Inflation: Is the rise in prices of goods and services in an economy and having an understanding of it is essential in order to trade financial markets effectively. Deflation on the other hand, occurs when prices experience an overall decline and normally occurs during periods of economic struggle.
Inflation has been practised throughout history as a tool that governments use to pay for its expenses, spur economic growth and control the populace of a country. Historically, governments would induce inflation by melting down gold coins and mixing them with other metals such as silver, copper or lead.
The government could thus issue more coins, at the same nominal value, effectively putting more coins into the money supply and diluting the real value of each coin. The effect of this is that the government can produce the same value money at a cheaper cost. The government is therefore able to gather more money to finance its expenses.
As the distribution of money increases, the populace feels more content as they believe (incorrectly) that they are becoming wealthier.
These days, governments are able to increase money supply much more easily by printing paper money, also known as fiat currency.
You need to know about inflation and deflation in order to understand what kinds of returns you should be targeting and what sort of returns may or may not be possible.
If inflation is high, then your returns need to be equally high or you are not making any money.
For example, let’s say that inflation was 3% last year but your portfolio only returned 2%.
In other words, even though your portfolio made 2%, you still lost money in real terms, since the prices of everything around you has gone up more than your wealth has. Similarly, if your investment makes 3% and inflation is also at 3%, you are no better off.
Generally, economists favor a level of inflation that is low and steady, around 2%. Much lower than that and economists fear stagnation while much higher and the implications from an economic slowdown become more severe. Central banks, therefore, use interest rates to try and keep inflation at around this 2% mark.
Any return you make must always be compared to the rate of inflation. Generally, when prices are dropping it is harder to make bigger returns so look for investments that are immune to low prices and benefit from lower interest rates. Investments such as banks and bonds, for example.
Conversely, if prices are forecast to rise, look to investments that retain their value, such as property, gold or commodity stocks.
We hope that you must have understood about inflation. Inflation plays a huge role in the stock market, so we have given you this article on this. But we would like to say one thing to you, to earn more profit, you have to be associated with this field, more and more books, courses, blogs can make you the king of the stock market. Do read our other important articles.