Inflation: How does it Impact our Economy?

Throughout this semester we have studied Macroeconomics as a class. Macroeconomics can be defined as the behavior of the economy as a whole. There are many different aspects of how the economy works and changes over time. We have covered the Business Cycle, Supply and Demand, Economic Growth, and many other topics. I have enjoyed applying this new knowledge to everyday topics that have affected me personally. While determining what I would like to cover on this t erm paper, I was intrigued by the topic of how inflation impacts our economy. Before this semester I wouldnt have been able to tell you wha t the word inflation even meant! Now I hope to cover the basic definition of what inflation is, who is affected/unaffected by inflation, and what can be done to counter the effects of inflation on the economy.

Inflation can be defined as the persistent increase in the general price level of goods and services in an economy over a period of time. An explanation could be given as when the general price level rises; each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money for most consumers. For example: say I went to Wal-Mart this week and bought $100 of groceries and completely filled up my cart. If inflation was to rise by 5 percent within the next year, I would go to Wal-Mart and if I bought the same exact products as before, my same cart of goods would now cost me $105.

With this example you can see that the dollar buys fewer goods as before. With this example you may see why inflation may be a problem to our economy, if pay rates arent rising at the same level as our inflation; we will begin to see issues with purchasing power.

Inflation is mainly measured by the Consumer Price Index (CPI), which is usually compiled by the Bureau of Labor Statistics. It is measured on a monthly and yearly level. The CPI is used to adjust tax income brackets for citizens and Social Security benefits. Rarely do we suffer from a negative CPI percentage, but it is possible. For example, the CPI fell from 215.3 in 2008 to 214.5 in 2009. The rate of inflation for 2009 therefore was -0.4 percent.(pg 179) I have included a graph for the annual rates of inflation for the United States for the last 50 years. As you can see from this graph, inflation rates peaked throughout the 70s and 80s and the rates of inflation have been mild for the last couple of years. The United States is beginning to see a small upward trend in its inflation rate currently and many are discussing the possibilities of it continuing to rise. You may ask, why did the United States see such a great growth of inflation during the 1970s? We can describe the cause of this specific example as a cost-push inflation. The major source of cost-push inflation has been so called supply shocks. Specifically, abrupt

increases in the cost of raw materials or energy inputs have on occasion driven up per-unit production costs and thus product prices. The rocketing prices of imported oil in 1973-1974 and again in 1979-1980 are good illustrations. As energy prices surged upward during these periods, the costs of producing and transporting virtually every product in the economy rose. Cost-push inflation ensued.(pg 181) Now that I have described what inflation is, we may ask who is most impacted by inflation directly? From reading the text book I was able to discover three parties who are affected the most, they are people with a fixed income, people who save, and creditors/ lenders. I would like to describe how inflation affects these three parties. With fixed income recipients, their money amount may be staying the same amount each month, but that allotted sum of money slowly loses its value over time with the consistent rise of inflation. This may include people using a private pension for retirement, landlords whose rent price stays the same for each apartment in their complex, or people working on minimum wage. Inflation rises faster than the opportunity to raise the inflow of cash. (Pg 183) Savers are also affected by raises in inflation rates. The real value or purchasing power of personal assets like savings accounts, insurance policies, and annuities decline faster than normal with higher inflation rates. In the 1980s the rate of inflation was at 13 percent, if people had savings account for a total of $1000 then by the end of the year, that $1000 would only be worth a real value of $938! This example describes the potential of harm that could come upon savers if inflation continues to rise at a high percentage. (Pg 183) Creditors are also impacted negatively for higher rates of inflation. As banks lend out sums of money to their customers, as time passes, each customer will pay back their loaned money plus interest. If inflation rises at a faster rate than what the rate of interest, the creditor

will end up receiving money that no longer has the same purchasing power as before. This could obviously be a negative aspect for a compa ny thats only source of income is based on the value of money. Some people may receive negative affects from inflation, but there are people who are unaffected by inflation because their incomes are adjusted according to the CPI on a yearly basis. For example, social security each year is adjusted to the CPI and then given out to the recipients on a basis of need. Union workers are given a cost-of-living adjustment each year that will adjust their income to the levels of inflation within the country. Some employers also provide pay level increases each year on top of performance bonuses to help with the rising costs of inflation. Inflation can be anticipated and planned for by completing certain measures. There are practices in place today that help companies if prices rise due to inflation, so they wont lose money in the long run. A perfect example of this is the variable interest rate on a car loan. For example, let us determine that we would like to purchase a car from a local dealership. We dont have all the cash available to purchase the car from our savings so we want to take out a loan from our credit union. The credit union is offering a variable interest rate loan at 3.5%. We decide to accept the terms of the loan and purchase the car for $15,000. As time goes time, lets say inflation begins to rise in the economy by 6%. By having a variable interest rate loan, the interest rate can raise over time to bring in enough money so the credit union can still make a profit on its loan. This might not be the best choice loan for the family that owns the car, but it will bring success to the credit union over the long run. As you can see,

interest rates for creditors go hand in hand with the level of inflation for each year. I have been intrigued by the topic of how inflation impacts our economy. After writing this paper, I can now be aware of decisions that I need to make in order to be unaffected by the impact of inflation on the economy. I hoped to cover the basic definition of what inflation, who is affected by inflation, and what can be done to counter the effects of inflation on the economy. I feel confident that I have been able to accomplish this goal.

Works Cited "The Coming Great Inflation." What Am I Missing Here RSS. Unkown, n.d. Web. 11 Nov. 2013. Brue, Stanley L., and Sean M. Flynn. "Businss Cycle, Unemployment, and Inflation." Macroeconomics: Prinicples, Problems, and Polices. By Campbell R. McConnel. 19th ed. New York: McGraw Hill, 2012. 179+. Print. "Inflation, in Perspective." Economix Inflation in Perspective Comments. N.p., n.d. Web. 11 Nov. 2013. Brue, Stanley L., and Sean M. Flynn. "Businss Cycle, Unemployment, and Inflation." Macroeconomics: Prinicples, Problems, and Polices. By Campbell R. McConnel. 19th ed. New York: McGraw Hill, 2012. 181+. Print Brue, Stanley L., and Sean M. Flynn. "Businss Cycle, Unemployment, and Inflation." Macroeconomics: Prinicples, Problems, and Polices. By Campbell R. McConnel. 19th ed. New York: McGraw Hill, 2012. 183+. Print "Leaving?" Insights-article. N.p., n.d. Web. 11 Nov. 2013. <https://reserve.usbank.com/insights/interest-rates>.