Why is inflation harmful, and what is it? An explanation

by Mapping Returns

Most people fear the word “inflation.” It denotes diminished purchasing power, excessive costs, increased consumption, and a lack of available funds.

What is it?

The rate at which a good or service increases or decreases over time is known as inflation (measured in percentage terms). Many people, nevertheless, fail to grasp this.

Inflation and high prices are frequently mentioned in the same sentence. A rupee amount that is high in price may be the outcome of inflation over time. The definition of inflation is the rate of change in a good or service’s price over time.

For a given product, inflation might go up or down. The majority of individuals do not believe that inflation can decrease. If the price of pulses decreases from Rs. 175 to Rs. 160 per kg, inflation will have decreased. However, a lot of people make the valid argument that the price is still high and deny that inflation is negative. If the price of milk stays at, let’s say, Rs. 50 a litre for a year, there is no inflation. However, people continue to discuss inflation rather than price increases, which are two entirely different things!

Is it harmful?

However, is inflation actually declining? All of us have been told that. But it’s not necessary.

Let’s pretend that inflation is moderate, at 5% per year, for example. We are aware that this issue will cause the good or service to cost more in the future. Thus, if we need the thing, it compels us to buy it right away.

People may get fearful and begin hoarding if inflation is really high, like, say, 12% pa. This is not a good thing since it could lead to an artificial shortage in the economy and drive up prices even further.

There is little motivation to purchase the things now if there is no inflation. We have a tendency to put off buying something until the last minute.

There is no reason to buy something today if inflation is negative, like, say, -1% pa, because it will be cheaper in the future. We find it difficult to consider negative inflation. However, it frequently occurs with commodities. For instance, after a few weeks, a vegetable that initially sells for Rs. 80 per kg reduces to Rs. 30 per kilo.


Low to moderate inflation encourages consumers to buy rather than put off purchases until later, which is not necessarily a bad thing. In fact, most economies desire this since it ensures that economic activity will continue in a positive direction.

Customers become cautious when buying discretionary things during periods of high inflation because they are concerned about the future. They only make enough money to get by. They often panic and stock up more on necessities (such as food, consumables, etc.), which drives up prices by causing an unwelcome shortage.

Reduced commercial activity has an impact on the businesses. This forces companies to raise their prices in order to earn the same amount of money as they did in the past, which increases inflation and discourages customers from making purchases.

The cost of capital also tends to be high in situations where inflation is strong. They are unclear if customers will still use them given their rising prices. As a result, businesses won’t make additional investments in the company, which slows growth.

There would be less of an incentive to buy now in the event of zero or negative inflation. Purchasing in the future makes sense if inflation is negative because the item will be less expensive. As purchasing decisions are continually put off, businesses are having a very difficult time.

Different goods have various inflation trajectories.

Different goods and products experience different rates of inflation. Because of this, the Consumer Price Index (CPI) is calculated using the total inflation of a basket of items that represents what typical consumers often purchase.

People use a wide range of goods and services to varying degrees. As a result, the impact of it will vary depending on the individual. Someone who has children in school, for instance, will be more concerned about education inflation. Another person concerned about fuel inflation is one who has a long commute to work. Therefore, depending on what they consume and how much they spend on it, different people will experience the effects of it in different ways.

Rates of interest and inflation

The interest rate should typically be greater than inflation to encourage investors to get a genuine return after taking inflation into account. Therefore, in a situation with high interest rates, the interest rates should ideally be higher than the current rate of inflation. But this isn’t always the case.

High interest rates make lending more expensive for firms and stifle economic expansion. As a result, interest rate levers need to be manipulated carefully. RBI controls the amount of money in the economy, monitors inflation, and uses the interest rate as one of its tools.

In the alternative scenario, there is little incentive to save and customers may prefer to spend the money instead when investment returns are lower than it. But that might once more contribute to it.

In the case of mild inflation, people tend to buy their wants right away rather than put them off. They have an incentive to invest too because interest rates are a little higher than inflation.

In conclusion, it is not necessarily a bad thing. In fact, some people might even prefer modest inflation. A red herring is either very high or very low.

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