Fundamental Beans

Inflation


Jul.20.2013

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Inflation is the reason why your parents paid less than a dollar for a gallon of milk, while you have to pay at least three dollars. Inflation is the general and progressive increase in the prices of the stuff that you buy. Moderate inflation is usually a sign of a strong economy, but you don’t want inflation to get out of control! That is why the central bank of each country tries to stabilize inflation-rate indicators such as the CPI (Consumer Price Index).

In fact, inflation rates and interest rates are interconnected. Higher interest rates result in lower overall growth and lower inflation. This happens because when interest rates are higher, consumers and businesses borrow less, save more, and invest less.

When inflation gets high, the Fed (and other central banks) tries to control it by raising interest rates. Because of the way inflation affects interest rates, when there is an increase in inflation, this will usually be bullish for the currency of that nation (if that nation’s central bank is smart!). The central bank will try to raise interest rates to help stop the increase in inflation. Conversely, if the numbers announced by a central bank indicate a decrease in inflation, this will put downward pressure on the currency because interest rates will be adjusted lower as a result.

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