Inflation:
We all have experienced Inflation in our lives one time or another. Every individual knows that the price of any item; it might be food grains like rice and wheat to precious metals such as gold and silver, increases over time. The first time I ever remember the price of rice was ₹8/- per kg and gold at ₹6000/- per 10gm. Now, in 2020, good quality rice is around ₹50/- per kg. Gold price is skyrocketing at ₹48000/- per 10gm. To be certain, our rupee has been losing its value over time.
Inflation refers to the rise in the prices of goods and services in daily use, such as food, clothing, housing, etc. Technically speaking, the Inflation rate is a measure of rate at which the average price level of a basket of selected essential goods and services increases over time i.e, for a month or year.
Simply put, the national currency, rupee or dollar, decrease in its value. We will not able to purchase the same quantity of items as we did a month or a year ago. It indicates the reduction of the purchasing power of our currency.
Types of Inflation:
There are three major types: Demand-Pull Inflation, Cost-Push Inflation, and Built-In Inflation
Demand-Pull Effect occurs when the overall demand for goods and services increases. Excessive demand or low production are the reasons. It creates a gap between demand and supply, which results in higher prices. For instance, the COVID-19 economic lockdown has a great effect on industrial production. We might experience an increase in the prices in the future.
Cost-Push Effect is a result of the increase in the cost of production. Examples include an increase in labor wages, transport charges, and raw prices. These factors play a significant role in the price rise of a final product.
Built-In Effect is the consequence of adaptive expectations. As the price of goods and services rises, workers/ employees expect and demand more wages/salaries to maintain their cost of living. This is a rare occurrence compared to the first two effects.
Measurement of Inflation:
The Consumer Price Index (CPI) and Wholesale Price Index (WPI) are the two most important indicators of Inflation.
Consumer Price Index (CPI): The CPI calculates adjustments in weighted average prices of primary consumer needs such as transportation, food, education, housing, and medical care.
Wholesale Price Index (WPI): The WPI measures the changes in the price of goods and offered services at the wholesale level (between producers and manufacturers) before they reach the retail customers.
Inflation in India:
In India, it is very common to experience a sudden increase in the prices of daily used essential items like food grains, vegetables, petrol, etc. It is usual for us to see the prices of onions and tomatoes going up 2 to 3 times. Nevertheless, the prices settle down within a month or less. These are classical examples of Demand-Pull Effect, where the affected region experiences a huge difference between demand and supply.
The RBI controls the flow of money in India. It aims for a 5% inflation rate in our country. Usually, the inflation rate is proportional to the GDP growth rate. In developed nations like the US, the inflation rate of 2% means good control in the prices.
How to confront Inflation:
Increasing your earning ability and income is the most effective way to protect yourself from inflation. That’s why any government or a private job hikes your basic pay and other allowances every year. So you can manage the growing expenses.
The other way is to invest your money in high-quality securities like blue-chip stocks, government bonds, etc. which pay a healthy interest rate. You can also invest in precious metals like gold and silver. Some Bank FDs and Government schemes also offer an interest rate of 8%.
There is also a good number of Mutual Fund schemes with historical yearly returns of 15% or higher. But, remember that investing is meant for the long term. For appreciable returns, you should be patient with your investments for 5 years or more.
In the current scenario, the stock markets are very volatile. Amid COVID-19 pandemic and lockdown, the economic activity has come to halt. So it is better to hold more cash in hand.
Adverse effects:
You know it very well, the cost of living increases when inflation is high. As a result, economic growth takes a hit. But, a certain level of inflation is necessary to increase expenditure and investments. If there is zero or negative inflation (deflation), the people tend to save most of their money in their deposits. If the expenditure and investments are low, economic growth is not possible.
For a healthy economy, a controlled positive inflation rate is essential. On the contrary, higher inflation demands people to spend too much and save very less. Because the value of money decreases considerably over time, the public will spend most of their savings. There is a chance of new and inexperienced investors putting their hard-earned money in low-quality stocks and other Ponzi schemes in stock markets.
That’s it buddies! I have done my best to provide as much information as possible and also keep the article brief. There is going to be another article on Inflation, where I will cover the missed points in this article.
Here is a superb video with explanation of Hyper-Inflation in Zimbabwe. Source: www.mru.org
Note:
I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID: shivakumar.lachapeta@valueinvesting.online.
Thank you for the simple explanation.
Thank you very much Prasad. The comments mean a lot to me and encourages to keep with my work.