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I found this video to be excellent as the host challenged the the government official - the Minister of Finance for Edmonton. On inflation rates and their plans to decrease it.

I enjoyed listening to both their reasonings as to why Canada's inflation problems are so severe at the moment. The Minister highlighted issues like Canadians overbuying goods during the pandemic, which shorted the Supply Chain, also talked about the war in Ukraine as a factor as to why things are as difficult as they are. He brought up new government shelter to put more money in the average person's pockets on a monthly basis. The Host however (and accurately) challenged this notion of putting "a little bit of change" in the average Canadian's pocket, and how it does nothing to actually decrease inflation. A very good video with real questions challenging the direction of our leadership.

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Government looks to help Canadians 'feeling the pinch' of inflation

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A very informative video from a political standpoint. This video highlights how government spending has affected inflation, the actual process of it and the potential repercussions. Through this i came across a new economic term called "stagflation"

This video highlights "Stagflation" which is double digits inflation rates, while still having sky high interest rates. This caused crippling unemployment numbers and basically sent the economy into a recession. It was alarming to find out that federal spending soared to over 100% (28 billion to 343 billion) This indicated a 40% increase in the federal debt in just one year. The video spells out that because the government is printing more and more money every year, it is devaluing it's currency. Which in turn increases the amount of inflation every year.

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Could Runaway Inflation and 20% Interest Rates Return to Canada?

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This article gives the complete year to year breakdown of Inflation in Canada. It also gives a breakdown of every other country in the world and measures the inflation rate of Canada in comparison

I enjoy this article because it gives me cold hard data. I can see the rate of inflation for every year since since 1960. And the troubling information that i took out of this article is that Canada has not experienced significant growth in their economy since the mid 70s to early 80's. For the past 50 years the economy has had minimal growth at best. And this reflects within the rate of inflation. For instance in 1972-75 The Canadian economy experience a growth of 3% on average. From 2019-2022 the Canadian economy has experienced a decrease of 2% on average.

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Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used.

Canada inflation rate for 2020 was 0.72%, a 1.23% decline from 2019.

Canada inflation rate for 2019 was 1.95%, a 0.32% decline from 2018.

Canada inflation rate for 2018 was 2.27%, a 0.67% increase from 2017.

Canada inflation rate for 2017 was 1.60%, a 0.17% increase from 2016.

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Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used.

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This Article is from the official Bank of Canada. They highlight how they determine their overnight rates. They speak about their balance sheet, the CPI inflation and it's plans to control rising inflation.

I really enjoy reading the perspective from the Banks themselves, the very entity that controls the economy, and how they see the inflation issue. They speak about how the Overnight rate works, which is when Banks come together to borrow and lend money. They settle based on data taken from the CPI (Consumer Price Index) where they narrow in on goods typically used by canadians and the current pricing of these goods. When they settle on their overnight rate, the market is fixed.

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Latest Update: April 13, 2022

Bank of Canada Announces Historic Rate Hike of 50 Basis Points

The Bank of Canada increased its key interest rate by 50 basis points on April 13, 2022, bringing the central bank's policy rate to 1.00%. This is the largest individual rate hike since 2000, and comes about amid soaring Canadian housing prices and inflation.

Highlights from the Bank of Canada's April 13, 2022 meeting include:

The Target Overnight Rate will increase by 0.50 percentage points to 1.00%.

CPI inflation of 5.7% is at a 30-year high and at a level not seen since 1991. It's expected to further increase to around 6%, and it currently remains well above the Bank of Canada's 2% target.

The spotlight now turns to the Bank of Canada's balance sheet, which currently stands at 19% of Canada's gross domestic product (GDP).

Quantitative tightening (QT) is set to begin on April 25, 2022. This will gradually reduce the Bank of Canada's balance sheet.

The 50 basis-point rate hike by the Bank of Canada revealed the central bank's hawkish side as it aims to control rising inflation. This decision was backed by confidence in the economy's recovery, evident through strong job growth as the unemployment rate fell to a record-low of 5.3% in March 2022. It's also spurred on by the hawks down south, with the Federal Reserve set for a 50 bps rate hike at the FOMC's next meeting on May 4, 2022.

Looking forward, another rate hike is all but certain at the Bank of Canada's next meeting. The next interest rate announcement will be on June 1, 2022, at 10 a.m. EST.

Best Mortgage Rates in Canada

Refinance: Changing your mortgage amount

Renew: Mortgage from a new lender at the end of your mortgage term

* Terms and conditions apply. Lowest rates are for high-ratio mortgages (LTV > 80%).

Bank of Canada Meeting Schedule for 2022

How the Bank of Canada Determines Its Target Overnight Rate

The Bank of Canada makes its decisions based on the growth of the Consumer Price Index (CPI) from Statistics Canada. This is calculated from the price of a monthly "basket" of goods and services typically used by Canadians. It represents a broad picture of consumer spending across Canada.

Using its monetary policy tools, the Bank of Canada aims to maintain inflation, as calculated by changes in the CPI, within a certain range. Introduced in 1991, the inflation-control target sets a range of 1% - 3% as the ideal range for annual inflation, with the midpoint of 2% being the common target rate. This range is reviewed regularly with the latest review being in October 2016.

The Bank of Canada reviews its benchmark interest rate eight times a year and considers both local and international, current and potential influences in their review. Although the Bank of Canada operates independently of the government, it is ultimately responsible to Parliament through the Minister of Finance.

How the Overnight Rate Works

Think of the banks as a group of friends. The banks don't like to hold cash and like to lend out their money whenever they can. Sometimes, Bank A might have a lot of cash on its hands while Bank B might have less. Since they're friends, Bank A is more than happy to lend money to Bank B. But they're banks, so they don't want to lend their money out for free. So they charge an interest rate.

Everyday, the banks come together and make offers to borrow and lend money. The rate that they settle on is called the "overnight rate" because it's the interest rate for borrowing cash "overnight". The Bank of Canada is the "mom" of the group. The Bank of Canada has a "target overnight rate" and tries to keep the overnight rate close to the target. If the rate gets too low because there's too much money, the banks can lend their money to the Bank of Canada instead. If the rate gets too high because there's a shortage of money, the Bank of Canada acts as a "lender of last resort" and will lend out money.

Bank of Canada Overnight Rate Changes Since 2010

Bank of Canada Overnight Rate Forecast

Bank of Canada Rate Forecast for 2021: Stable at 0.25%

Despite rising asset and commodity prices, the Bank of Canada has signalled that their Target Overnight Rate will remain stable at 0.25% for 2021. We expect to BoC to maintain their commitment and do not expect any rate changes by the end of 2021.

Our rationale is based on the uncertainty of recovery from COVID-19 as well as the policy and political motivations of the Bank of Canada. While Canada's economy showed a higher-than-expected rebound in Q1 2021, new lockdowns and the high likelihood of the spread of new variants have put a pause on further growth. Slow vaccine rollout campaigns are also likely to prevent a full recovery by the start of Q4 2021. We expect these factors will push the Bank of Canada to maintain a loose monetary policy in order to continue to support Canada's recovery from COVID-19.

From a policy and political side, the new Federal 2021 budget expects a budget deficit of $154.7 billion CAD for the next year and elevated deficits for the years after. The Bank of Canada already owns more than 40% of total federal government debt and we expect them to continue to help to monetize federal debt as well as assist in Canada's economic growth.

Bank of Canada Rate Forecast for 2022: Rising to 0.50%

Due to rising asset and commodity prices as well as expectations for a better-than-expected economic growth in 2021 and 2022, we expect the Bank of Canada's target overnight rate to rise to 0.5% by the end of 2022.

Record-breaking activity in Canada's housing markets and rising commodity prices are likely to put upward pressure on CPI measures in 2022. CPI is already expected to exceed 2% in 2021, and we expect that the Bank of Canada will find that the rise in the rate of inflation is not temporary. Consequently, we predict that the BoC will raise their target overnight rate to a minimum of 0.50% by the end of 2022.

At this point in time, we do not expect the target overnight rate to exceed 0.75% in 2022. The US Federal Reserve has signalled that it will maintain its overnight rate at the zero bound until 2023, putting pressure on the BoC to maintain a similar stance. At the same time, both the Federal Reserve and the Bank of Canada have other tools to tighten monetary policy including the reduction of their QE programs. We expect the BoC to slowly reduce its debt purchase program before it takes further actions to raise its policy interest rate.

Why Not Negative Rates?

The zero lower bound is no longer the strict rule that it once was - the European Central Bank (ECB), the Bank of Japan (BOJ), and central banks of Denmark, Sweden, and Switzerland have all experimented with breaking the zero barrier. The ECB and BOJ have both used negative deposit rates since 2014 and 2016 respectively, and the BOJ has had decades of experience with near-zero rates. Why doesn't the Bank of Canada do the same with negative rates?

Negative rates have significant implications for the financial sector as banks can't offload the costs of the negative rate onto their clients (imagine how popular a negative-rate savings account would be). According to a BoC paper from 2015, this can significantly compress margins for banks and other financial institutions as well as create market distortions. Due to these reasons and other effects of a negative interest rate policy, the Governor of the Bank of Canada, Tiff Macklem, has announced that he does not see negative interest rates as a viable option for the BoC.

Bank of Canada Interest Rate Forecast Chart

Bank of Canada Interest Rate Forecast for the Next 5 Years

Above, we have predicted that the Bank of Canada's Target Overnight Rate will remain at 0.25% for 2021 and rise to 0.50% in 2022. From 2023 onwards, the outlook is less certain and highly dependent on global macroeconomic factors. CPI inflation is expected to surpass the BoC's target of 2% in 2021 and stabilize at 2% in 2022 and beyond. However, it is likely that increased global liquidity and fiscal spending will continue to put upward pressure on prices and drive inflation upwards. Conventionally, this would prompt the BoC to continue to raise rates.

However, the massive amounts of debt raised by both federal and provincial Canadian governments will pose a barrier to any further increases in interest rates. The Federal government alone is expected to borrow $713 billion CAD in 2020, more than double the amount raised in 2019. The 2021 Federal Budget shows a commitment to further deficit spending with a deficit of $154.7 billion this year. While much of Canada's debt is already owned by the Bank of Canada, it would be counter-productive to the aims of Canada's government to increase rates and tighten monetary policy while the government is deficit-spending to boost the economy.

The Bank of Canada and Mortgage Rates

Through the key policy rate and its other monetary policy tools, the Bank of Canada influences the interest rate for all borrowing and lending transactions in Canada. For example, changes in the key policy rate usually lead to changes in bank Prime rates. Subsequently, the key policy rate has significant influence on variable mortgage rates that are based on a lender's Prime rate.

Changes in the key policy rate and monetary policy can also affect fixed mortgage rates. Fixed mortgage rates usually follow the yields of Government of Canada 5-Year bonds. A shift in monetary policy can lead to changes in the bond yields, which will then lead to changes in fixed mortgage rates.

Best Mortgage Rates in Canada

Refinance: Changing your mortgage amount

Renew: Mortgage from a new lender at the end of your mortgage term

* Terms and conditions apply. Lowest rates are for high-ratio mortgages (LTV > 80%).

Canada Mortgage Rate Forecast

Variable Rate Forecast

We expect variable mortgage rates to remain stable until 2021 with a rate hike in the second half of 2022. Variable mortgage rates are based on the Prime rate, which follows to the Bank of Canada target overnight rate. Our projections show that the BoC is unlikely to deviate from its current overnight rate of 0.25%. Consequently, Prime rates and variable mortgage rates are likely to also remain stable.

Increased competition in the mortgage sector may lead to discounts for new mortgages or refinances, but variable mortgage rates are already near historical lows and it is unlikely that rates will go down further.

Fixed Rate Forecast

As of April 2021, fixed mortgage rates are already rising to take into account higher inflation expectations and 5-year bond yields. We expect them to remain at current levels until the second-half of 2021 before rising further to match rising inflation expectations.

Bank of Canada Overnight Rate History

The Beginnings of Canada's Central Bank in 1935

The Bank of Canada was created as part of the Bank of Canada Act in 1935. It was recommended by the Royal Commission in response to the economic conditions of the Great Depression. In March 1935, the Bank of Canada was opened to the public as a private institution with shares sold to public investors. It was quickly nationalized as a public institution by an amendment to the Bank of Canada Act in 1938.

1935 - 1945: The Great Depression and World War II

The Bank of Canada rate (not officially the target overnight rate until much later in the century) started at 2.5% in 1935 and ended at 1.5% in 1945. The economy strengthened during the war as Canada played a vital role in supplying natural and manufactured resources to the Allies. There was also increased employment, especially of women. The decrease in the Bank of Canada rate encouraged people and businesses to borrow money to invest in new manufacturing plants and housing.

1935 - 1955: The Post-War Period

After World War II, the Bank of Canada rate did not rise until October 1955, when it was changed to 2.0%. This low-interest rate environment promoted investment in new infrastructure, manufacturing, housing and consumer goods.

1977 - 1991: Stagflation

After the upward change in 1955, the Bank of Canada rate continued to rise slowly throughout the 1960s and early 1970s. In October 1978, the benchmark rate hit double digits for the first time at 10.25%. This was due in part to the global oil crisis and the OPEC oil embargo. With record-high prices for oil in August 1980 that continued into 1981, the Bank of Canada rate hit an all-time high of 20.03% in August 1981. The lowest rate reached during this period was 7.14% (March 1987).

1991 - 2008: Economic Recovery

After the recession of the 1980s, the Bank of Canada rate between 1991 - 2009 generally went downwards with only a few exceptions. The inflation-target rate was introduced at the beginning of this period.

2009 - 2017: The Great Financial Crisis

In March 2009, the BOC rate dipped below 1% for the first time to 0.5% in response to the Great Financial Crisis. Despite a minor recovery, in 2014, oil prices dropped a staggering 60%, causing a recession in Canada's oil-driven export economy. The Bank of Canada rate then dropped from 1.25% to 0.75% in 2015.

2018-Present: Low Inflation and COVID-19

Despite widespread economic growth, 2018 and 2019 were marked by continued low inflation, preventing the Bank of Canada from raising rates any higher than 1.75%. This was quickly reversed with the impact of COVID-19 with a two 50 basis point drops in March 2020. The Bank of Canada rate now lies near its lower limit at 0.25% and is unlikely to be raised anytime soon due to the deflationary impact of reduced consumer spending and distressed economy.

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Bank of Canada Interest Rate 1935-2022 & 2022 Forecast | WOWA.ca

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The Bank of Canada increased its key interest rate by 50 basis points on April 13, 2022, bringing the central bank's policy rate to 1.00%. This is the largest individual rate hike since 2000, and comes about amid soaring Canadian housing prices and inflation.

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This video backs up the statistics on our current inflation crisis. In August 2021 alone the inflation rate spiked 4.1%. In the video the experts gave tips on combating inflation.

The standout part of this video is the tips given to the viewer on how to respond to inflation. Such as we of the Labor Force should not just wait for the market to set the price, we should not wait for the government to increase our wages. We need to be the ones who control the economy, and this would be done by demanding higher wages. If we were to strike from work, it would cause a ripple effect because Companies would have to take action because the demand for workers would increase, causing them to increase wages to attract the lost workers

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Rising inflation across Canada could lead to interest rate hike in 2022: analyst

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I choose this short video for me because it illustrates how Inflation and Interest rates work in real time. This is a very current video (Based in January 2022) so this highlights the obstacles that our Economy is facing at this very moment.

I like that the video highlights price hikes in grocery stores, because for many of us the term "Inflation" and "Interest rates" does not really hit home until we feel it's effects on our food. When the single most important tool for our survival is compromised, it forces us to pay closer attention to what is affecting it

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Investigating Inflation: How will rising interest rates lower inflation?

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I enjoyed this website because it was very detailed. It explained the direct relationship of Inflation vs Interest rates and how they run inversely to eachother. In this website i was able to see infographics, stats and not only issues but potential solutions as well.

I particularly enjoyed learning about the inverse relationship of Inflation and Inflation rates. For instance, when Interest rates decrease, Inflation rates increase. Because Money circulating in the market will decrease, and borrowing will become expensive. Once that happens demand for goods and services decrease.

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Inflation rate signifies the change in the price of goods and services due to inflation, thus signifying increasing price and increasing demand of various goods whereas interest rate is the rate charged by lenders to borrowers or issuers of debt instrument where an increased interest rate reduces the demand for borrowing and increases demand for investments.

The interest rate affects inflation, and both are closely related. They are generally referred to together in macroeconomics. This article looks at the differences between Interest Rates and Inflation.

What is Inflation?

Inflation is the rate at which the general level of prices for goods and services rises. As for price increase, this leads to a fall in the currency's purchasing power. It is necessary to keep the inflation rate within permissible limits for the smooth functioning of an economy.

Let us understand inflation with an example- Suppose in 1990 a man buys petrol daily of INR 100 for his car and the price of one liter was INR 40, in INR 100 he gets 2.5 Liters of petrol. If he buys petrol of INR 100 considering the current rate of petrol INR 90 per liter, he will get 1.1 L of petrol. Although INR 100 remains the same, its purchasing power decreased 28 years earlier, and he gets 2.5L petrol at the same price as today's 1.1L of petrol. It is called inflation.

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Source: Inflation vs Interest Rate (wallstreetmojo.com)

What is Interest Rate?

The interest rate is when the lender is lending funds to the borrower. The interest rate strongly impacts the country's economy and has a major impact on stock and other investments.

The interest rate is decided by considering two factors.

Capital availability - Capital is costly if a rate of interest is high.

If the interest rate is low, bank customers will not get sufficient return on their funds, demotivating customers to keep the amount in the bank. As a result, the bank will not have funds.

If money is cheap, people will get the motivation to get money in the market The money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. and as a result, the value of money will decrease. It will increase inflation.

The rates of interest for loans and deposits are different. The interest rate for loans is high, whereas deposits are comparatively less. The interest rate is a price for holding or loaning money, i.e., the price for depositing or borrowing money.

Infographics

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For eg:
Source: Inflation vs Interest Rate (wallstreetmojo.com)

It's important to know about the Quantity Theory of Money The Quantity Theory of Money is an economic theory that defines the relationship between the money supply and the price of products. It states that an increase or decrease in the money supply will result in inflation or deflation, respectively. to understand the relationship between these rates better.

Relationship Between Inflation and Interest Rate

Quantity Theory of Money determines that supply and demand for money determine inflation. If the money supply increases, as a result, inflation increases, and if money supply decreases lead to a decrease in inflation.

This principle is applied to study the relationship between inflation vs. interest rate. When the interest rate is high, the supply for money is less, and hence inflation decreases, which means supply is decreased. In contrast, when the interest rate is decreased or low, the supply of money will be more, and as a result, inflation increases, which means that demand is increased.

To control high inflation, the central bank increases the interest rate. When the interest rate increases, the cost of borrowing rises. It makes borrowing expensive. Hence, borrowing will decrease, and the money supply will fall. A fall in the money supply in the market will lead to a decrease in money with people to expensive goods and services. With the supply constant, the demand for goods and services will decrease, which leads to falling in the price of goods and services.

In a low inflationary situation, the rate of interest reduces. A decrease in the rate of interest will make borrowing cheaper. Hence, borrowing will increase, and the money supply will increase. With a rise in the money supply, people will have more money to spend on goods and services. So, the demand for goods and services will increase, and with supply remaining constant, this leads to a rise in the price level, which is inflation.

Hence, they are inversely related and have their impact. As described above, if an interest rate is high, then inflation and money circulation in a market will be below. Conversely, if an interest rate is less, then money circulation will be high in a market, increasing inflation.

Interest vs Inflation - Inverse Relationship?

Effect of Increase
If the interest rate increase, inflation decreases
Money Circulations in the market decreases
Borrowing became expensive
Demand for goods & services decrease
Interest rate increase leads to a fall in the price of services and goods

If inflation increase, interest rate decreases
Money Circulations in the market increases
Borrowing became cheap
Demand for goods & services increase
Inflation leads to a rise in the price of service and goods

Effect of Decrease
If interest rate decrease, inflation increases
Money Circulations in the market increases
Borrowing became cheap
Demand for goods & services increase
Interest rate decrease leads to a rise in the price of services and goods

If inflation decreases, the interest rate increase
Money Circulations in the market decreases
Borrowing became expensive
Demand for goods & services decrease
Inflation decrease leads to a fall in the price of services and goods

Through this, we can say that the inflation and interest rate are dependent on each other, and the relation between them is an inverse relationship where one increases and the other decreases and vice versa.

Conclusion

Inflation affects the price of goods and services. These prices are very important for the customer and the seller as they want secure inflation where prices are stable, or if in case it increases, it should increase gradually. The purchasing power of their currency should not affect. Price stability is very much needed for a healthy economy. Considering this interest rate is decided. To control inflation, interest rates needed to change after a regular interval to maintain a healthy economy. Inflation vs. Interest rate has a vital role in a market. It helps the investor calculate how much return his investment needs to Inflation affects the price of goods and services. These prices are very important for the customer and the seller as they want secure inflation where prices are stable, or if in case it increases, it should increase gradually. The purchasing power of their currency should not affect. Price stability is very much needed for a healthy economy. Considering this interest rate is decided. To control inflation, interest rates needed to change after a regular interval to maintain a healthy economy. Inflation vs. Interest rate has a vital role in a market. It helps the investor calculate how much return his investment needs to maintain his standard of living, and the investor invests in a product that gives a return more than inflation.

Recommended Articles

This has been a guide to Inflation vs. Interest rate. Here we also discuss the relationship between inflation and interest rates with infographics and a comparison table. You may also have a look at the following articles -

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Inflation rate signifies the change in the price of goods and services due to inflation, thus signifying increasing price and increasing demand of various goods whereas interest rate is the rate charged by lenders to borrowers or issuers of debt instrument where an increased interest rate reduces the demand for borrowing and increases demand for investments.

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Hello and welcome to my padlet! I chose this topic because of its sheer depth and importance. This topic affects our daily lives every single minute of the day. Our quality of living for better or for worse revolves around money. So understanding it's value and how it works is very powerful knowledge to acquire.

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I found this website to be very concise and straight to the point. It breaks downs the meaning of Inflation, Deflation and even Hyperinflation in very clear and simple terms. It explained the Pros and Cons of these terms and why they are so important in the grand scheme of things.

I particular enjoyed the Hyperinflation topic. Which is a dire situation no country wants to get to. Hyperinflation is basically an accelerated version of inflation where prices shoot up to more than 50% more per month. If you bought a box of cereal for $5.00 it would be worth $7.50 at the end of the month, a car worth $20.000 would be $30.000 at the end of the month. This would be a national crisis because clearly a person's money would not be able to keep up with this kind of radical increase

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Inflation destroys wealth.

When inflation happens, the amount of things you can buy with your money decreases. But why does this happen? What is inflation? Is it necessary for a functioning economy?

Let's find out!

What is Inflation?

At its core, Inflation is a measure of the average price increase for a basket of goods that include key items that everyone needs. This basket of goods typically have things such as:

Food

Housing

Clothing

Transportation

Healthcare

Education

And many more everyday goods/services....

If the rate of inflation in America is 2%, then every year we will be able to buy 2% less goods and services with the same amount of money.

If your income doesn't keep up with the pace of inflation, then your purchasing power goes down.

A good example would be the cost for a bag of chips from a vending machine. The bag of chips used to cost $0.50, then $0.75 a few years later, then $1.00 a few years after that, and the prices keep going up.

If you had a dollar back when the bag of chips cost $0.50 then you could get two bags for your dollar, but now you can maybe get a single bag of chips for your dollar. The purchasing power of your dollar has decreased.

So how and why do prices for goods rise? The rise in cost usually comes as a result of businesses raising their prices. If times are slow and they are having trouble selling their goods, then prices will drop. However, if times are good and things are flying off the shelves then prices will inevitably go up.

One thing to note is that an increase in price due to inflation is not the same as an increase in price due to quality. For example, if a Model XYZ computer costs $1000 last year but costs $1100 this year, the price rise isn't purely due to inflation. There is likely an increase in quality for the product due to better processors, memory, screen and so on.

There is also a strong psychological factor to inflation. It's not some formulaic, mechanical process that occurs predictably. After all, there is usually a human element involved when a business raises their prices.

You might have also heard the term "deflation". Deflation is the exact opposite of inflation, and occurs when there is a drop in the average price for the same basket of goods.

What Causes Inflation and Deflation

Inflation happens when too many people have too much money and they're all trying to buy the same goods and services. For example, if everyone suddenly got an extra $50,000 then we would likely be out buying things with that money - and businesses would probably raise their prices.

When there is too much money flying around then the prices of everything starts to increase and this is what causes inflation.

Deflation usually happens when businesses don't produce as much since they don't feel that there is demand for it. Some businesses will drop prices in order to capture whatever demand there is left.

Deflation has a strong psychological effect on customers. If you see prices dropping all the time, then maybe you'll hold off on buying things because you think the prices will continue to drop.

Uncontrolled deflation is just as dangerous as uncontrolled inflation.

What is Hyperinflation

Hyperinflation is inflation gone wild. It's technically defined as an inflation rate that is higher than 50% per month.

How crazy is that? 50% per month! This means that something like a box of cereal could cost $5 at the beginning of the month, and that same box would cost $7.50 at the end of the month. Or that $20,000 car at the beginning of the month now costs $30,000 at the end of the month.

Once the cycle of hyperinflation starts it is hard to stop as people will want to spend their money as soon as they get paid. This would likely cause businesses to raise their prices even more and reinforce the hyperinflation cycle.

As insane as this all sounds, hyperinflation does happen. In 2018, Venezuela had an inflation rate of 1,700,000% - and no that's not a typo. In the picture below you can see money just laying on the streets of Venezuela since it was worth basically nothing.

This particular case of hyperinflation came as a result of the Venezuelan government increasing the money supply by more than 10%, and people losing faith in the integrity of their central bank. The situation got so bad that people were using cartons of eggs as currency. America hasn't had anything close to hyperinflation since the Civil War when the Confederates printed money to pay for war expenses.

To have hyperinflation these days you essentially need a failed government..

How Central Banks Try to Control Inflation and Deflation

Central banks aim to control inflation and deflation to keep their economies functioning effectively.

To combat inflation, you have to make people and businesses less willing to borrow money to buy stuff. Central banks to this by raising the interest rate. Whenever you hear the Federal Reserve saying they are raising their benchmark interest rate, they are trying to keep inflation in check.

If it's more expensive to borrow money, then the amount that people borrow will be less. If less people and businesses are borrowing, then in essence less money is being created (check out our article on " What is Money " if this doesn't make sense). You now have less money chasing the same amount of goods and services, and this drives prices down.

To combat deflation, the central banks do the opposite. They will drop interest rates in the hopes that this will make people and businesses more willing to spend money. However, this may not be enough because people and businesses may not borrow money even if it's easy to do so.

If people and businesses don't want to spend money, then the federal government is essentially forced to spend money themselves and run a deficit to inject money into the economy. When you see the economy struggling and the federal government starting a bunch of infrastructure projects, this is what they're trying to do.

Deflation is very hard to stop once it gets started. This is the reason why most central banks are willing to run a slight inflation 1.5%-3% just to make sure they don't get themselves into a deflationary environment.

Why is deflation so dangerous? One of the main reason is that almost everyone takes out loans to buy things.

Let's consider a house that was purchased for $100,000 where the buyer took out an $80,000 mortgage. In a deflationary environment the prices of things drop. This means that the $100,000 may now be worth only $60,000. However, the buyer still owes the bank $80,000 on the loan. This situation would force a lot of people to be underwater, and can potentially collapse the economy as no one would want to buy anything.

In a deflationary environment, as soon as you buy something it is worth less than what you paid for it so people are inclined to hold on to their cash. Without consumer spending our entire economy would grind to a halt.

What is Inflation Infographic

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Inflation destroys wealth. When inflation happens, the amount of things you can buy with your money decreases. But why does this happen? What is inflation? Is it necessary for a functioning economy? Let's find out! At its core, Inflation is a measure of the average price increase for a basket of goods that include key items that everyone needs.