Terms Related To Inflation: In this article, we will learn about some of the most important terms related to inflation. In the time of inflation, economists mostly used these terms for describing the situations.
Terms Related To Inflation
What is inflation tax?
The inflation tax is not a direct or indirect tax, it is just a value of money that is paid for holding the cash. In other words, it is a situation when inflation works as a tax (inflation tax is also known as seignorage). Let us understand this with an example.
Suppose you have Rs 10,000 and you want to purchase a TV but suddenly you drop your idea of purchasing a TV and you decided to save your money. Now you have two options either you save your money in the form of cash or deposit that money into your bank account at 10% per year interest (here we are assuming that you have saved your money into your bank account). After one year you withdraw your money (which is now Rs 11000) and now you decided to purchase that TV but you noticed that due to inflation the price of that TV also increased by Rs 2000 and now it costs Rs 12000.
What happened in this situation? Here you have to extra Rs 1000 if you want to purchase that TV and this extra amount is known as inflation tax.
Lets understand why it happens?
This happens due to government expenses. As government earns from direct or indirect tax and then they use this money for their expenditure. But what happens if the government spends more money than their earnings? In the case of extra spending, the government has to print more money. In this scenario, the extra printed money circulated into the market, and money starts losing its value due to its higher quantity.
What is inflation spiral?
This is a situation when inflation and wages both are rising in a vicious circle. It is also known as the wage-price spiral. Let us understand this with an example.
Suppose the economy is facing inflation. Now in the case of inflation, the prices of goods and services increase, when the prices of goods and services increase people demand more wages and when they get more wages they demand more. As they get more wages they demand more and inflation further increases. When inflation again increased again they demand furthermore wages and again when they get more wages their demand again increase. This wage price makes a circle which is also known as a vicious circle.
What is inflation accounting?
Inflation accounting is a type of accounting that is used by corporate to adjust their overstated profit due to inflation. In other words, when a firm calculates its profits after adjusting the effect of the current level of inflation, this process is known as inflation accounting.
What is inflation premium?
Inflation premium is a type of bonus that is brought by inflation to the borrowers. In other words, the inflation premium is a difference between the nominal interest rate and the real interest rate. The nominal interest rate is charged by banks and the real interest rate is paid by the borrowers. In the time of inflation real interest is always lower than nominal interest. Let us understand this with an example.
Suppose you gave Rs 100 to your friend at a 10% interest rate and after one year your friend return you Rs 110 but in this time frame the inflation has grown at the rate of 20%. This means now you have to pay Rs 120 for those products which you could purchase at Rs 100 one year before (in inflation the purchasing power of money decreases). Now focus on this situation you got Rs 10 for your lending but in reality, your friend has got Rs 10.
Here the interest amount which you got is known as real interest. The benefit which your friend got is known as inflation premium. The sum of real interest and inflation premium is known as nominal interest.
What is Phillips Curve?
The concept of the Phillips curve was given by Alban WilliamHousego Phillips. The Phillips curve is a graphical curve that shows an inverse relationship between inflation and unemployment. In simple words, the curve suggests that the lower the inflation, the higher the unemployment, and the higher the inflation, the lower the unemployment. Let us understand this with the Phillips curve graph.
In this graph, P denotes the rate of inflation (means inflation due to wage) and U denotes unemployment. Now you can notice in the graph that when the inflation is at W0 then unemployment is at U3 and when the inflation increases and reach the level of P2and unemployment also decreases and reach the level of U1. Means Phillips curve simply shows that when inflation increases the unemployment decreases.