Kavan Choksi Finance Expert Talks About the Effects of Inflation on The Economy

Inflation is a way of measuring the change in the price of everyday goods and services, right from haircuts and movie tickets to fuel and groceries. As Kavan Choksi Finance Expert mentions, the effects of inflation do not stop with shoppers feeling the pinch on their wallets. In fact, rise in inflation rates can impact the economy in several ways.

Kavan Choksi Finance Expert briefly discusses the impact of inflation on the economy

Prices of goods and services do go up with time. However, if it is 10% more expensive than it was 12 months ago, then that is the approximate rate of inflation in food. Central Banks hence try to keep inflation below 2% so that prices do not rise too fast and make goods and services unaffordable for those on the lowest incomes.

Rising inflation has far-reaching impacts across the economy, such as:

• Lost purchasing power: The most obvious impact of inflation is the loss of purchasing power, and the people with low income or fixed income are usually the ones to most significantly face its effect. Hence, as inflation takes hold, people must try to monitor how well their income manages to keep pace with the changes. If possible, they should negotiate for a raise or switch up income streams to keep up with rising expenses.
• Higher interest rates: The Federal Reserve, also known as the Fed, has a toolkit to tame inflation, which involves raising interest rates. As the interest rates go up, it becomes more expensive to borrow money. Average customers tend to take advantage of borrowing to buy major assets like houses and vehicles. Therefore, rising interest rates impact household purchases across the nation.
• Uncertainty and planning challenges: Unpredictable or high inflation rates can create uncertainty in the economy. Businesses and individuals may struggle to plan for the future, as they cannot accurately predict the future value of money. Long-term planning becomes challenging, leading to suboptimal investment decisions and potentially hindering economic growth. Retirees and lower-income wage earners are the first to feel the bite of higher prices caused by inflation. However, eventually, it works its way up the income chain and can threaten companies or even entire industries.
• Economic growth slows: The Fed tightens its monetary policy when inflation runs rampant. As the money supply starts to dry up, credit requirements get tighter and borrowing becomes more expensive. The cost of borrowing money is intentionally increased with the aim of lowering consumer spending and slowing inflation. This can however prove to be a challenge for consumers wanting to make major purchases.

As per Kavan Choksi Finance Expert, as the Fed tries to adjust the market with monetary policy and interest rate hikes, sometimes it may overcorrect. If the market is not ready for the Fed’s sanctions, it can lead to lower economic growth for the country. When such a situation takes place for a single quarter it is known as a contraction. However, if this happens for two quarters in a row, it is generally considered the start of a recession.