Inflation & Central Banks

Posted by Jaden Brown-swaby on

During recent times; you may have heard a lot of conversation around the subject of inflation, but still have no clue what it is. In this week's blog post, we will be explaining what Inflation is and the effects it can have on society and individuals. We will also be touching on Central Banks and the important role they play in our day-to-day lives. 

Inflation is the general increase in the price of goods and services within an economy. This corresponds to the reduction of purchasing power within money. In other words, your money is worth less as it buys fewer goods and services than it could have done before. Inflation tends to reduce the value of a currency over time. 

Inflation is commonly measured using the inflation rate, this is normally a percentage figure.

As the inflation rate increases the cost of living also increases, this is due to the surge in prices of essential products and services. A healthy rate of inflation is seen to be around the figure of 2% or lower. 

In the UK, the “Office for National Statistics” or ONS is responsible for calculating the UK’s inflation rate. The ONS produce a headline inflation rate every month. They do this by collecting the average household purchases and prices of over 700 everyday goods and services within the UK in multiple locations, up and down the country, including online purchases giving them over 180,000 price points to read from.

This is combined with detailed information on the UK’s spending patterns, helping to calculate abs determine accurate price changes on goods and services, allowing them to generate the inflation rate for the given month. 

The Consumer price’s index: including Owner occupiers housing cost or, for short, the CPIH calculates the average inflation rate across the country, however, everyone else has their own personal inflation rate.

Your personal inflation rate can be determined by what the majority of your income is spent on. Some people may spend larger proportions of their income on things such as: Gas, Electric and Petrol. Depending on their lifestyle and spending patterns, these factors can and will reflect how inflation and the cost of living directly affects them. 

 

As well as a range of disadvantages, Inflation can be said to also carry some advantages.In this section I will be explaining some of the advantages and disadvantages of Inflation and what sorts of impacts they can have. 

Advantages:

One advantage of Inflation; is that, whilst moderate, Inflation can actually be good and further enable economic growth. The opposite to Inflation is Deflation or a fall in prices. This can can be very harmful to an economy, as deflation increases the real value of debt increasing the burden on society and individuals leading on a rise in discouragement towards spending and investments. The falling prices brought about by Deflation could not only cause uncertainty within consumers but also cloud their judgements based on poor predictions of CHEAPER FUTURES.

Another advantage of Inflation is that HIGHER PROFITS can be made. This will usually benefit producers of products and investors, as the price of commodities increasing due to inflation will also positively affect the value of their stock, hence producing more profits.

Lastly, Inflation decreases the value of debt. “How does this work?” I hear you ask, Well that’s because of the decrease in the value of money - making it easier for debtors to repay their loans as well as Institutions getting more money making it easier for people to borrow from banks. Ha, talk about snowball effect!

Disadvantages:

Inflation also comes with several disadvantages and is considered to be a problem when the inflation rate rises above 2%, in comparison to the UK’s current inflation rate of around 7%.  

Inflationary Growth or growth through inflation tends to be unsustainable and can lead to periods of BOOM and BUST economic cycles, which can be very damaging to an economy, further leading to a RECESSION. High inflation rates create confusion and a lot of uncertainty and discouragements between investments/investors and larger firms as well as the potential stunting of long term economic growth, as a whole. 

Another disadvantage is that the cost of living can go up, drastically making it harder for people to purchase essential items. This can become a problem when the cost of living increases, but the overall wages don’t. This definitely makes it harder for people from poorer backgrounds, denying them the access to basic things. 

High inflation is seen as unacceptable by Governments and Central Banks, prompting them to reduce it, however this comes at a cost and has its own price to pay. Normally this will involve higher interest rates to reduce spending and investment but the reduction in Aggregate Demand (total demand of goods and services) will lead to a decline in economic growth and can cause unemployment in some cases.  Although inflation can be reduced this way, it also has a ripple effect causing more problems in other areas . With such occurrences, it is better to try and maintain a low at all times in order to avoid more costly measures in attempts to reduce it in the foreseeable future.

I will further touch on Central Banks and their roles in society. Many YOUNGER PEOPLE may not be aware of Central Banks as they are not accessible by the public but only by qualifying financial institutions. (so don’t worry - it’s not because you’re not doing something right haha).

A Central Bank is a financial institution that oversees and regulates a nation or group of nations MONETARY systems and policies. They enact monetary policies by easing or tightening money supply and availability of credit to high street banks seeking  to keep the nation’s economy at an even kneel with low and stable inflation rates. They basically prevent a country’s banking system from failing.

Central Banks act as a regulatory authority of a nations monetary supply as they are the sole provider and printer of a country’s notes and coins in circulation. They also hold the power to take tender out of circulation just like in recents times with the change to plastic notes and the new £1 coins. (Shiny, right?)

Some of the worlds Central Banks include:

  1. U.S Federal Reserve System (Fed)  🇺🇸
  2. European Central Bank (ECB)   🇪🇺
  3. Bank of England (BOE)  🏴󠁧󠁢󠁥󠁮󠁧󠁿
  4. The People’s  Bank of China (PBC)  🇨🇳
  5. Bank Of Japan (BOJ)  🇯🇵
  6. Swiss National Bank (SNB) 🇨🇭

A central bank has two main functions: Macroeconomic and Microeconomic. Macroeconomic functions are used when regulating inflation and creating price stability. This is predominantly done through Open Market Operations or OMO for short. The point of OMO is to either inject the market with liquidity (which can be through the printing of new cash) or to absorb the extra funds within the market, both of which will directly affect the level of inflation within that Central Bank’s nation.

Microeconomic functions can be described as when a Central Bank is functioning as a lender of the last resort.

If the commercial bank does not have enough LIQUIDITY to meet its clients demands, keeping in mind that they typically do not hold reserves equal to the needs of the entire market, they can turn to a central bank to borrow additional funds. Central banks set the requirements for commercial banks through POLICIES. They will regulate member banks through a few necessities such as capital and reserve requirements, and how much cash they must keep on hand.

Most Central Banks are Government-owned but are separate from their country’s ministry or Department of Finance (DOF). Although they handle the buying and selling of government bonds, political decisions should not influence the operations and targets of a Central Bank.


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