Why inflation happens and the impact on common people? What does it mean by interest rate and how does it influence a country's growth?

 Today’s topic is going to be inflation. I will try to bring all the related information a person needs to know to understand the economy. How does inflation impact the market and everyone’s life? What are the reasons that inflation can rise in the economy? The actions can be taken to bring down inflation, does this necessary to happen! Is there any good sign of inflation!

So, let’s start today’s discussion without wasting a second of time.

 INFLATION: In simple words, inflation simply means the rising prices of goods and services. The rate is not fixed but it is likely to rise every year by a few percentages. Whatever product we buy or services we take, there is slightly a higher cost that we pay compared to the last year is called inflation. It keeps on happening every year, and that’s why it gets unnoticed by common people. But if the time gap increases by 5 years, you will clearly see the differences in prices.  

WHY INFLATION HAPPENS?

There might be multiple reasons behind inflation but the most common one is when the supply of money increases in an economy, it is believed that the rate of inflation is about to increase by a few percent. Let’s understand the concept in detail.

For example, there is a market where everyone is coming and buying their necessary products. Suddenly, the government decides to put a lot of money into the market in one way or the other to increase the growth rate of that particular area. Like they start giving loans to the common people at a lower interest rate so they would spend more. People are happy to take that money. After that, people start purchasing way more products than they really need to. The spending of common people is increasing, which means the economy is growing. Everyone is happy out there. The people who are associated with businesses would start making more and more products, and people get employment. The scenario still looks good. At this moment, when businesses see that people are purchasing things more aggressively so they would start rising the prices of products due to balance out the demand and supply chain. After increasing the price, people would start slowing down their spending habits, they won’t be buying products as much as they used to. And for that reason, a lot of businesses get crashed, people shut down their businesses, and because businesses do not get a lot of profits, they would start firing people. With time, businesses would start cutting their prices down but the prices of the products would never come down to their previous price. It is an unstoppable circle that would continue to happen. And that is how inflation comes into the economy.

We keep on hearing these days that inflation is so high in India, even in the USA, the inflation is higher than it is in India. Although the year 2022 isn’t finished yet, it was a high inflationary period. Inflation in India is around 8-9%, which means today’s 100 rupees would be worth 91-92 rupees after a year. That is how inflation is eating our money. And that’s why investing plays an important role to protect our money. In order to protect our money from inflation, we have to invest our money in assets that can generate more interest than inflation. That is the only way to provide security to our money otherwise it would become very hard to get retirement irrespective of the amount of money we have. It would be a whole separate discussion where we can invest our money in! today I will only talk about inflation, and how it is impacting our day-to-day life.

WHAT ARE THE STEPS THAT CAN BRING INFLATION DOWN?

 As we have seen that in order to increase the growth rate of a country, the government prints a lot of money and puts it into the economy, so at least people would have money to spend and the economy will not have to suffer a lot, as the same way, governments have ways to decrease the inflation too. Although it takes a period of time and sometimes a lot of negative news comes out as disadvantages. Before understanding the scenario, we have to understand a few things.

As we know RBI (Reserve bank of India) is the head of all the banks that are there in India, in the same way USA has the Fed (federal reserve) which controls all the banks in the USA irrespective of how large the bank is. Every country has one head bank that controls all the banks in that country. All the banks have to follow the rules set by that supreme bank. In India, RBI is the supreme bank. If any bank fails to follow certain rules, then that bank has to follow the penalty. Banks like RBI for every country are not motivated by its profits, rather their motive is to create some rules and circumstances, so the economy will be able to deal with bad situations. In RBI, we cannot open our bank account, it is a bank for all the commercial banks in India where we open our accounts in.

INTEREST RATE OR REPO RATE:  Now the second thing is the interest rate or (repo rate). We often hear this term in many ways. Like interest rates have been increased, Fed is increasing the interest rate! RBI has increased the interest rate by 0.5%! and people get confused with the interest rate because there are many kinds of interest rates out there like it could be home loan interest rate, bank interest rate, it might be your car loan interest rate, etc.

Here, the interest rate means the interest that RBI in India or the Fed in the USA charges over the banks to that they have given a loan to. If RBI comes and says that they are going to increase the interest rate or the repo rate by 0.5 percent, it simply means commercial banks have to pay 0.5% more interest on the loans that they would take further.

So, if tomorrow, the government or the RBI wants to bring inflation down then they simply have to increase the interest rates. To understand how these interest rates are impacting the market, we have to understand how banks are generating their profits. Banks charge interest on the loans that they give to people or businesses. So, if RBI increases the interest rate, banks would also increase the rate of interest. Now you can think on your own in which scenario would you like to take a loan from banks when the interest rate is 2-3% or when the interest rate is 6-7%. Most likely your answer would be the first one until or unless a major necessity has come your way. That’s why RBI has been continuously increasing the interest rate every quarter of this year because the inflation was too high this year.

The inflation was too high because of the covid pandemic. It was so sudden, the world was not ready for that. During covid pandemic, people lost their lives, businesses got crashed, people were fired from their jobs, unemployment started rising, and people didn’t have money to spend on things, in one way, our economy caught slow down. And for that reason, the market crash happened. But the government knew what to do in that critical situation. They printed a lot of money, decreased the interest rate, and started putting a lot of money into the economy, after that within a few months Indian economy got back its growth.

WHAT HAPPENS IF THE CENTRAL BANK CONTINUES TO INCREASE THE INTEREST RATE ONLY? 

But there is also a problem if RBI would only increase the interest rates to bring inflation down. Because if the interest rate is so high, then businesses wouldn’t take more loans, and people won’t be taking more loans to start a new start-up due to high-interest rates. And for that reason, what would end up happening is our economy will not grow, GDP will stop growing, and a bunch of other problems.

The same thing happened in the USA in 1970, the Fed continued to increase the interest rate quite aggressively and they successfully brought inflation down but because the interest rate was too high, people stopped taking more loans and the entire USA had to suffer economically. It took more than a decade to get back the rate of growth that the USA deserves.

So, those are the things that I wanted to talk about. I can understand it has taken a huge amount of time, and a lot of people will not come to this part of the article but if you are reading this line, then thank you that you have spent a few minutes of your precious time reading this article. I hope you got something to learn ……