Inflation is everywhere! Everyone is talking about inflation as it touches a 13-year high.

But what exactly does inflation mean? What are the causes of inflation? How does it affect the common man and the economy as a whole?

Inflation is basically a rate of increase in the price of goods and services which in economics defined as “The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index (CPI).” In India, however, it is measured using the wholesale price index (WPI). The CPI is based on a basket of goods and services with different weights, reflecting the expenditure of a typical consumer. The weighted average of price rises of these goods and services gives the inflation figure. Inflation simply reduces the worth of your money. For example: the same 1 kg of apples you used to buy at Rs. 100 will cost you Rs. 110 next year, if the inflation remains at 10%.

There are two theories in the economics that are generally accepted as the causes of inflation.

• Demand pull inflation – Happens when too much money chases too few goods. This situation mostly exists in a growing economy where there are huge expansions from the government and private sector leading to increase in employment which in turn will increase the purchasing power of the consumer. This will lead to an environment where people have got too much money to buy goods and/or services but the supply of goods and services are not growing at the same rate resulting in a supply and demand mismatch. To adjust this, producers will increase the price of goods.

• Cost push inflation – Happens when the aggregate cost of resources goes up for the companies due to decrease in supply or increase in taxes. Companies pass this increase on to consumers in the form of increased prices. For example, crude oil prices have gone up sharply in past few months on account of decrease in supply. The economy sectors where oil is the part of their cost element will pass on this increase to customers by increasing prices of their goods and services.

It is not necessary that only one type of inflation exists in an economy at a time. They can co-exist. For instance, in India right now we have both types of inflation, oil and metal prices have gone up to record highs, giving rise to cost push inflation. At the same time, purchasing power has also increased due to increases in employment, wages, and easy availability of money, creating demand pull inflation. This combined effect has taking inflation to the 13-year high that we are experiencing right now.

Inflation is not always an evil; within limits, inflation is required for an economy to grow. It’s said that inflation is the sign of a growing economy. Imagine an environment where there is no price increase; in fact prices are falling (this situation is opposite of inflation known as deflation). There will be no increase in wages. Nobody would like to have that environment.

But when inflation is too high it adversely affect the consumer and the economic conditions of the nation as well:

• In a fixed interest rate environment the creditor will lose money if he has not properly estimated the inflation and accordingly fixes the interest rate. High inflation can sometime result in negative real interest rates. This can be currently seen in India as the inflation is touching 11.4% and the interest rate on fixed deposit is 9% it is actually giving negative return of 2.4%
• It decreases the savings of the individuals. As the prices increase, the consumer has to shell out more money from his pocket to buy the same products but his income has not increased. Therefore he has to eat up his savings.
• As savings get reduced, automatically investments will reduce, affecting the economy negatively.
• If the inflation in one country is greater than another, the products and services of the former will become less competitive due to the increase in its prices.

To control inflation central banks take monetary actions and government takes fiscal measures. But individuals should also take some steps to get over it. They should invest their money in the investment avenues which gives better return, should try to minimize unwanted expenses, reduce the consumption of the commodity that has become very expensive, and find out some substitute that will help them in managing their own inflation.