Finance
Jan 26, 2023
What is inflation?
Inflation is defined as a long-term increase in the general price level of goods and services in an economy. When prices rise, each unit of currency buys less goods and services; hence, inflation implies a decrease in money's buying power. Deflation is a similar concept that refers to a continuous decline in the general price level of goods and services.
The Consumer Price Index (CPI), which measures the change in the price level of a basket of goods and services used by households, is the most often used indicator of inflation. The Federal Reserve, the United States' central bank, employs a price index known as the Personal Consumption Expenditures (PCE), which is comparable to the CPI but includes a larger range of products and services. Inflation may be caused by a variety of factors, the most frequent of which is a rise in the money supply/ printing money. Prices rise when the money supply expands faster than the pace of economic expansion because there is more money chasing the same number of goods and services. This is referred to as demand-pull inflation.
Cost-push inflation, which happens when the cost of manufacturing rises, is another source of inflation. This can be triggered by causes such as an increase in raw material prices or a pay rise. When the cost of manufacturing rises, businesses will raise the pricing of their goods and services to compensate. A combination of demand-pull and cost-push forces can also produce inflation. A rise in demand for products and services, for example, paired with an increase in production costs, might result in a continuous increase in pricing.
Governments can strive to control inflation through monetary and fiscal policies. Monetary policy is concerned with managing the money supply, whereas fiscal policy is concerned with adjusting government expenditure and taxation. To manage the money supply, central banks such as the Federal Reserve can use techniques such as open market operations, discount rates, and reserve requirements. It should be noted, however, that managing inflation is not always straightforward and can be a delicate balance. If a central bank raises interest rates too rapidly to contain inflation, economic growth will decline and a recession will occur. On the other hand, if a central bank does not raise interest rates sufficiently to manage inflation, it can lead to hyperinflation, which is a rapid and uncontrollable rise in prices.
Inflation can also have a range of economic consequences. Inflation that is moderate might be helpful since it encourages consumption and investment. High inflation, on the other hand, may be harmful since it can cause uncertainty, discourage investment, and shift wealth from people on fixed incomes to those who possess assets that rise in value with inflation. In short, Inflation is defined as a prolonged rise in the general price level of goods and services in an economy. It can be induced by a rise in the money supply, an increase in production costs, or a combination of the two. Governments can strive to manage inflation through monetary and fiscal policy, but it is a tricky subject. Moderate inflation might be good, but excessive inflation can be harmful.
Inflation in the Netherlands and expectations
Inflation rose sharply last year, from 0.9% in 2021 to 12-14% in 2022. This will be slightly lower in 2023 to about 8% as expected. The increase is also clearly visible in the high energy and gas prices. In addition, it is also noticeable in the wallet where groceries have become more expensive. If inflation rises too fast, the European Central Bank must intervene to push back on the increase of the inflation.
In the meantime, the European Central Bank has already taken firm action to limit the consequences of the corona crisis. Globally, there have been significant delays due to lockdowns and the shutdown of the entire economy due to the pandemic. The ECB assumes that these disruptions are temporary and may reverse once the supply problems are resolved.
Interest rates for the past 10 years
Over the past few weeks, mortgage rates have already risen sharply several times, in most cases doubling. Rising interest rates have made borrowing much more expensive. Lenders have been able to keep their rates the same for a long period of time, but that is now changing. Interest rates will continue to rise as the year progresses. The US is already one step further, the FED will raise the rates in three steps this year. This has direct consequences for interest rates in Europe. Furthermore, the unpredictability of the coronavirus ensures that the ECB continues to operate cautiously.
The European Central Bank (ECB) expects that the interest rate will increase again in 2023. In other words, it becomes more expensive for lenders to borrow money from the ECB. As a result, interest rates will be raised in order to keep the margins of the banks in check.
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