Central bankers believe that mild inflation, in the 1 to 2 per cent range, is the most benign for a country’s economy. High inflation, stagflation or deflation are all considered to be serious economic threats.
The following factors can lead to inflation:
Economists generally believe that money supply is the key cause of inflation; in 2008, however, skyrocketing prices of oil, food and steel caused runaway levels of inflation in the world economy that collapsed only because of the global Financial Crisis.
One of the economic effects of inflation is the change in the marginal cost of producing money. This involves the appropriate 'price' of money which, in this case, is the nominal rate of interest. This 'price' indicates the return which has to bepre-determined to hold back the printing presses, in place of some other assets which offer the market interest rate.
In addition, if a country has a higher rate of inflation than other countries, its balance of trade is likely to move in an unfavorable direction. This is because there is a decline in its price competitiveness in the global market.
A high rate of inflation can cause the following economic impediments:
The value of investments are destroyed over time.
The central banks, monetary authorities or finance ministries of most nations have the authority to take economic measures to control rising inflation by regulating the following factors:
Reducing the central bank interest rates and increasing bank interest rates.
Different schools of thought emphasize different factors as the root cause of inflation. However, there is a consensus on theview that economic inflation is caused either by an increase in the money supply or a decrease in the quantity of goods being supplied, and that the effects of either high inflation or deflation are extremely damaging to the economy.