· Inflation: Inflation is a general increase in prices and a fall in the purchasing value of money.
· How to measure inflation: Inflation can be measured by calculating the average price of a basket of goods and services over a period of time.
Inflation is divided into two types:
· Core Inflation: The goal of determining basic inflation is to determine whether the price increase results from a surge in demand for goods and services, or if it results from temporary and accidental factors. Therefore, when measuring core inflation, some goods and services are excluded, whose price change almost distorts the data or gives an illogical figure.
(Excluded: administratively-set goods and services - food commodities such as grains and fruits)
· Overall inflation: It measures the rate of change in the prices of all goods and services so that the purchasing power of the citizen can be calculated (its goal is to measure the citizen’s experience with regard to goods and services).
What are factors drive inflation increase or decrease?
Supply-driven factors are those that affect the supply of goods and services, such as geopolitical or geographic factors. It is important to differentiate between a rise in prices and a shortage of a commodity. For example, curtailing Russia's oil exports led to a rise in prices, as the price of oil before the sanctions ranged from $99.02 to $99.50 per barrel. Currently, it ranges between $139.13 and $139.50 per barrel, which is the highest price a barrel of oil has reached since the financial crisis of 2008. One of the reasons for this is the geography of the occurrence of natural disasters such as earthquakes, hurricanes, and volcanoes.
One of the main reasons affecting the occurrence of an increase in inflation is the increase in demand for commodities. This occurs due to an increase in the money supply by printing money or borrowing from abroad, which leads to the deterioration of the actual value of the currency.
Is inflation a positive thing?
Inflation is not always bad and can have some positive effects in some cases. For example, inflation can stimulate demand for goods and services due to the fear of rising prices, which increases demand for goods.
An example of this is what happened in the United States before the U.S. Federal Reserve's policy of raising interest rates and the American people's fear of inflation, which greatly increased the demand for commodities.
This will lead to an increase in production and jobs, which will enhance economic growth. In addition, inflation can stimulate investment in fixed assets such as real estate, stocks, bonds, gold, and precious metals, as their value can increase with the increase in prices.
Evidence for this is Japan's attempt to raise the inflation rate, as the Japanese inflation rate has remained less than 2% over the past 25 years. The Bank of Japan deliberately kept interest rates low, which makes borrowing money for companies cheaper, which may lead to more investment and economic growth.
It can be said that inflation is not always bad, but when it exceeds its normal level, it can have negative effects on the economy and investment. Therefore, governments and global financial institutions seek to monitor inflation rates and intervene when needed to maintain stability and encourage economic growth.
An investment is an asset or item acquired with the goal of generating income or appreciation. Appreciation refers to an increase in the value of an asset over time. When an individual purchases a good as an investment, the intent is not to consume the good but rather to use it in the future to create wealth. Investments can include stocks, bonds, real estate, businesses, gold, precious metals, and other investment projects.
The effect of inflation on investment:
Inflation is a concern for investors, as changes in inflation rates, interest rates, and geopolitical events affect different types of assets in different ways. This is an issue of particular concern for people with fixed incomes.
The effect of inflation on your investment portfolio depends on the types of assets you own. If you invest in gold, concern about inflation should not be present, as gold is historically a good hedge against inflation in the long run. This is because gold prices rise in addition to the depreciation of the currency in general. Gold is a risk hedge tool, and most banks tend to buy gold during economic crises.
Fixed income investors (bonds) are the most affected by inflation. For example, if you invest $1,000 in Treasury bonds with a 10% return, you will receive $1,100 at maturity. However, the $100 that represents the return on the bond is not worth the same as $100 a year ago. This is because inflation has decreased the purchasing power of your money. Therefore, we must take in consideration inflation rates and their impact on your returns. If inflation is 4%, the return should be 6%. Inflation benefits borrowers at the expense of lenders.
The example shows the difference between the nominal interest rate and the real interest rate. The nominal interest rate is the growth rate of your money, while the real interest rate is the growth of the purchasing power of your money. In other words, the real interest rate is the nominal interest rate minus inflation.
As an investor, you should look at the real rate of return for your money. Most investors only look at the nominal return and forget about their purchasing power.
Gold and other precious metals have been considered the best hedge against inflation, as their value rises as the currency depreciates. Consumer goods tend to be vulnerable to inflation and are not a good hedge against inflation.