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What Is Inflation and How It Affect Your Finances & Investments?

Inflation affects daily life—moderate levels support growth, while high inflation diminishes purchasing power. Understand its causes, effects, and management. What Is Inflation and How Is It Measured? Inflation refers to the rise in the general price level, which leads to a decrease in the purchasing power of money. It usually occurs over time, meaning that you can no longer buy as many goods or services as you could before with the same amount of money. Inflation is typically measured using several key indicators, each with its calculation method and scope. These indicators help governments, central banks, and economists formulate and adjust economic policies. They also guide businesses in forecasting future cost changes and market price trends. For consumers, inflation indicators reflect the extent of price increases in daily life, affecting purchasing power, savings returns, and investment choices. 3 Key Inflation Indicators: CPI, PPI, PCE Consumer Price Index (CPI)CPI measures changes in the prices of everyday goods and services consumers regularly purchase, such as food, housing, transportation, and healthcare.However, Core CPI, often called core inflation, excludes highly volatile items—typically food and energy. This helps policymakers avoid overreacting to short-term price fluctuations and provides a clearer view of long-term inflation trends.Application Scope: Government policies, wage adjustments, consumer purchasing power analysisRelease Schedule: The U.S. Bureau of Labor Statistics releases the previous month's data between the 10th and 15th of each month. View US CPI Producer Price Index (PPI)The PPI measures price changes at the production stage, focusing primarily on the prices of goods in industries such as manufacturing, agriculture, and mining. It can provide an early indication of rising costs for goods.Additionally, changes in the PPI often precede changes in the CPI, as businesses tend to pass on increased costs to consumers.Application Scope: Business cost forecasting, supply chain management, commodity price trendsRelease Schedule: The U.S. Bureau of Labor Statistics releases the previous month's data between the 10th and 15th of each month, usually one day before or after the CPI release. View US PPI Personal Consumption Expenditures Price Index (PCE)The PCE measures price changes for all consumer goods and services, including harder-to-measure items like healthcare and education. The PCE’s weighting adjusts dynamically based on changing consumption patterns, making it a more accurate reflection of actual changes in living costs compared to the CPI.The core PCE excludes volatile items such as food and energy, and it is the Federal Reserve’s (Fed) preferred core inflation indicator as it more accurately reflects underlying price pressures in the economy.Application Scope: Fed monetary policy, long-term inflation trend analysisRelease Schedule: The U.S. Bureau of Economic Analysis releases the previous month's data on the last Friday of each month. View US PCE Other Inflation Indicators In developing countries like India and the Philippines, the Wholesale Price Index (WPI) is an important inflation indicator, reflecting price fluctuations from the production stage to the wholesale market, particularly for raw materials and commodities. Additionally, the GDP deflator is also used to measure price changes across the entire economy, covering price fluctuations in all economic activities, including consumption, investment, and government spending. It has a broader scope than the CPI and PPI, making it more suitable for overall economic analysis. ▌Learn more: How is the GDP deflator calculated? Causes and Impacts of Inflation Inflation typically arises from an increase in the money supply, rising demand, or supply chain bottlenecks. These factors may act independently or simultaneously, affecting the economy and causing prices to rise. When inflation occurs, it can have various effects, such as reducing the purchasing power of money, raising business production costs, and even influencing investment markets and consumer behavior. Moderate inflation can support economic growth, but if inflation becomes too high or uncontrolled, it may threaten financial stability. 5 Common Types of Inflation Demand-Pull Inflation When the economy is booming, or the government increases spending or cuts interest rates to stimulate consumption, demand for goods and services becomes overheated. When total demand exceeds total supply, businesses raise prices to address the shortage. Cost-Push Inflation Supply chain disruptions, rising tariffs, or wage growth can lead to higher production costs, forcing businesses to raise prices, which drives inflation. Monetary Inflation When there is too much money in circulation and economic growth cannot keep pace, the value of money decreases, leading to widespread price increases. Simply put, when there's too much money, things get more expensive. Structural Inflation Internal structural problems within the economy, such as low industry efficiency, supply chain bottlenecks, or market monopolies, lead to an imbalance between supply and demand, causing long-term price increases. This type of inflation is complex and long-term, requiring targeted reforms by the government and cannot be solved by short-term monetary policy. Asset Inflation When large amounts of money flow into asset markets such as stocks and real estate, it drives up asset prices, indirectly influencing overall inflation. For example, in a low-interest-rate environment, investors rush into the housing market, pushing home prices up. This makes housing costs a source of inflationary pressure and exacerbates wealth inequality. Recently, U.S. President Donald Trump’s proposed tariff policies, such as imposing tariffs on steel and aluminum, are expected to directly raise the cost of raw materials for U.S. manufacturing. Tariffs on products like chips, cars, and semiconductors will also increase the manufacturing costs of tech products, potentially driving up their prices. These additional costs may be passed on to consumers, triggering cost-push inflation. Severity of Inflation Inflation can be categorized based on its severity, each reflecting different underlying causes and impacts on the economy. Mild inflation can encourage spending and investment, while galloping inflation might signal economic instability. Hyperinflation, however, can lead to a collapse of consumer confidence and require drastic economic reforms to control. Inflation Type Severity Description Inflation Rate Hyperinflation Most Severe Typically caused by fiscal crises, excessive money printing, or political instability, leading to soaring prices, currency collapse, and economic turmoil. Monthly inflation rate rate exceeds 50% Galloping Inflation Moderate Severity Often driven by surging demand, supply shortages, or government policy, resulting in rapid price hikes. Annual inflation rate of 7-20% or higher Mild Inflation Mild A healthy economic phenomenon with minimal impact, as prices rise gradually. Central banks usually target 2% inflation Inflation Expectations Can Fuel Inflation Inflation expectations refer to the anticipation among businesses, consumers, and workers that prices will rise, leading to behaviors that further accelerate inflation. For example, businesses may raise prices in advance, affecting retail sales data, while workers may demand higher wages, both of which contribute to driving prices up. For example, some U.S. manufacturers anticipated higher import costs due to President Donald Trump’s tariffs on steel and aluminum. As a result, several businesses preemptively raised prices to offset expected increases. (Reference: US factories likely to feel the pain from Trump’s steel and aluminum tariffs) Inflation’s Impact on the Economy, Businesses, and Consumers Moderate inflation stimulates consumption and investment, often reflecting healthy economic growth. However, excessive inflation reduces purchasing power, increases uncertainty, and may hinder economic expansion. For businesses, inflation raises production costs and compresses profit margins. During periods of high inflation, businesses may increase prices and wages to cope with rising costs, often passing these expenses on to consumers, which drives up the cost of living. As consumers face higher living expenses, they may reduce spending, which can hurt business sales. Meanwhile, demands for wage increases to offset inflation could further raise operating costs, creating a challenging cycle for both businesses and consumers. This resembles the inflationary pressure caused by trade policies introduced after U.S. President Donald Trump took office, which heightened market concerns over employment and supply chain issues, further dampening consumer spending and hindering retailers’ operations. ▌Learn More: Trump Expands Tariff Scope: Autos and Semiconductors in Focus amid Global Supply Chain Uncertainties How Consumers and Businesses Can Combat Inflation In times of inflation, both consumers and businesses must adopt strategies to build financial resilience and enhance competitiveness—key to weathering inflationary pressures How Can Consumers Fight Inflation? Reevaluate Budget Priorities: Focus on essential spending and cut back on discretionary expenses. Invest in Inflation-Hedging Assets: Consider real estate or gold to protect against inflation. Allocate Funds to Stocks or Treasury Inflation-Protected Securities (TIPS): Mitigate the impact of currency depreciation. Enhance Skills and Income Potential: Increase earning capacity to keep wages aligned with inflation. How Can Businesses Combat Inflation? Regularly Review and Adjust Pricing Strategies: Protect profit margins from erosion. Optimize Supply Chain Management: Explore alternative materials and suppliers, and consider stockpiling key resources. Leverage Automation and Digitization: Boost productivity and reduce reliance on inflation-sensitive resources. Invest in Inflation-Resilient Assets: Allocate capital to real estate or commodities to safeguard value. Phillips Curve: The Relationship Between Unemployment and Inflation The Phillips Curve, introduced by New Zealand economist A.W. Phillips in 1958, illustrates the inverse relationship between unemployment and inflation. By analyzing historical data in the UK, Phillips observed that when unemployment is low, inflation tends to be higher, and when unemployment is high, inflation usually declines. (The X-axis represents the unemployment rate, and the Y-axis represents the wage inflation rate, with an inverse trade-off between the two. Source: Federal Reserve Bank of St.Louis) Elaborately, during periods of economic expansion and low unemployment, companies raise wages to attract workers, which increases production costs and drives up prices. Conversely, when the economy slows down and unemployment rises, wage growth slows, reducing inflationary pressure. Mechanism of the Phillips Curve Relationship: Increased Demand → Business Expansion → Lower Unemployment → Wage Increases → Higher Production Costs → Rising Prices (Inflation) Decreased Demand → Business Contraction → Higher Unemployment → Wage Declines → Lower Production Costs → Reduced Price Pressure (Lower Inflation) (From 1978 to 1980, the U.S. Experienced High Inflation and Low Unemployment. Source: DataTrack) ▌Related Indicators United States: CPI (YoY) United States: Unemployment Rate Pros and Cons of Inflation Moderate inflation can inject vitality into the economy and promote overall healthy economic development. However, inflation acts like an invisible tax, unequally redistributing wealth and posing challenges to long-term economic stability and social harmony. Pros Cons Stimulates consumption and investment Reduces debt burden Increases asset resale value Decreases purchasing power of money Expands the wealth gap Reduces savings value Pros of Inflation Moderate inflation has a positive impact on the economy, driving consumption and investment. As people expect prices to rise in the future, they tend to make purchases or investments in advance to avoid higher costs, such as for cars, appliances, or real estate. Inflation helps reduce the debt burden, especially for borrowers with fixed-rate loans. As the value of money gradually decreases, the real burden of debt lightens, benefiting individuals with mortgages, businesses seeking financing, and even government debt. Additionally, in an inflationary environment, the resale value of assets typically increases. For example, real estate usually appreciates with rising prices, creating wealth-building opportunities for asset holders and encouraging more capital investment in the market. Cons of Inflation The most direct effect of inflation is the continued decline in purchasing power, meaning that the same amount of money can buy fewer goods and services, increasing the real cost of living for consumers. More concerning is that inflation tends to exacerbate wealth inequality. The wealthier classes typically hold more tangible assets, such as real estate, stocks, and art, which increase in value during inflation, thus safeguarding or even growing their wealth. Lower-income households, on the other hand, are less likely to benefit from asset appreciation and are more vulnerable to price increases, which widens the wealth gap. Inflation also erodes the value of savings. When the inflation rate exceeds interest rates on deposits, the real value of bank savings shrinks year by year, making plans for retirement, education, or homeownership more difficult. Historical Hyperinflation Crises Hyperinflation is typically triggered by excessive money printing, misguided economic policies, wars, or recessions. Governments, in an attempt to cover spending or fill budget deficits, print excessive amounts of money, leading to an oversupply of currency and rising prices. International sanctions and trade restrictions can also exacerbate the situation, driving prices even higher, eventually resulting in currency collapse and loss of public confidence in the money. Here are several notable hyperinflation cases that illustrate how these factors have led to severe economic crises in different countries. Weimar Republic: Excessive Money Printing Led to Collapse (1921-1924) After World War I, Germany faced massive war reparations and the pressure of economic reconstruction, prompting the government to begin printing large amounts of money. By the peak in 1923, prices were doubling almost every hour. People used wheelbarrows filled with cash to buy basic items, and the price of a cup of coffee could increase before you even finished drinking it. In some cases, people even used banknotes as fuel. Eventually, USD 1 equaled 4.2 trillion Marks. This economic disaster wiped out the savings of the middle class and created the conditions for Hitler's rise to power. (In 1923, during Germany's hyperinflation, children played with worthless coins. Source: Flickr / dalecourtarts) Zimbabwe: Policy Mistakes + Supply Chain Collapse (2000s) Due to the Zimbabwean government's forcible land seizures, agricultural production declined, and excessive printing of money to cover government expenditures led to an oversupply of currency. Additionally, international sanctions restricted trade and foreign investment, worsening the economic situation. This ultimately resulted in extreme inflation in 2008, causing the currency to completely collapse. The government continuously issued higher denomination banknotes, even printing bills with values as high as 100 trillion. People had to carry bags of cash to buy basic goods, and many stores adjusted prices every hour. By 2009, the government was forced to abandon its currency and switch to using the U.S. dollar, South African rand, and other foreign currencies for circulation. (Zimbabwe's government issued banknotes with denominations as high as 100 trillion Zimbabwean dollars. Source: Flickr / CashInfo.org) Venezuela: Oil Dependence & Policy Failures (2010s to Present) Venezuela was once the wealthiest oil-producing country in South America, heavily reliant on oil export revenues. However, after the decline in oil prices in the early 2010s, government revenue significantly decreased. Coupled with improper economic policies, this led to an expanding fiscal deficit and a sharp deterioration in inflation. Since 2016, inflation has worsened, people's savings have evaporated, and basic goods have become scarce, triggering a massive wave of migration. In 2017, the U.S. increased sanctions on its oil and financial sectors, worsening the economy. It wasn't until 2023 that the sanctions on Venezuela's oil were relaxed, allowing the country to resume oil exports. However, high inflation continues to make life difficult for the population, with the economic recovery remaining slow and the future filled with uncertainty. (Venezuelan citizens risk their lives traveling to Colombia in search of help. Source: Flickr / prmpress) Inflation vs. Deflation vs. Stagflation For policymakers, moderate inflation is typically the preferred choice. Deflation is seen as more difficult to manage, while stagflation is the most challenging economic dilemma, often requiring structural reforms rather than simply monetary policy to resolve. Comparison Item Inflation Deflation Stagflation Definition Prices rise, money loses value Prices fall, money gains value Prices rise and economy stagnates Causes Too much money, higher demand, rising costs Lack of demand Supply shocks, policy errors Impact Promotes growth, but excessive inflation can lead to hyperinflation Suppresses investment and consumption, potentially leading to recession Hard to manage, requires balancing both Risks Wealth depreciation, lower buying power Economic stagnation, rising unemployment Rising prices and unemployment together Unemployment Rate Low High High Policy Response Tighten money supply Ease money supply Tackle both inflation and stagnation Examples Common Japan's "lost three decades" 1970s Oil Crisis View Japan Core CPI Inflation is a key economic phenomenon that affects everything from national policies to everyday life. Moderate inflation can drive economic growth by stimulating consumption and investment. However, when inflation spirals out of control, it leads to declining purchasing power, rising business operating costs, and increased financial stress for households. Understanding the causes and impacts of inflation, as well as adjusting financial strategies accordingly, is essential for the long-term stability of individuals, businesses, and the broader economy. Track Key Inflation Indicators ▶ Read More How to Calculate CPI and Inflation Rate? 5 Key Formulas US Inflation Barometer: Why Inflation Expectations Matter?