Over the past two or three years, we have seen prices constantly rise. The logical question we ask ourselves is how to ignore the negative consequences of inflation. One is to learn to live with less money, and the other is to compensate for the lack of funds.
Three things are key during inflation. The first is to control your expenses. The second is to invest in assets that retain their value. The third is to increase your income.
What is inflation?
Inflation (from inflation - to inflate, to inflate) is a process of devaluation of money and reduction of its purchasing power caused by a disruption of the balance of the money and commodity supply. This process is externally manifested in the form of an increase in the general (average) price level of goods and services.
In its classical form in the past, inflation was considered a “pure” monetary phenomenon. Its causes are sought in monetary circulation. It is believed that its basis lies in the abuse of the monetary mechanism - unjustified money emission and overflowing of the channels of monetary circulation with excess money. This is followed by an increase in commodity prices and the provision of money.
In modern conditions, it is necessary to understand inflation as a multi-factor process. It is not accepted only as a monetary phenomenon. Its causes are sought deeper - not only in the sphere of circulation, but also in the sphere of production. The genesis of inflation is rooted in a disruption of the balance between the money and commodity mass. The imbalance between them can be due to one side (the money) or the other side (the commodity) mass.
Different factors influence inflation. They can be grouped as follows:
1. Inflation caused by the demand factor. These are inflationary factors that cause inflationary demand (the money supply) to exceed the supply of goods (the commodity supply), thus unsatisfied demand appears, i.e. the demand for goods and services becomes greater than their supply, which leads to an increase in their prices. The following factors deserve attention:
• Budget deficit (budget expenditures exceed budget revenues) - chronic budget deficits and the need to finance them leads to an increase in taxes, an increase in government debts, and in the past - to additional money emission. In modern countries, budget deficits are rarely financed directly by the emission method (printing money), and the credit method is mainly applied. Covering the deficit with borrowed funds forms the internal and external debt of the state. When used continuously, government loans can also have an inflationary effect. The constant withdrawal by the government of loans from the central bank against the issuance of government securities ultimately leads to an increase in the money supply.
• Credit expansion. Provision of credit by banks leads to an increase in money in circulation. Excessive expansion of credit by the central bank, respectively commercial banks, can cause a serious imbalance in the ratio of "goods-money".
• Inflow of foreign currency into the national economy. This can occur as a result of the export of goods or when receiving international loans in foreign currency. After the exchange of foreign currency into local currency, the money supply in the country increases.
• Increase in income of the population at a faster rate than labor productivity.
2. Inflation caused by supply factors (cost inflation). This refers to invoices that lead to a decrease in the supply of goods and an increase in the prices of manufactured goods. In this category, the main importance is given to “non-monetary” factors such as:
• A significant decline in production or a decrease in imports. In such a situation, the demand for goods becomes greater than their supply, respectively, an increase in commodity prices is observed. Even with an unchanged value of the money supply, the presence of a commodity deficit is a prerequisite for the depreciation of money.
• Increased demand for production factors (means of labor, objects of labor or labor), on the one hand, and an increase in production costs on the other, can exert pressure on the price of goods to rise. Such an effect is observed in the following cases:
- Increase in the price of energy and other raw materials (electricity, oil, agricultural products, metals, etc.) This leads to an increase in the cost and hence the selling prices of the goods in the production of which they participate, along the entire chain from extraction, through processing, to wholesale and retail trade.
- The demands of workers and unions for wage increases can cause a similar effect - an increase in production costs, and hence prices. It comes to a turning of the inflationary spiral “prices-wages” rising prices require rising wages, and rising wages increase prices.
- Excessively high interest rates paid by producers or traders for the bank loans they use may force them to transfer the interest burden onto the prices of the goods they sell.
- Import inflation, which is associated with rising prices of imported goods. This in turn affects the rise in prices of goods whose production is carried out with imported raw materials. Thus, rising prices in a given country are easily transferred to another through foreign trade relations.
- Presence of monopoly structures. They allow monopolists, using their market power, to calculate high or speculative profits in prices, without significantly increasing the quality of the goods and services they offer.
- Exports of goods and services are growing faster than imports. As a result, the supply of goods on the domestic market decreases and, given a given demand, their prices rise.
Inflation can be viewed in many aspects. This necessitates the differentiation of different types of inflation, according to certain criteria.
Depending on the growth of prices, inflation can be:
• Moderate (creeping) inflation - when an increase in commodity prices of up to 10% per year is recorded.
• „galloping” inflation - it is observed an annual increase in prices from 10 to 200%.
• Hyperinflation- an increase in prices of over 200% per year, with some months seeing values of over 50% per month. This type of inflation completely disrupts the national monetary system.
From the point of view of the impact of the inflation process on prices, the following are known:
• Open inflation - prices are formed freely based on market invoices. Open inflation constantly reflects on an increase in commodity prices;
• Hidden inflation - in this case, the state freezes the growth of prices. This type of inflation is manifested not as an increase in commodity prices, but as a commodity deficit, supply of low-quality goods and the formation of “tails” in front of the shops.
A number of other economic phenomena are related to inflation, such as:
• Deflation- a process opposite to inflation, which is characterized by a decrease in the prices of goods and an increase in the purchasing power of money. Despite these attractive characteristics at first glance, deflation is not always a positive phenomenon. It is inherent in economies that are stagnant. Low incomes of the population cause effective demand to lag behind the supply of goods. Prices of goods fall. In order to keep their profits within acceptable limits, manufacturers and traders strive to reduce their costs, including by laying off unnecessary labor. Unemployment increases, and with it effective demand decreases even more. This is how the so-called deflationary spiral turns.
• Devaluation- in modern conditions it comes down to a decrease in the exchange rate of the national currency against foreign currencies.
• Stagflation (stagnation + inflation) - a state of the economy in which a simultaneous decline in economic growth and inflation are combined, with unemployment increasing in parallel.
• Denomination- the process of replacing old banknotes with consolidated new ones (extra zeros are removed) in order to facilitate accounting relationships. In our country, in 1999, the Bulgarian lev was denominated. The old 1000 leva became 1 new leva. The BNB puts new denominated banknotes and coins into circulation.
• Nullification- the state declares banknotes invalid because their depreciation has reached enormous proportions (millions or billions of times). This makes it difficult for the functioning of monetary circulation. Thus, old banknotes are destroyed and business entities lose their savings (accumulations), since they are not compensated with money from the new issue.
Consequences of Inflation!
Inflation can have both a positive and a negative impact on socio-economic processes.
The following points can be attributed to the positive consequences:
1. Inflation has a stimulating effect on the turnover of goods, so the expectation of price growth in the future encourages consumers to purchase goods today.
2. Inflation is a factor of “natural selection” in the development of the economy. In conditions of inflation, weak enterprises in the economy go bankrupt. Thus, only the strongest and most efficient enterprises remain to function in the national economy. In addition, inflation can contribute to the competitiveness of national goods.
3. In an economy with underemployment, moderate inflation causes a small reduction in real incomes, which forces people to work more and better.
4. Inflation redistributes income between creditors and debtors, and profits are in favor of borrowers. Having received a long-term amount at a fixed rate, the borrower is obliged to return it at a fixed rate only part of it, because real purchasing power has decreased as a result of inflation.
5. Inflation benefits debtors, buyers, importers, and workers in the real sector.
The following points can be attributed to the negative consequences of inflation:
1. All cash reserves (cash in hand, in deposits, loans, etc.) are devalued. Thus, owners of money in current accounts lose income from unforeseen inflation.
2. Securities are devalued.
3. It affects money emissions.
4. There is a spontaneous, uncontrollable redistribution of income, as a result of which creditors, sellers, and workers in budget enterprises lose out during inflation. For example, creditors (creditors) expect to return the money after a while, the purchasing power of which has been lost.
5. The economic well-being of those who keep money in banks decreases if the bank's interest rate is lower than inflation.
6. The growth of prices is accompanied by a fall in the exchange rate of the national currency.
7. All basic economic indicators, such as GDP, profitability, interest rates, etc., are distorted.
8. Inflation affects the volume of national production. For example, in hyperinflation, production stops and the volume of sales of goods and products is reduced, which in turn leads to a decrease in the real volume of national production, an increase in unemployment, the closure of enterprises and bankruptcies.