Inflation is common to the economy of any country. How did it originate and why does it prosper?
Inflation was caused by paper money
Just imagine a happy farmer. He grows corn. When farmer’s plow breaks down, he goes to the blacksmith and asks to repair it. For this work, the farmer pays the blacksmith with corn. This is called a commodity exchange.
One day the blacksmith replied the farmer that he would not mend his plow for the corn because he needed milk. This first disagreement between the seller and the buyer has led to the emergence of metallic money circulation. Now the farmer pays the blacksmith with gold coin, and the blacksmith exchanges the coin for the necessary goods and services.
The more blacksmiths and farmers appeared, the more actively precious metals were mined. And one day the farmer paid the blacksmith with paper money. For one coin, equal to one gold coin, the blacksmith was able to buy a liter of milk and a loaf of bread. However, a year later, for the same monetary unit the blacksmith was able to get only 900 grams of milk and half of a loaf of bread. Paper money began to cost less than the gold coin.
How did this happen?
A part of money was "eaten" by inflation.
Inflation depends on the financial policy of the state
Paper money is easy to produce; it’s easier than to produce the coins of pure gold. The country begins to print more money, more than it could produce gold coins. Why then the state is constantly printing new money? The answer is the following – in order to finance public spending during the crisis and to support resources for lending. Also, inflation can be caused by the following factors:
- reduction of the volume of national production;
- increase in the amount of state taxes and fees;
- monopoly of the specific companies on the formation of prices for goods.
These factors result in rising prices in the supermarkets. However, it’s important to consider the inflation not only as a result of government mistakes. This is economic phenomenon. Market factors are the basis of the inflation:
- increasing demand for the product that causes the increase in its price;
- rising prices for raw materials and energy are forcing the manufacturer to raise prices as well;
- higher prices for imported goods can lead to a rise in prices for similar domestic products.
Inflation exists, even when you do not talk about itIn Ukraine, inflation was 49% in 2015. This is the second index in the world. Next to us were Yemen (30%), Syria (33.6%), and South Sudan (41.1%). Our neighbors, Russia and Belarus, have inflation indicators at the level of 15.4% and 15%.
Annual inflation from 10% to 50% is called galloping inflation. It is dangerous for the economy and requires a permanent anti-inflation measures.
In 2015, inflation in the US in was about 1%, while in the EU it was about 3% depending on the country. This is moderate inflation that is necessary for normal economic development.
The Soviet Union also experienced inflation; however, it was not due to the price increase but because of the decline in the purchasing power of money. In the USSR, the level of prices and wages plan were set by the state, but inflation manifested itself in short supply of goods, the growth of costs for their production, and the decrease in the quality of the goods. In economic practice, this is called latent inflation.
Inflation forces you to spend more and eats the money you invest
Inflation not only forces you to spend more money on goods and services, it also deprives you of the savings. Consider the example of a 5% inflation. A year ago, you bought 2 kg of meat for 100 UAH, but this year you will pay 105 UAH. But those 100 UAH that you have not spent last year will become a 95 UAH this year.
Can you imagine what happens to the money when inflation is kept at a level of 49%?
To protect your savings, the income must exceed the costs of inflation
In the conditions of average annual inflation up to 10%, the following options of investments are beneficial:
- bank deposits when the annual deposit rate is higher than the inflation index. Bank deposits are beneficial in the short terms (up to 5 years) and only in a stable currency;
- the purchase of the real estate . This is a good long-term investment, even taking into account the costs associated with buying, selling, and servicing of the property;
- the purchase of securities. This is one of the best ways to increase savings in the long term if you can properly assess the situation on the securities market.
Under the conditions of a crisis and galloping inflation, to keep the money is more difficult. Bank deposits are unprofitable because inflation is rising faster than deposit rates. In this case, the optimum solutions would be:
- the acquisition of a stable foreign currency;
- the acquisition of precious metals;
- the purchase of securities.
Inflation should not be regarded as an absolute evil. Moderate inflation stimulates economic growth, contributes to the revitalization of the market, higher prices, and profit margins. Under the conditions of galloping inflation (50%), which Ukraine is now facing, the country can win at the expense of exports because the devaluation of the hryvnia significantly reduces the price of domestic goods. However, of course, whether the country will be able to somehow win in this situation depends on the professionalism of those in charge of the fight against the economic crisis.