How Do Inflation and the CPI Affect Us?
Rising prices and inflation
When the economy is in a growth cycle, the improvement of domestic economies leads to an increase in the consumption of goods and services, which translates into an increase in prices. The basic rule of economics says that the higher the demand, the higher the price.
National monetary base
When countries are not experiencing economic growth, governments make and issue money to pay their debt or deficit, which has increased the country’s monetary base. In these cases, more money is in circulation than the economy needs.
Consider if each of us were given a million dollars, our final position would be the same since the demand for goods and services would go up so much that prices would counter-balance the available money. It could cause typical household items to skyrocket; for example, a loaf of bread would be worth $1,000.
Interest rates
Inflation may also vary depending on the behavior of interest rates. If inflation rises because of a good economic situation, this is considered an overheated economy. The way to cool down the economy is to raise interest rates, which will reduce the number of loans granted. It will consequently reduce consumption so that prices will fall. In the same way, lower interest rates will favor economic growth and, therefore, inflation.
Increased energy prices
The rise in energy prices also produces widespread inflation, as it is present in manufacturing or transporting almost all products. The most difficult thing for a government to maintain is a good rate of sustained economic growth and low inflation.
Measuring inflation
Many indexes measure the variation in the price of goods and services in an economy. These indexes include the Index of Prices of Investment Goods, the Wholesale Price Index, the Producer Price Index, and the Consumer Price Index. The Price Index is particularly interesting since it directly affects family economies.
Consumer price index
The Consumer Price Index (CPI) measures the price variation of goods and services necessary for the daily life of households and families. In particular, the prices of a series of products called basic baskets are measured monthly. In that basket, products are excluded and included as the uses and customs of consumers vary. For example, 20 years ago, the price of a mobile telephone was not counted but is included in today’s basic basket.
How does the CPI affect us?
The importance of the CPI is that it measures the variation of our purchasing power. If prices rise, we can buy less goods and services with our income, so it is said that we lose purchasing power. We are poorer, even if we earn the same income.
Many companies and the State offer their employees or pensioners at the beginning of the year a salary increase in relation to what the CPI of the previous year has risen.
Many people mistakenly think they have a larger salary when the increase is equal to the CPI increase. However, they are maintaining their purchasing power because they can buy the same as the previous year. If the wage increase exceeds the CPI, we gain purchasing power. Similarly, if the wage increase is lower than the rise in the CPI, then there is a wage freeze and loss in purchasing power.
Price increases and purchasing power
The price increase affects us if our salaries do not increase to accommodate them. Even so, as prices rise steadily and wage increases are made at the beginning of the year, to maintain our purchasing power, a low or moderate rate of inflation that does not cause the speed of price rises to cancel wage increases will be necessary. If not, we will permanently lose purchasing power.
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