The term ‘inflation’ is used quite often when people talk about the economy or the GDP, but what actually is inflation? Inflation is a rise in prices, which eventually leads to the decline of purchasing power over time. Simply put, when the prices of products and services go high, people are left with lesser money to buy them. The rise in prices means that a unit of currency effectively buys less than it did in prior periods. Inflation can be contrasted with deflation, which occurs when prices decline and purchasing power increases.
With this explanation, it seems obvious that inflation is bound to affect the common man, but how? First, let’s understand what happens to the economy during times of inflation. As mentioned before, inflation happens because of increased demand or decreased supply (or both), and in order to control the effects of inflation, RBI hikes interest rates. However, high inflation and rising interest rates affect corporate profitability. Once input costs are higher, production becomes less, eventually affecting the growth of the economy. Naturally, the cumulative effect of all of this results in the lowered GDP of the country.
In a healthy economy, annual inflation is typically in the range of two percentage points, which is what economists consider a signal of pricing stability. It is not always bad for the economy as it can also stimulate spending, and thus create more demand and productivity when the economy is slowing down and needs a boost.
So, how does inflation affect the common man and corporates? It is a cycle that needs to be controlled. Firstly, consumers lose purchasing power as the prices become too high. At the same time, companies also pay more to purchase input materials, and the rise in price significantly impacts consumer spending and customer relationships. Note that the rise in prices of utilities like food and fuel impacts the common man the most. As the cost of living increases for the common man, the value of the currency diminishes. This has a direct impact on the economic growth of the country.
If inflation remains high household budgets are not the only thing that will be affected. In the long run, it is going to adversely affect the common man’s savings which are largely dependent on fixed-income instruments.
On the other hand, deflation is exactly the opposite of inflation; wherein the overall level of prices in an economy declines and the purchasing power of currency increases. It can be driven by growth in productivity and the abundance of goods and services, by a decrease in aggregate demand, or by a decline in the supply of money and credit. If not under control, both of them can significantly and negatively affect consumers, businesses, and investors.