and predictable level of inflation. According to Marta Campillo and Jeffrey Mrion, best way to have a manageable inflation is not through institutional arrangements or the use of fiscal policy or monetary tools of Central Banks but rather by economic fundamentals, such as openness, political stability, and tax policy” (356). Different countries have different inflation rates. Some have negative inflation rates while others have double digit inflation rates. Among the economies in the world that have lowest inflation rates are San Marino with negative inflation rate of -1.5 percent, Northern Mariana Islands with a negative inflation rate of -0.8 percent. Burkina Faso has an inflation rate of -0.2 percent which means that the prices of goods and services there actually decrease as time goes by (visualeconomics). There are also countries that has almost no change price such as Japan and Niger which has a mere 0.1 percent inflation rate. United States on the other hand is in the median with an inflation rate of 2.9 percent. There are also countries which as a staggering inflation rates due to its political and social upheavals. For example, Zimbabwe has a staggering inflation rate of 12,563 percent. Other countries also have high inflation rates but not as high as Zimbabwe such as Burma which has an inflation rate of 35 percent, Guinea with an inflation rate of 23.4 percent, Venezuela has an inflation rate of 18.7 percent while Sao Tome and Principe has an inflation rate of 18 percent (visual economics). Works Cited Blanchard, Olivier (2000). Macroeconomics (2nd ed.). Englewood Cliffs, N.J: Prentice Hall. ISBN 0-13-013306-X Robert Barro and Vittorio Grilli , “European Macroeconomics”. Macmillan, ISBN 0-333-57764-7 Dijamco, Kathleen. "Mickey Mouse Money: During the Japanese Occupation of World War II an Egg Roll Cost 300 Pesos."The Filipino Express: 17. Feb 26 1995. ProQuest. Web. 9 May 2013 . Marta Campillo and Jeffrey A. Miron. "Inflation and Real Interest” Reducing Inflation: Motivation and Strategy”. University of Chicago Press. Retrieved from http://www.nber.org/chapters/c8889.pdf Mundell, James, Journal of Political Economy, LXXI (1963), 280–83 Street, James H. LATIN AMERICAN ADJUSTMENTS TO THE OPEC CRISIS AND THE WORLD RECESSION.By: Social Science Quarterly (University of Texas Press). Vol. 59 Issue 1, p60-76, 17. 1978 Read More