What kind of inflation might be described

As economic growth picks up, inflation generally increases. Raising short-term rates has the opposite effect: it discourages borrowing, decreases the money supply , dampens economic activity and subdues inflation. Management of the money supply by central banks in their home regions is known as monetary policy. Raising and lowering interest rates is the most common way of implementing monetary policy. Banks must hold a percentage of their deposits with the central bank or as cash on hand. A government at times will attempt to fight inflation through fiscal policy.

Although not all economists agree on the efficacy of fiscal policy, the government can attempt to fight inflation by raising taxes or reducing spending, thereby putting a damper on economic activity; conversely, it can combat deflation with tax cuts and increased spending designed to stimulate economic activity. Most investors aim to increase their long-term purchasing power. Inflation puts this goal at risk because investment returns must first keep up with the rate of inflation in order to increase real purchasing power.

If investors do not protect their portfolios, inflation can be harmful to fixed income returns, in particular. Many investors buy fixed income securities because they want a stable income stream, which comes in the form of interest, or coupon, payments.

However, because the rate of interest, or coupon, on most fixed income securities remains the same until maturity, the purchasing power of the interest payments declines as inflation rises. In much the same way, rising inflation erodes the value of the principal on fixed income securities. Unlike bonds, some assets rise in price as inflation rises. Price rises can sometimes offset the negative impact of inflation:.

To combat the negative impact of inflation, returns on some types of fixed income securities are linked to changes in inflation:.

Through its monetary policy tools, the Fed works to encourage full employment and stabilize prices. Please note that the following contains the opinions of the manager as of the date noted and may not have been updated to reflect real time market developments.

All opinions are subject to change without notice. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk.

Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.

Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be appropriate for all investors. Department of Labor Statistics.

There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. It measures inflation across the basket of goods purchased by households, and is computed by taking the difference between current dollar PCE and chained dollar PCE.

The Harmonised Indices of Consumer Prices HICP is an economic indicator that measures the changes over time in the prices of consumer goods and services acquired by households. The HICP gives a comparable measure of inflation in the euro-zone, the EU, the European Economic Area and for other countries including accession and candidate countries.

A moderate amount of inflation is generally considered to be a sign of a healthy economy, because as the economy grows, demand for stuff increases. This increase in demand pushes prices a little higher as suppliers try to create more of the things that consumers and businesses want to buy. Workers benefit because this economic growth drives an increase in demand for labor, and as a result, wages usually increase.

Very low inflation usually signals demand for goods and services is lower than it should be, and this tends to slow economic growth and depress wages. This low demand can even lead to a recession with increases in unemployment — as we saw a decade ago during the Great Recession. Deflation , or falling prices, is particularly bad. When prices are decreasing, consumers will delay purchases.

For example, why buy a new washing machine today if you could wait a few months to get it cheaper? Deflation also discourages lending because it leads to lower interest rates. Too much inflation can cause the same problems as low inflation. If left unchecked, inflation could spike, which would likely cause the economy to slow down quickly and unemployment to increase. Cutting interest rates now should boost the U.

Changes in the CPI are used to assess price changes associated with the cost of living , making it one of the most frequently used statistics for identifying periods of inflation or deflation.

In the U. The Consumer Price Index has been revised six times. The WPI is another popular measure of inflation, which measures and tracks the changes in the price of goods in the stages before the retail level. While WPI items vary from one country to other, they mostly include items at the producer or wholesale level. For example, it includes cotton prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing.

Although many countries and organizations use WPI, many other countries, including the U. The producer price index is a family of indexes that measures the average change in selling prices received by domestic producers of intermediate goods and services over time.

The PPI measures price changes from the perspective of the seller and differs from the CPI which measures price changes from the perspective of the buyer. In all such variants, it is possible that the rise in the price of one component say oil cancels out the price decline in another say wheat to a certain extent. Overall, each index represents the average weighted price change for the given constituents which may apply at the overall economy, sector, or commodity level.

The above-mentioned variants of price indexes can be used to calculate the value of inflation between two particular months or years. While a lot of ready-made inflation calculators are already available on various financial portals and websites, it is always better to be aware of the underlying methodology to ensure accuracy with a clear understanding of the calculations. One can find price index data on various portals in a tabular form.

From that table, pick up the corresponding CPI figures for the given two months. For September , it was Plugging in the formula yields:. Inflation can be construed as either a good or a bad thing, depending upon which side one takes, and how rapidly the change occurs. For example, individuals with tangible assets that are priced in currency, like property or stocked commodities, may like to see some inflation as that raises the price of their assets, which they can sell at a higher rate.

However, the buyers of such assets may not be happy with inflation, as they will be required to shell out more money. Inflation-indexed bonds are another popular option for investors to profit from inflation.

On the other hand, people holding assets denominated in currency, such as cash or bonds, may also not like inflation, as it erodes the real value of their holdings. Investors looking to protect their portfolios from inflation should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts REITs.

Inflation promotes speculation, both by businesses in risky projects and by individuals in stocks of companies, as they expect better returns than inflation. An optimum level of inflation is often promoted to encourage spending to a certain extent instead of saving. If the purchasing power of money falls over time, then there may be a greater incentive to spend now instead of saving and spending later.

It may increase spending, which may boost economic activities in a country. A balanced approach is thought to keep the inflation value in an optimum and desirable range. High and variable rates of inflation can impose major costs on an economy.

Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and planning decisions. This introduces an additional source of uncertainty into the economy, because they may guess wrong about the rate of future inflation. Time and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices, rather than real economic fundamentals, which inevitably represents a cost to the economy as a whole.

Even a low, stable, and easily predictable rate of inflation, which some consider otherwise optimal, may lead to serious problems in the economy, because of how, where, and when the new money enters the economy. Whenever new money and credit enters the economy it is always into the hands of specific individuals or business firms, and the process of price level adjustment to the new money supply proceeds as they then spend the new money and it circulates from hand to hand and account to account through the economy.

Along the way, it drives up some prices first and later drives up other prices. This sequential change in purchasing power and prices known as the Cantillon effect means that the process of inflation not only increases the general price level over time, but it also distorts relative prices , wages, and rates of return along the way. Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and Austrian economists even believe this process to be a major driver of cycles of recession in the economy.

It is done by implementing measures through monetary policy , which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money supply. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation, which is thought to be beneficial to the economy.

Price stability—or a relatively constant level of inflation—allows businesses to plan for the future since they know what to expect. The Fed believes that this will promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change.

For this reason, the Fed doesn't set a specific goal for maximum employment, and it is largely determined by employers' assessments. Maximum employment does not mean zero unemployment, as at any given time there is a certain level of volatility as people vacate and start new jobs. Monetary authorities also take exceptional measures in extreme conditions of the economy. For instance, following the financial crisis, the U. Fed has kept the interest rates near zero and pursued a bond-buying program called quantitative easing.

Some critics of the program alleged it would cause a spike in inflation in the U. There are many complex reasons why QE didn't lead to inflation or hyperinflation , though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects.

Consequently, the U. The European Central Bank has also pursued aggressive quantitative easing to counter deflation in the eurozone, and some places have experienced negative interest rates , due to fears that deflation could take hold in the eurozone and lead to economic stagnation. Moreover, countries that are experiencing higher rates of growth can absorb higher rates of inflation. Stocks are considered to be the best hedge against inflation, as the rise in stock prices is inclusive of the effects of inflation.

Since additions to the money supply in virtually all modern economies occur as bank credit injections through the financial system, much of the immediate effect on prices happens in financial assets that are priced in currency, such as stocks.

Additionally, special financial instruments exist which one can use to safeguard investments against inflation. They include Treasury Inflation-Protected Securities TIPS , low-risk treasury security that is indexed to inflation where the principal amount invested is increased by the percentage of inflation.

To get access to stocks, ETFs, and other funds that can help to avoid the dangers of inflation, you'll likely need a brokerage account. Choosing a stockbroker can be a tedious process due to the variety among them. Gold is also considered to be a hedge against inflation, although this doesn't always appear to be the case looking backward.

Since all world currencies are fiat money , the money supply could increase rapidly for political reasons, resulting in rapid price level increases. The most famous example is the hyperinflation that struck the German Weimar Republic in the early s.

The nations that had been victorious in World War I demanded reparations from Germany, which could not be paid in German paper currency, as this was of suspect value due to government borrowing.