Lesson 20 – What is inflation?

Inflation is a increase in the general price level of goods and services, corresponding to a decrease in the currency’s value over time. Simply put, it signifies that the cost of living is rising. When inflation occurs, each unit of currency buys fewer goods and services than before.

The most common measure of inflation is the Consumer Price Index (CPI), which measures the average change in prices paid by households for a commonly purchased basket of goods and services. The CPI is expressed as a percentage change from a base period, which is usually set to 100. When the CPI increases over time, it suggests that inflation is occurring. A CPI of 110, for example, means that prices have increased by 10% since the base period.

What causes inflation?

Inflation can be caused by a variety of factors, including:

1. Increase in demand: When there is an increase in demand for goods and services, it can lead to higher prices as producers try to keep up with demand.
2. Increase in production costs: If the cost of producing goods and services goes up, businesses may increase prices to maintain their profit margins.
3. Increase in money supply: If the central bank prints more money and injects it into the economy, it can lead to an increase in demand, which in turn can cause inflation.
4. Exchange rate fluctuations: When the value of a country’s currency falls relative to other currencies, it can lead to higher import prices and cause inflation.

Effects of inflation

Inflation can have both positive and negative effects on the economy and individuals. Let’s take a look at some of them:

1. Reduced purchasing power: When inflation occurs, the value of money decreases, which means that consumers can buy fewer goods and services for the same amount of money.
2. Increase in interest rates: Inflation can lead to an increase in interest rates, which can make borrowing more expensive and reduce spending.
3. Wage increases: Inflation can lead to an increase in wages as workers demand higher pay to keep up with rising costs.
4. Increased business profits: Businesses may be able to increase their profits as they raise prices to keep up with inflation.
5. Decrease in international competitiveness: If a country’s inflation rate is higher than that of its trading partners, its exports may become more expensive, making them less competitive in the global market.

How to protect yourself from inflation

While inflation is a natural part of the economy, there are steps that individuals can take to protect themselves from its effects. Some of these include:

1. Investing in assets: Assets such as stocks, commodities and cryptocurrencies can provide a hedge against inflation by increasing in value over time.
2. Diversifying your portfolio: Spreading investments across different asset classes and sectors can help reduce the risk of inflation impacting one’s portfolio.
3. Budgeting and saving: Keeping track of expenses and setting aside savings can help you maintain your purchasing power even in times of inflation.
4. Keeping an eye on interest rates: Keeping track of changes in interest rates can help you make informed decisions about borrowing and investing.

How can cryptocurrencies help tackle inflation?

Cryptocurrencies have gained popularity as an innovative solution to tackle inflation.

One of the key ways in which cryptocurrencies can help tackle inflation is through their decentralized nature. Unlike traditional currencies, cryptocurrencies are not controlled by a central authority such as a government or a central bank. Instead, they operate on a decentralized network, which means that no single entity has control over the supply of the currency. This decentralized structure means that cryptocurrencies can potentially offer a hedge against inflation. As the value of traditional currencies erodes due to inflation, the value of cryptocurrencies, which have a limited supply, could potentially increase in value. This is because their supply is fixed, which means that they cannot be artificially inflated by a central authority.

Although cryptocurrencies like Bitcoin experience inflation, it is not subject to the same inflationary pressures as traditional currencies. This is because the supply of Bitcoin is limited through halving roughly every four years, countering inflation and preserving scarcity.

However, cryptocurrencies are susceptible to high volatility. It is also worth noting that all cryptocurrencies are not as effective as Bitcoin to address the issue of inflation. For instance, stablecoins are a type of cryptocurrency that aims to maintain a stable value. While they may seem like a potential solution to tackle inflation, they may not be as effective as one would hope. One of the main issues is that stablecoins are typically backed by fiat currencies such as the US dollar, which are subject to inflation themselves. This means that even if the stablecoin is maintaining its value in relation to the US dollar, it is still being indirectly affected by inflation.