Calculate Real Return Of Investment: Inflation Calculation

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* Inflation rate has been compounded annually.

Most people understand that inflation can raise the price of their food or reduce the value of a dollar in their wallets. When you hear about inflation, you probably think you’re paying higher grocery prices at the grocery store.

A common cause of inflation is an increase in the cost of producing goods and services, which leads to higher prices. Another cause of inflation is when the demand for goods and services exceeds what can be produced at the time, causing prices to rise. Demand-pull inflation occurs when the demand for a good or service increases but supply stays the same, causing prices to rise. Cost-push inflation occurs when the supply of a good or service is somewhat limited, but demand stays the same, causing prices to rise.

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What Is Inflation?

The increase in the prices of goods and services and therefore the decrease in purchasing power per rupee is called inflation. Inflation is one of the main factors that reduce the value of your money over time. Inflation can be contrasted with deflation, which occurs when the purchasing power of a currency increases and prices fall.

The reason is inflation, which describes the gradual rise in prices and the slow decline in the purchasing power of your dollars over time. Inflation refers to a significant rise in prices in a sector or industry, such as the automotive or energy industries, and eventually the entire economy of a country. There are many types of inflation, characterized by its cause or rate of growth. To refresh your memory, inflation is the general increase in the price of goods and services over time, such as common groceries, household items, medical services, and transportation.

However, because the interest rate on most fixed income securities stays the same to maturity, the purchasing power of interest payments declines as inflation rises. Similarly, rising inflation lowers the value of fixed-income securities. Accelerating inflation hurts long-term bonds even more, given the cumulative impact of lower purchasing power on cash flows in the distant future.

What is Hyperinflation?

If inflation is predicted, people often buy more to avoid future price spikes. Higher inflation could also stimulate spending, as consumers will seek to buy goods quickly before their prices rise even further.

However, when stagflation occurs, prices remain high even as consumer spending declines, making the purchase of the same goods more and more expensive. In an inflationary environment, uneven price increases inevitably reduce the purchasing power of some consumers, and this decline in real incomes is the biggest cost of inflation. While you may notice that the prices of things you buy regularly go up or down, inflation has a wider impact on your bottom line.

When inflation occurs, a business can often pass on the higher prices it incurs to run its business for customers. This can lead to an upward spiral in prices, sometimes referred to as “runaway inflation” or “hyperinflation“.

Reason Behind Inflation

Supply shocks that disrupt production, such as natural disasters, or increase production costs, such as high oil prices, can reduce overall supply and lead to “cost-driven” inflation, in which the impetus for price increases comes from supply disruptions. .

Conversely, when the cost of production or goods rises—due to wage inflation, natural disasters, monopolies, taxes, and subsidies, or changes in the nation’s money supply—the result is cost-driven inflation. For example, when the expansion of the money supply leads to a speculative boom in the price of oil, the cost of energy for all uses rises and pushes up consumer prices, which is reflected in various inflation measures.

When inflation rises suddenly or unexpectedly, economic uncertainty can increase, leading to lower corporate earnings forecasts and lower stock prices. Even low inflation can significantly reduce purchasing power in the long run. Even moderate inflation means that money held in cash or in bank accounts with low annual interest rates will lose purchasing power over time. However, you can keep up with inflation or even slightly exceed it by opening a high-yielding savings account.

How to Calculate Real Return?

To fight inflation, you need to avoid keeping your money dormant (cash) or in your savings account that offers paltry interest in real terms. In addition to saving you money, inflation is a big reason why you shouldn’t hide cash in a shoebox or under your pillow.

Your money may be safe in an account that pays 0.5% per year, but if the inflation rate is 2%, your money loses 1.5% of its purchasing power every year. So in this scenario, if your savings weren’t generating at least 2% a year, the inflationary effect would mean that your money could buy less during the year. However, your savings may not grow fast enough to fully offset the losses from inflation.

When savings don’t grow at the same rate as inflation, there’s no loss in nominal value, but those savings don’t buy as much as they did a year ago. Inflation can rise and fall, but if, for example, inflation were at 2%, this means that the prices of basic goods that households need to buy, such as food, fuel, and clothing, will rise at a rate of 2%. year.

Key Points Inflation is the rate at which the value of a currency decreases and hence the general level of prices for goods and services increases. Inflation is designed to measure the aggregate effect of price changes on various products and services and to provide a unique representation of value for the increase in the price level of goods and services in an economy over a given period.

Quantification of the rate of decline in purchasing power can reflect the rise in the average price level of a basket of individual goods and services in an economy over some time. This average is divided by the price of the same basket from the previous year, causing inflation to rise or fall. The value of this basket at any point in time in the base year is the consumer price index (CPI), and the percentage change in the CPI over a given period is consumer price inflation, a measure of inflation most commonly used.

Inflation is measured by tracking the prices of goods and services that often directly contain commodities, as well as products closely related to commodities. Inflation is usually a broad measure, such as a general increase in prices or an increase in the cost of living in a country. Inflation is the increase in the cost of a wide range of consumer goods and services in various sectors such as gas, food, and housing.

Conclusion

It can also be measured as a percentage per month or as a price doubling time. In contrast to low inflation, in which price increases are protracted and generally undetectable except by examining past market prices, hyperinflation sees a rapid and continuous rise in nominal prices, the nominal value of goods, and the supply of currency. Inflation becomes hyperinflation when an increase in the money supply turns certain areas of price power into a general frenzy that must be spent quickly before money becomes worthless.

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