Inflation is the increase in the price of products and services over time. As the years go by you've probably seen the price of products and services going up, some more than others. But it’s rare to see prices going down!
Do you remember when a loaf of bread cost $1? It wasn’t all that long ago. And today we pay closer to $5! That’s the power of inflation.
But what causes inflation? Here are some of the key triggers that lead to prices going up. And up. And up…
Mo’ money
From time to time the Reserve Bank of Australia introduces more money into the economy, known as Quantitative Easing (QE) and referred to as “printing money”. When this happens, people have more to spend. This increased buying power creates additional demand for goods and services, which results in a lag in supply and causes suppliers to raise their prices. This process is known as demand-driven inflation.
Cost-push inflation
Cost-push inflation is driven by an increase in the cost of production of goods or services. This increase is duly passed on to the consumer, resulting in higher prices.
A good example of cost-push inflation is the price of petrol, which is driven, among other things, by the price of oil. So, as oil gets more expensive, so does refined petrol. And as the price of petrol goes up, so too does the cost of moving goods from point A to point B. This, in turn, drives up the price of the goods being transported, leading to higher inflation.
How is inflation eased?
A cure for high prices is high prices.
High prices often lead to a reduction in demand, as consumers’ buying power becomes limited. This results in a drop in consumption of particular goods or services, and ultimately an easing in prices.
Other methods to ease inflation include a programme (tapering) to reduce buying and selling bonds, or increasing interest rates.
But how does this affect the stock market?
Many stocks during the period may be volatile as inflation affects future cash flows. The general trend will be downward, though, giving investors a great opportunity to “buy the dip”.
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