What is inflation? How does it affect the cost of living?

The word inflation is used regularly. The country’s inflation figures are often in the news. Interest rates in the country are fixed based on inflation. Central banks around the world focus on inflation estimates. But simply, many people do not know what is meant by inflation. It is often mentioned that in the olden days things could be obtained for a small sum. Over the years, the trend of increasing prices of goods and services has been observed. The word inflation comes in connection with this topic. The simplest explanation for inflation is that the price of goods increases. But inflation is increasing due to many reasons. Hence the concept of inflation is a bit complicated.

There are three main reasons that increase the price of goods. The first type occurs due to currency depreciation. The second type of inflation occurs in a different situation. Consider a country with economic growth. People are hoarding money. Here the demand in the economy is increasing. Demand increases when demand increases and hence prices increase. This is known as demand pull inflation. The third type of inflation is related to price rise. Or the cost of the goods required to produce a product increases. As a part of this, the price of goods has to increase. This is known as cost push inflation.

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A country as a whole has the effect of inflation. There is a direct relationship between unemployment and inflation. If inflation goes unchecked it will adversely affect the unemployment and growth of the country. Economists estimate that the optimum rate of inflation is 2% in developed countries and 2 to 6% in developing countries.

Inflation in India is controlled by the government and the Reserve Bank. The interest rates or repo rates are fixed by the Reserve Bank from time to time through monetary policy. Repo rate, in simple terms, is the interest paid by banks when they borrow money from the Reserve Bank. The Reserve Bank also controls inflation.

If the repo rate is increased, the banks will have to pay more interest to the Reserve Bank. As a result of this, banks increase the interest rate on loans. This will reduce people taking loans and reduce the amount of money spent in the economy. In other words, it is possible to control the increase in price by controlling the increasing demand.

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