Those who pay any attention to financial markets and the economy will often hear about inflation. There is often a certain amount of fear associated with too much inflation. Other times you may hear about not enough inflation in the economy. However, many people do not actually know what exactly inflation is.
What is inflation?
When the overall purchasing power of a particular currency declines, this is referred to as inflation. Economists will measure inflation by looking at the increase in prices of a select group of goods and services within an economic region during a specified period of time. An increase in prices results in a unit of currency effectively purchasing less than it did in the previous time period. Usually this increase in prices is expressed as a percentage.
Impact of inflation
In practical terms, inflation results in individuals not being able to buy as much with the currency they are holding. Falling purchasing power for the general populace will eventually result in decreases in demand for goods and services. As a result, the continued growth of an economy will be hampered.
Most economists see inflation as a phenomenon which occurs when a nation’s money supply is growing faster than the growth of the economy.
How do central banks manage inflation?
One way a nation manages inflation is through actions taken by its central bank. The central bank can constrain the money supply through various mechanisms. For example, a central bank can reduce the amount of bond purchases it makes. It can also raise its benchmark interest rates. These actions are meant to manage the money supply and available credit in hopes of curbing inflation.
How can governments mitigate inflation?
Along with central banks, governments can also play a role in mitigating inflation in a nation’s economy. One way to decrease the money supply circulating in the economy is to raise taxes. Governments can also take actions to reduce supply chain constraints which will help reduce consumer prices, therefore allowing the currency more buying power for everyday people.
How can investors deal with inflation?
As an investor you will want to be keenly aware of the direction of inflationary trends. Rising inflation will mean some assets will become more risky and less lucrative compared to times of low inflation. For example, technology stocks tend to be more volatile and riskier during inflationary times due to rising interest rates which increases the cost of borrowing for these companies.
On the other hand, there are other types of investments which may produce more income as a result of increasing inflation. This might include commodities or real estate. Also, the increasing interest rates during times of inflation may make debt instruments, such as government bonds, produce more income for investors.
Consulting with a financial professional
Factoring inflation into your investment strategy may not be completely straightforward. There are questions of timing, as far as when to invest in assets as a response to inflation expectations. Also, having the right balance between risk and reward in your portfolio will be important and should be customized since not every investor is the same. Contact us today and speak to one of our knowledgeable financial professionals to help ensure your investment portfolio is optimal.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and investors may incur a profit or a loss. Past performance does not guarantee future results.