Inflation measures price increases over a certain period of time, which is usually one month. When prices increase, consumers lose their purchasing power. For example, if the price of a dozen eggs was $3 last year and $4 this year, consumers are paying more for the same product. This example represents a 33% inflation rate.
Although the historical average annual inflation rate is much lower than this, certain products and services have experienced rapid inflation. Economic and social circumstances commonly impact inflation. For example, the recent pandemic caused inflation to spike to 8% in 2022 in the United States.
Furthermore, the opposite of inflation is deflation, meaning goods and services are becoming less expensive. Deflation is common after periods of high inflation. It’s important to remember that the inflation rate is not a rolling average. In the aggregate, between 2022 and 2023, the total inflation rate was 11.4%.
Inflation has a broad impact on the economy and consumers. Let’s explore some of these impacts in more detail.
Inflation increases the cost of spending programs and guides monetary policy. For example, if price changes in groceries skyrocket, the government may need to increase the budget for food stamps and grocery aid programs. Similarly, interest rates and inflation rates are inversely related. As inflation rises, interest rates decline. Inflation also impacts gross domestic product numbers, which also impacts monetary policy.
One of the biggest impacts of inflation rates is on consumer prices. Energy costs, groceries, transportation, and housing are all impacted by inflation. For example, if the annual inflation rate is high, the average cost of living also increases. It becomes more expensive to buy groceries and pay the heat bill, especially if wages aren’t rising alongside inflation.
Inflation also has a direct impact on a country’s money supply. When the money supply is too high, the value of a country’s currency decreases, which means purchasing power drops and inflation increases. As a result, the government closely monitors the money supply to ensure a favorable balance between the amount of money in circulation and inflation rates.
Inflation also erodes investment gains. Let’s say that a stock you hold increases 5%. If inflation is 6% for that same year, you didn’t make any money. In fact, your investment lost 1% of its value.
Inflation and climate change are also related. When there are higher temperatures, the risk of crop failure increases. If crop failure does occur, the supply of certain items becomes scarcer, resulting in higher prices. To combat some of the impacts of climate change on inflation, The Inflation Reduction Act of 2022 was passed to lower greenhouse gas emissions.
Since inflation plays a powerful role in regulating economic activity and price levels, there are a few different indexes used to track changes. Remember, these indexes are specific to the United States. Each country will have its own way of tracking inflation. Let’s explore a few of the popular ones.
The Consumer Price Index (CPI) is one of the most popular indexes used to track inflation. This index takes a basket of goods and services and analyzes the changes. For example, some of the categories tracked include groceries, energy costs, transportation, healthcare, personal care, and housing. Within each of these categories, specific goods and services are measured. In the grocery category, a gallon of milk or a dozen eggs might be used to monitor inflation.
The Producer Price Index (PPI) measures many of the same aspects as the Consumer Price Index; however, it looks at price changes from the producer side. Instead of the final costs seen at grocery stores and energy bills, the PPI looks at how much the price level changes for producers. Let’s say it costs a producer $2 to produce a dozen eggs. If this cost increases to $2.50, the price level will change, which will eventually impact consumers.
The Personal Consumption Expenditure Index tracks changes in consumer spending. For example, if consumers are no longer buying luxury goods, like high-end steak, it can indicate that the annual rate of inflation is increasing and households are cutting back. Price stability and spending consistency in the Personal Consumption Expenditure Index means inflation is stable.
The formula for calculating inflation is relatively straightforward when it comes to price evaluations of one good or service. Here’s the formula for calculating inflation:
Inflation = (Current Price – Prior Price) / Prior Price x 100
Let’s say you want to measure the price of a gallon of milk. Last year, the milk was $3. After visiting the grocery store today, the price of milk is now $3.50. To calculate the inflation rate, you would subtract $3 from $3.50 to get a price change of $0.50. Then, the prior price of $3 is divided from $0.50 to get 0.167. Multiplying this by 100 gives us an inflation percentage of 16.7%.
Inflation for a certain basket of goods or services can also be measured by using information from the Consumer Price Index. The formula for calculating the percent inflation rate between periods is as follows:
Percent Inflation Rate = (Final CPI Index Value / Initial CPI Value) x 100
Let’s go through an example. You want to see how the purchasing power of milk has changed over the past decade. You go back into the historical information of the CPI and find the initial value of 25.1 and the final value of 75.2. Dividing these numbers by each other results in a value of 2.996. Multiplying this number by 100 tells you that the value of milk has changed 299.6% over the past ten years.
Summary
Vendor management is the act of ensuring that your third-party vendors meet regulatory requirements and contractual obligations. This safeguards your business from …
Multi-factor authentication (MFA) is a security method that requires users to prove their identity using two or more distinct factors before accessing …
Imposter scams are a type of fraud where scammers pretend to be trusted individuals, companies, or government agencies to deceive victims into …
End-to-end B2B payment protection software to mitigate the risk of payment error, fraud and cyber-crime.
