Inflation is when prices of goods and services increase over time. It can be good, bad or neutral. Inflation that’s too high can have a negative effect on the economy because it makes people avoid buying things they think will become more expensive in the future. Instead of being a sign of an overheated economy, as most people think, high inflation is actually a sign of weakness in an economy. The reason for this is simple: High inflation means that the demand for cash is less than the supply of it; there are more dollars out there looking to be spent than there are things to spend them on. In other words, when inflation goes up, so does the cost of goods and services.
What Causes Inflation?
There are two main causes of inflation: Demand-pull inflation and cost-push inflation. In demand-pull inflation, demand for goods goes up and there isn’t enough supply to meet that demand. This could be caused by a growing population, more people entering the workforce, or just more people spending money. Too much money in circulation can also cause inflation because there will be more demand for goods than there are goods to meet demand. Cost-push inflation happens when the price of goods increases — something happens to make them more expensive to produce. This increase in the cost of goods is then passed on to the consumer in the form of higher prices.
Adverse Supply Shock — A sudden reduction in the supply of a good or service or an unexpected increase in the cost of production.
Adverse Demand Shock — A sudden increase in the demand for goods or a sudden drop in the demand for money that puts upward pressure on prices.
How to Tell If Inflation Is Good, Bad or Neutral
If the economy is growing and employment is high, then you can expect to see some amount of inflation. Typically, if inflation is between 1–3% per year, it’s considered neutral. When you see inflation between 4–6%, it’s considered bad inflation. And anything above 6% is considered high inflation. — The best way to tell if inflation is good, bad or neutral is to look at the unemployment rate and the Gross Domestic Product (GDP). If the economy is growing and the unemployment rate is low, then you can expect some amount of inflation. With that being said, if inflation is between 1–3% per year, it’s considered neutral. When you see inflation between 4–6%, it’s considered bad inflation. And anything above 6% is considered high inflation.
Neutral Inflation: When Prices Just Stay the Same
When inflation is neutral, the cost of goods and services is just rising at the same rate as the rate of inflation. In neutral inflation, people aren’t getting paid more for their goods and services. Instead, prices are just getting increased because there is more demand for them than there is supply. For example, if McDonald’s is experiencing a lot of new customers because people are eating more fast food, they’ll increase the price of their food so they can keep up with demand. While this might sound like bad inflation, it’s actually just neutral inflation because the increase in price is equal to the increase in wages.
Bad Inflation: When Prices Increase But the Economy Stays the Same
When inflation is bad, the cost of goods and services increases while wages stay the same. This can lead to more people turning to things like payday loans. While this might not seem like a big deal, it can cause a lot of problems for the economy. People might stop spending as much money on goods and services because they’re worried about prices rising even more. This can lead to lower employment rates and/or lower wages since there are fewer goods and services being produced. Bad inflation can also cause people to start hoarding money because they’re worried about prices rising even more. This can lead to less money in circulation in the economy — which can cause a recession.
Good Inflation: When Prices Increase and the Economy Improves
When inflation is good, the cost of goods and services increases while wages increase as well. This can cause prices for goods and services to go up, but it’s a good thing because it shows that the economy is growing. For example, if you’re being paid more for your goods and services, you’ll likely spend more on other goods and services. This, in turn, will cause those prices to go up as well. With that being said, when inflation is good, it’s because the economy is growing. And a growing economy is a good sign for everyone.
Conclusion
Inflation is when prices of goods and services increase over time. It can be good, bad or neutral. Inflation that’s too high can have a negative effect on the economy because it makes people avoid buying things they think will become more expensive in the future. When inflation is neutral, the cost of goods and services just rises at the same rate as the rate of inflation. When inflation is bad, the cost of goods and services increases while wages stay the same. And when inflation is good, the cost of goods and services increases while wages increase as well.
