Inflation is the rate at which the prices for goods and services increase. Inflation often affects the buying capacity of consumers. Most Central banks try to limit inflation in order to keep their respective economies functioning efficiently.
There are advantages and disadvantages to inflation.
Causes of Inflation
Inflation is caused by multiple factors, here are a few:
1. Money Supply
Excess currency (money) supply in an economy is one of the primary cause of inflation. This happens when the money supply/circulation in a nation grows above the economic growth, therefore reducing the value of the currency.
In the modern era, countries have shifted from the traditional methods of valuing money with the amount of gold they possessed. Modern methods of money valuation are determined by the amount of currency that is in circulation which is then followed by the public’s perception of the value of that currency.
2. National Debt
There are a number of factors that influence national debt, which include the nations borrowing and spending. In a situation where a country’s debt increases, the respective country is left with two options:
Taxes can be raised internally
Additional money can be printed to pay off the debt
3. Demand-Pull Effect
The demand-pull effect states that in a growing economy as wages increase within an economy, people will have more money to spend on goods and services. The increase in demand for goods and services will result in companies to raise prices that consumers will bear in order to balance supply and demand.
4. Cost-Push Effect
This theory states that when companies face increased input costs on raw materials and wages for manufacturing consumer goods, they will preserve their profitability by passing the increased production cost to the end consumer in the form of increased prices.
5. Exchange Rates
An economy with exposure to foreign markets mostly functions on the basis of the dollar value. In a trading global economy, exchange rates play an important factor in determining the rate of inflation.
The plus side to Inflation
A healthy inflation rate (2-3%) is considered positive because it directly results in increasing wages and corporate profitability and maintains capital flowing in a growing economy.
Steps to offset Inflation and its effects on Your Retirement
Factoring for inflation is an essential process for financial planning. The question is how much will you actually need when you retire? Here are a few ways you can retire financially sound keeping inflation in mind.
1. Invest in long-term investments.
When it comes to long-term investments, spending money now can allow you to benefit from inflation in the future..
2. Save More
Retirement requires more money than one might imagine. The two ways to meet retirement goals are to save more or invest aggressively.
3. Make balanced investments
Though investing in bonds alone feel safer, invest in multiple portfolios. Do not put all your eggs in one basket to outpace inflation.