Understanding Inflation

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UNDERSTANDINGINFLATIONW

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INFLATION

It can be a complicated concept. Let us begin...with a definition.

in・fla・tion (in-‘flā-shǝn), n. a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the losss of value of currency.

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Essentially, it means stuff costing more over time.

But...is it that simple? What are its effects?

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INVESTMENTS

Inflation is often villified. However, it is more complicated than that.

I am pretty sure you would have heard all the horrors about inflation and how it will EAT your investments.

INFLATION

Let us take a look at how it is measured..

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It collects information of like prices of these items every month.

The government then averages and weighs these pr ices using various formulas.

The result is a number called the Consumer Pr ice Index (CP I ) .

T h e C P I i s a measurement of how much stuff all around us costs us. The last C P I m e a s u r e d i n S e p t e m b e r i n Singapore is 109.3.

So what does CPI have to do with inflation?

Generally, CPI is an indicator of inflation. When it increases, inflation increases accordingly. However, there are a range of other measured indices as well.

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The government h a s a l o n g shopping list of i t e m s a n d services.

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So is inflation bad? It means I have to pay more for my stuff!

It can be. But it all depends on the situation. If inflation is 3% and you have...

...$100 in a milo tin, it will be worth $97 after a year.

MILO TIN

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MILO TIN

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$100 $97

Inflation IS bad.

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...$100 in an investment with a 4% return, the investment will be worth $101 after a year. The real rate of return is only 1%

INVESTMENT

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Inflation is bad, but it is manageable through investments.

INTEREST

What you think you get.

What you get.

What inflation gets.

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...a $100 loan from the bank with a fixed interest rate of 2%, you will owe the bank $102 after a year. However, it will only be worth $99. This means that inflation paid $1 of your debt.

Inflation, in this case, IS good.

$100 before inflation.

$97 after inflation.

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Ok. If I owe money, inflation works to my advantage! But too much of it can’t be good right?

Yes. There will be effects of unanticipated or excessive inflation.

Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.

When prices are constantly changing, energy and money is diverted to keeping the prices upda ted , wh i ch c rea tes inefficiencies.

Lenders (like banks) are then less likely to make loans if they cannot accurately adjust the rates to make up for inflation.

Individuals with pensions or fixed income will see a decline in their p u r c h a s i n g p o w e r a n d , consequently, their standard of living.

If the inflation rate is greater than that of other countries, domestic products become less competitive.

People hoard tangible items as a way to shed excess cash before it is devalued. This creates shortages of hoarded items.

Hyperinflation can occur when a currency loses its value so rapidly that the very concept of currency becomes meaningless. This results in the issuing of trillion dollar bills. The economy

If you can see by now, inflation is inevitable. It is a sign of a growing economy and affluence of the people. To avoid inflation, investors often convert assets from money to capital projects, thus in turn creating even more growth.

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RATE OF INFLATIONTOO MUCH

TOO LITTLE

SWEET SPOT

High prices

Hoarding

Hyperinflation

Risk of deflation

Liquidity trap

High unemploymentStable and predictable economy

Ok. So inflation is not inherently bad. But how do we get it? What causes it?

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SCENARIO 1

The economy is good.

Companies employ more people.

W h o m a k e mo re money and buy more stuff.

To meet the demand f o r m o r e s t u f f , companies employ m o r e p e o p l e .

Eventually,

The demand for stuff will out-pace the capacity to produce it.

The price of stuff goes up.

T h i s i s t e r m e d a s Demand-Pull Inflation.

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SCENARIO 2

There i s subs tan t i a l increase in the cost of a good or service.

Such as a disruption in the oil supply.

Price of oil goes up.

The price of goods and services that rely on oil goes up.

This is termed as Cost-Push Inflation.

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SCENARIO 3

Due to inflation in the past, people now expect inflation to occur.

Workers push for higher wages to o f fes t the expected inflation.

Employers pass on the higher wage costs to the consumer.

The price of stuff goes up and inflation occurs.

This is termed as Built-In Inflation.

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CurrentInflation

Rate

Demand-Pull

Cost-Push

Built-In

These 3 definitions form the current inflation rate that we know of.

What about money supply?

The government needs to pay for stuff it can’t afford.Prints extra money.

M o r e m o n e y i n circulation

Value of money goes down.

Prices are raised to compensate.

Inflation happens.

It affects too! When the government prints money or relaxes credit, this is a form of Demand-Pull, but it generally happens in a really bad economy.

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Time

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Higher Inflation

Lower Inflation

Slowing Economy

Growing Economy


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inflation gets out of hand, what can be done?

Controlling inflation lies mostly with the Monetary Authority of Singapore (MAS). It is a delicate balance between keeping the economy moving and keeping inflation in check.

Higher Inflation

Lower Inflation

Slowing Economy

Growing Economy

MAS

Lower Interest Rate

MAS

Higher Interest Rate

The economy can be spurred in this manner, but it will inevitably risk inflation.

Or inflation can be slowed, at the expense of a slower economy.

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Higher Inflation

Lower Inflation

Slowing Economy

Growing Economy


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Ok...a quick recap! Inflation ocurrs when the price of stuff goes up. It is not always bad. However, too much or too little of it will spell trouble for the nation. The main causes of inflation relate to the demand and costs of goods and services. The Singapore government can affect inflation by raising or lowering interest rates!

MAS

Modest Rates Modest Rates

Generally, the Singapore government will try to keep it balanced.

Spot on!And since inflation has to occur and it is

not a constant, we must constantly be on a look out for investments that will keep our money growing.

At GIANTS LEARNING TECHNOLOGIES, we specialise in equipping our clients with the knowledge, skills and opportunities to financial instruments such as market stocks and shares, mutual funds, real estate, and FOREX.

Understanding Inflation

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