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Inflation

Inflation is the erosion of the purchasing power of money over time, due to a rise in prices.

As time goes by in a growth economy, prices go up slightly. This is due to the fact that expenses creep up and businesses must maintain a profit. Competition keeps expense growth to a minimum. Your government averages the growth in prices across all product sectors and publishes an annual inflation figure which is expressed as a percentage. Ideally governments like to keep inflation less than 3% but more than 0%. When inflation is less than 0% this is called Deflation.

 

So what does inflation and deflation mean to the economy?

 

Inflation robs the people of their buying power. If you earn and save $1,000 and put it away, without earning any interest this money will be worth less and less as time goes by. If inflation accumulated to 50% over 20 years you wouldn’t have $1,000 anymore, you would have $500. Your account would still say $1,000 but it would only buy you $500 dollars worth of goods (in today’s money) at that future time because all the average prices doubled.

 

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Deflation increases the buying power of money. Before you think this is good please understand prices only go down across the economy if there is no demand, and no demand means a shrinking economy and people will find themselves out of work and if left to continue can grind an economy to a halt.

So deflation is bad, high inflation is bad and very low inflation is the best compromise. Ideally no price movement would be best, but fixed economies have never worked (see Supply and Demand) as there is no incentive for people to achieve their best, and unfortunately that goes against human nature.

 

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