What is inflation? Why are prices increasing for everyday items? What are the consequences of inflation? How can we control or limit rising prices? Let’s discuss these questions and more on today’s episode of Thinking in English!
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Stable (adj) – firmly fixed or not likely to move or change
I’m looking for a stable job in a bank!
Out of business (idiom) – closed down/no longer in business
My local hairdresser went out of business last month
Hypothetical (adj) – imagined or suggested but not necessarily real or true
This is hypothetical, but if I offered you a job, would you accept it?
Worth (adj) – having a particular value, especially in money
My house is worth $200,000
Keep track of something/someone (idiom) – to continue to be informed or know about someone or something
My sister has had so many jobs, I can’t keep track anymore
Goods (n) – things for sale, or things that you own
There is a 10 percent discount on electrical goods today
Monetary (adj) – relating to money in a country
The recent recession has been blamed on a bad monetary policy
Interest rate (n) – the interest percentage that a bank charges you when you borrow money, or the interest percentage a bank pays you when you save money
Interest rates are increasing
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Inflation is Everywhere…
Depending on where you live in the world, you may have noticed things becoming more expensive over the past few months. Even in countries that traditionally have very stable prices, fuel in gas stations and food in supermarkets have started to become more expensive.
In the UK, prices are rising at the fastest rate in over 40 years. Energy costs have soared – on average people are paying three times more for energy this year compared to last year. The consequences are already clear – companies are going out of business or increasing their prices to deal with massive energy bills. In my hometown, the local butcher (shop selling meat) which is famous for having some of the best sausages in the UK closed a few days ago – their energy bill was 4 times higher than last year.
And for individuals, costs are much higher. People are already having to reduce their energy use – and it will get even worse as the weather in the UK gets colder. Talking to my parents the other day, my mum already told me she is planning on using our heating far less this year due to the cost!
The same is true in countries all across the world. Prices are rising, things are more expensive, and the consequences are going to be widespread!
These rising prices are connected to an economic phenomenon called inflation. You will definitely be hearing a lot about inflation over the next few months (and actually I have already mentioned inflation in a few recent episodes!) so it is important that you understand and have the vocabulary to describe inflation. Today, let’s discuss what inflation is, what the consequences are, and how to control inflation!
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What is Inflation?
Prices sometimes increase, sometimes decrease, and sometimes are very stable. It is part of the economy – well, part of a free market economy. Inflation, in the simplest terms, is a general increase in the prices of things over time.
Let’s take a hypothetical example – the price of bread. If last year a loaf of bread cost $1 and this year the same loaf costs $1.10… then the price of bread has increased by 10% in one year. Therefore, bread inflation is 10%.
However, the price level of an individual good is very different to inflation. If millions more people start eating carrots tomorrow, that means there will be greater demand for carrots and the price will probably increase. Similarly, if people decided not to eat onions… it is likely the price of onions will decrease.
Inflation, however, is when everything gets more expensive! Inflation is a general rise if the level of prices across the economy. In Europe, everything from fuel and energy to vegetables and technology have become more expensive over the past year – this is inflation.
Importantly, inflation is not just an increase in prices, but an increase in prices relative to the value of money. If inflation this year is 10%… that means that your money is worth 10% less than it was last year. Your $1 this is worth less than $1 last year… as you can buy less.
Sometimes inflation can take the form of “shrinkflation.” Rather than prices increasing by themselves, the size of the goods may also decrease. In 2014, a KitKat chunky (a popular chocolate bar) weighed 48g and cost £1.25. In 2018, the price had increased to £1.56, but product was also only 40g.
How to measure inflation?
To calculate the inflation level in an entire economy, you need to calculate the increases (or decreases) of all the prices in an economy – for all the goods and services. How does this happen?
The exact process of determining inflation is different around the world, but often they are based on something called a consumer price index. In the US, the Bureau of Labor Statistics employs hundreds (maybe even thousands) of people who travel around the country visiting stores and recording the prices of millions of products. They look at the difference in prices between similar goods, and the differences between different regions in the country.
The same is true in the UK. Government agencies keep track of hundreds of everyday items – this is known as the “basket of goods.” The “basket of goods” contains around 700 things people in the UK buy often and is constantly adjusted to match people’s interests. By comparing the price of this year’s “basket of goods” with last year’s “basket of goods” can tell you how fast prices are changing – or in other words, the rate of inflation.
Economists give greater importance or weight to things that people spend more money on. For example, increases in the average price of electricity are considered more important than an increase in the price of sugar. If a country eats more chicken than beef, then changes in the price of chicken is considered more important than the price of beef.
This is a very simplified explanation of how inflation is calculated. There are many other calculations used to get an accurate picture of the economy. For example, the data has to reflect changes in quality of products. Modern day smartphones are of course more expensive than the Nokia phone I had when I was 13… but they are not really the same product. The same is true with a lot of other technology.
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Why does inflation happen?
What causes inflation? This is not an easy question to answer… in fact there are professors around the world who dedicate their lives to studying inflation. However, I will try to introduce a few simple explanations and summaries of expert’s opinions.
The current high inflation rates have a number of different causes. In the UK, the impact of Russia’s invasion in Ukraine has been serious. Oil and gas prices are high, meaning that energy bills and fuel prices are also high. Food prices have also increased as Ukraine is unable to export or produce grain.
Prices have also increased for things including raw materials, used cars, and furniture. Interest rates are also high – making loan and mortgage repayment high. All of these things have combined together to create the highest rate of inflation in the UK for 40 years.
In most cases, inflation is connected to an increase in the amount of money in an economy. As there is more money, the value of each bit of money is reduced. This can be caused by a government giving more money to its citizens, the currency being devalued, or the government loaning new money to banks.
According to the great economist Milton Friedman, “inflation is always and everywhere a monetary phenomenon.” He believed that the reason prices increase is because the people in charge of managing economies allow prices to increase.
People often assume that outside factors cause inflation. Russia’s invasion of Ukraine, for example, has caused energy and food prices to increase. Or China’s development in the 1990s led to an increase in the number of Chinese people eating beef which led to an increase in beef prices. Increases in these prices cause increases in other commodities… and eventually everything is more expensive.
Friedman believed that this logic was incorrect. He was writing during the 1970s oil crises – and he believed that just because oil prices were increasing, this did not mean prices for everything should increase. With a successful monetary policy and economic management, high oil prices could be balanced with lower prices in other parts of the economy. Friedman suggested inflation was due to the people in charge allowing all prices to increase.
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Consequences of Inflation?
Is inflation a problem? Does it really matter if prices are increasing?
Inflation is not necessarily a bad thing. In fact, a little inflation helps to create a strong and healthy economy. Government’s set targets for inflation – the UK aims for around 2%. If average wages are also increasing, rising prices can actually be helpful.
But, high levels of inflation can be harmful to an economy. At the moment, levels of inflation are high and unstable – it means that people are unable to predict the future. We don’t know how much to spend, invest, or save – as we don’t know how expensive things will be in the future. If there is a possibility that basic goods like food will be 10-15% higher next year, then I might think twice about how I spend my money right now.
Everyday items will be more expensive and normal people will be more uncertain about the future. Some prices can increase faster and/or earlier than other prices – changing the balance of the economy.
And if inflation gets out of control, it can lead to severe problems or even economic collapse. Turkey has had serious inflation over the past year – basic goods can now be almost twice as expensive as last year. But this does not even get close to Venezuela or Zimbabwe – two countries which have recently experienced hyperinflation.
Around 15 years ago, Zimbabwe has an inflation rate of 80 billion per cent in one month… 80 billion per cent. Prices were so high that people stopped using their own currency and instead bought things using currencies like the US dollar.
How can Inflation be Controlled?
Can we stop inflation? How can rising prices be controlled?
The traditional response to rising prices and inflation is to raise interest rates. Higher interest rates encourage people to save money – it is more expensive to borrow money and people with mortgages have to pay back more every month. As people have less money to spend, they will buy fewer products and thus prices will fall.
The problem right now is that inflation is linked to international events. Global rises in energy prices make it difficult for a country to address inflation with interest rates.
If we go back to Milton Friedman – he believed that the cause of inflation was governments and central banks letting prices increase instead of balancing the economy. However, even if Friedman was correct… it doesn’t mean he was right in practice.
Here is an example – Friedman might suggest raising interest rates when oil prices are really high as this will reduce spending and increase saving. However, raising interest rates also increase unemployment. More unemployment lowers the prices of other goods as people have less money to spend… and therefore no inflation.
But… is causing more unemployment to stop prices rising a good idea? To me, it sounds like balancing a bad thing with another bad thing. A government has to decide between to the negatives of inflation and the negatives of unemployment!
Today, I have tried to give you all a basic introduction to inflation. I’m sure some of you studied economics at university, and probably know more about inflation than I do, but I think this episode is a useful and simple guide to inflation. It has also introduced you to some important economic vocabulary!
Around the world, prices are increasing – and this is known as inflation. Inflation can have serious consequences for economies and normal people. As I mentioned at the beginning of the episode, businesses are already closing in the UK and there is a lot of fear in Europe about this year’s winter.
How about in your country? What is your country’s rate of inflation? Have you noticed prices increasing? How do you think we should stop inflation?
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