Today, I will show you some information about inflation. What causes inflation?

How does it affect your standard of living? My presentation will shed some light on these questions and consider other aspects of inflation. 1. Definition of Inflation Inflation means a persistent rise in price levels of commodities and services, leading to a fall in currencys purchasing power. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of money does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. After inflation, your dollar can't buy the same goods it could beforehand. A country is said to under pressure of inflation when the prices of most goods and services continue to creep upward. It is measured by Consumer Price Index (CPI), Wholesale Price Index (WPI), Retail Price Index (RPI). There are several variations on inflation: Deflation is when the general level of prices is falling. This is the opposite of inflation. Hyper-inflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. It is a situation where the price increases are so out of control that the concept of inflation becomes meaningless. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month! The inflation in Zimbabwe for the month of March 2008 rose to 355,000%! Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices. In recent years, most developed countries have attempted to sustain an inflation rate of 2-3%. Causes of Inflation Economists wake up in the morning hoping for a chance to debate the causes of inflation. There is no one cause that's universally agreed upon, but at least two theories are generally accepted: Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies. Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports. Costs of Inflation Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. For example,

banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up. Problems arise when there is unanticipated inflation: Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan. Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run. People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. The entire economy must absorb repricing costs ("menu costs") as price lists, labels, menus and more have to be updated. If the inflation rate is greater than that of other countries, domestic products become less competitive. People like to complain about prices going up, but they often ignore the fact that wages should be rising as well. The question shouldn't be whether inflation is rising, but whether it's rising at a quicker pace than your wages. Finally, inflation is a sign that an economy is growing. In some situations, little inflation (or even deflation) can be just as bad as high inflation. The lack of inflation may be an indication that the economy is weakening. As you can see, it's not so easy to label inflation as either good or bad - it depends on the overall economy as well as your personal situation. How Inflation Affects Economy Inflation occurs when the total demand for goods and services in an economy exceeds the supply of the same. When the supply is less, the prices of these goods and services would rise, leading to a situation called inflation. Inflation affects the rich and poor and it poses a threat to the economy. When inflation affects economy, to maintain the same living standard you have to pay more for same amount of goods and services you had used prior to inflation. Remember that your income may not increase at same rate as inflation. People tend to save less in an economy affected by inflation because the price of services and goods are very high and there is nothing or very less left over income available to

How is it measured?
Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year. there are two main price indexes that measure inflation:

Consumer Price Index (CPI) - A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics. Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller. U.S. PPI data can be found at the Bureau of Labor Statistics.

You can think of price indexes as large surveys. Each month, the U.S. Bureau of Labor Statistics contacts thousands of retail stores, service establishments, rental units and doctors' offices to obtain price information on thousands of items used to track and measure price changes in the CPI. They record the prices of about 80,000 items each month, which represent a scientifically selected sample of the prices paid by consumers for the goods and services purchased. In the long run, the various PPIs and the CPI show a similar rate of inflation. This is not the case in the short run, as PPIs often increase before the CPI. In general, investors follow the CPI more than the PPIs. Besides highlighting the difference between purchasers and consumers, the main differences between the two indexes is that the PPI is only domestic, and it removes the entire retail service sector from the equation, both of which can be seen as "noise" if you are trying to understand nuts and bolts U.S. economics. The CPI, with its consumer perspective, collects data on anything that is bought by consumers, and includes imports, as well as sales and excise taxes. PPI is just the price the producer gets for its good. The differences between the PPI and CPI are consistent with the different uses of the two measures. A primary use of the PPI is to deflate revenue streams in order to measure real growth in output. A primary use of the CPI is to adjust income and expenditure streams for changes in the cost of living. (PPI FAQs Bureau of Labor Statistics) the inflation rate is a measure of inflation, the rate of increase of a price index (for example, a consumer price index). It is the percentage rate of change in price level over time.[1] The rate of decrease in the purchasing power of money is approximately equal. The inflation rate is used to calculate the real interest rate, as well as real increases in wages. Official measurements of this rate are input variables to COLA adjustments and inflation derivatives prices.

Investments
When it comes to inflation, the question on many investors' minds is: "How will it affect my investments?" This is an especially important issue for people living on a fixed income, such as retirees.

So, what is the best investment during inflation? The good news is that there are a multitude of securities and assets that can protect against inflationary pressure. The bad news is if such a scenario comes to fruition, your purchasing power is reduced. For every prominent investor worried about deflation, there is another concerned with the converse scenario. Here are the best investments during inflation: Avoid Cash/US Dollars: Inflation typically results in domestic currency devaluing. You can fight this by simply not holding it and allocating the capital into other assets and investments. Nowadays, cash is most certainly part of the asset allocation picture. During inflation, you want to have as little of it on hand if possible. Buy Gold & Precious Metals: If you'll think back toward the end of the crisis, gold was all the rage. As the Federal Reserve's printing presses worked overtime to churn out US dollars to resuscitate the economy, many became very worried about inflation. Their number one investment to protect against this? Gold. While precious metals in general are a solid bet, gold in particular is seen as a hedge against uncertainty and a store of value. Short Fixed Income: Bonds should be avoided due to a weak domestic monetary system. In particular, avoid US Treasuries as they will underperform. As yields start to rise, bond prices will fall. A plethora of prominent investors have gone this route in order to gain inflationary protection. Buy Emerging Markets: A weak domestic currency (US dollar) implies higher returns can be found abroad in other countries. A monetary system in trouble in the home land means your dollars should be invested abroad (especially consider commodity producing nations such as Australia and Brazil). You can invest in either emerging market currencies, equities abroad, or investment funds denominated in those foreign currencies. Buy Technology: While this was also a suggestion for investing during deflationary times, it applies to inflation under the same rationale. Regardless of environment, technology is in demand and will continue to evolve. Buy Treasury Inflation Protected Securities: These types of treasuries (known as TIPS for short) provide the safety of a government bond with the bonus of protection against inflation. After listening my presentation, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, the impact of inflation depends on your personal situation. Inflation versus Deflation Both Inflation and Deflation are socially bad, but inflation may be considered to be the lesser of the two evils. Inflation is unjust in its effects on the following counts:

1. Inflation redistributes income in the favour of the rich and the profiteer class at the cost of the poor masses - the wage-earners and consumers. 2. Through its redistributive effects, inflation increases the inequality of income in the community by widening the gulf between higher income groups and lower income groups. The rich become richer and the poor become poorer during inflation. 3. Inflation is regressive in effect in the sense that it hits hard those who are already weak and cannot protect themselves. It is specially the middle class which suffers most due to inflation. 4. Inflation is unjust because it affects different classes of people in society in different ways and different degrees .if inflation were to affect everyone in the society in exactly the same manner and to the same degree, it would not alter the economic and social relationships in the community. But inflation takes away wealth from some people and transfers to others arbitrarily without taking into consideration the sound maxim of social equity. 5. Inflation is also unjust because it breaks public morale. From the point of view of social ethics, inflation is always demoralizing; it introduces the spirit of gambling. It promotes speculation, hoarding, and diverts business skill and efficiency from productive purposes to speculative purposes. 6. Inflation erodes real savings by deterioration in the value of money. 7. Inflation creates money illusion and generates artificial prosperity, which is not permanent. On the other hand, Deflation is inexpedient and, therefore, not advisable. It is considered inexpedient for the following reasons; 1. Deflation means falling prices in general which adversely affect the marginal efficiency of capital. Consequently, investment volume tends to contract causing unemployment to increase. 2. Deflation paves the way for depression. In a depressionary phase, economic activity contracts, scale of production is curtailed, output shrinks, no new investment if forthcoming; on the contrary, investment is curtailed. 3. By reducing aggregate income, it also pauperizes every group in society. It inflicts on society the harsh punishment of mass unemployment. Volume of employment falls, money income of the community diminishes and, therefore, even though people's purchasing power is increased due to falling prices, they are unable to buy goods in the required quantity. Thus, aggregate demand falls, profit falls producers suffer heavy losses and curtail investment and output further, leading to a further decline in employment and income. This clearly shows that through inflation is unjust, it is better than deflation. Prof. Keynes showed a preference for inflation, because it is the lesser of the two evils. The following points bring out the fact that inflation is a lesser evil:

1. Inflation, though it redistributes income and wealth in the community in an unjust manner, does not reduce the national income of the community. Deflation, on the other hand, reduces the national income of the community and pauperizes society as a whole. 2. Deflation increases the level of unemployment in the economy, whereas inflation at least implies that all factors are employed in some way or another. Inflation is a post-full employment phenomenon; deflation is an under-employment phenomenon aggravating the problem of unemployment. 3. It is easy to control inflation by a clear money policy, coordinated by appropriate fiscal policy, but it is difficult to recover from deflation. Once a deflationary tendency starts, it increases business pessimism, the marginal efficiency of capital diminishes, and investment is contracted, and ultimately a severe depression sets in. Monetary policy becomes helpless here, and no amount of increase in the money supply can revive the price level and business expectations or marginal efficiency or capital in the economy during depression. On the other hand, an inflationary spiral can be reflated by controlling credit and money supply.

VietNamNet Bridge The ups and downs of inflation can be a confusing situation for many, however, Patrizia Tumbarello, the International Monetary Fund's Vietnam desk officer, attempts to interpret the effects inflation has on the country's economic environment. A remarkable feature of Vietnam's emergence in the global economy has been its transition to a lower inflation environment since the introduction of reforms under doi moi. Inflation fell from 453% in 1986 to single digits during the second half of the 1990s, as the government adopted prudent macroeconomic policies along with far-reaching reforms to liberalise domestic prices and open up Vietnam's economy to international trade and investment. After remaining in single digits during the late-1990s, inflation began an upward trend that accelerated in 2004. The average rate of inflation rose to 7.7% in 2004 and peaked at 8.3% in 2005, before easing somewhat in 2006. Despite its recent decrease, headline inflation has remained higher than in other emerging markets (EMs) in the region. The 12-month rate of inflation has stood at 6.6% as of December 2006, compared to less than 5%, on average, in the ASEAN-4 (Indonesia, Malaysia, Philippines and Thailand). The figure is also significantly lower rate in China. Moreover, core inflation (proxied by the non-food component of the consumer price index (CPI) net of fuel and fuel-related items) has remained on an upward path. These developments suggest that, in contrast to 2004-05, when the primary causes of inflation appeared to be food-supply and oil-price shocks, inflation was more broad-based in 2006. The unfavourable impact of inflation on poverty and growth are well-known. Inflation is essentially a regressive tax that hits the poor the hardest. High and uncertain rates of inflation can also discourage private investment and hurt a country's export competitiveness by leading to increases in production costs.

What is special about inflation in Vietnam, and should it be a cause for concern? Although Vietnam has recorded an impressive economic performance over the last few years and, following its recent WTO accession, is poised to be the next tiger in Asia, it is still a low-income country. Therefore, any simple comparison with the more "mature" EMs in the region is not straight forward. In fact, it is conceivable that Vietnam's somewhat higher rate of inflation may be a benign manifestation of the structural changes underway in a rapidly developing economy. One possible interpretation along the above lines is that Vietnam's inflation may be a side-effect of an adjustment of relative prices of the sort that would be appropriate when large productivity gains in tradable sectors trigger wage increases, which spill over into the rest of the economy. Economists call this type of adjustment the Balassa-Samuelson effect. If this is the case, inflation can be viewed as a temporary effect of a move towards a new market equilibrium and, as such, it should be no cause for concern. While Vietnam has experienced gains in productivity in the tradable goods sector, there is no evidence of a medium-term trend increase in the relative price of non-traded goods compared to traded goods. One possible way to explain this is by arguing that the spill-over of tradable sector wage increases to other sectors is likely to be attenuated in an economy in which a big part of the labour force is still underemployed in agriculture, and is willing to move to the non-agricultural sector at prevailing wages. Price liberalisation is another important factor that could have influenced inflation dynamics in recent years. The prices of several important commodities were liberalised to a great extent during 2002-04. However, key prices and tariffs, including those for electricity, water, petroleum products, air tickets, and telecom charges continue to be set by the government, and some of the prices for other key inputs remain subject to legal ceilings or administratively set price ranges. Indeed, the largest increases in inflation occurred well after the bulk of price liberalisation took place, during a period in which the administrative controls on some prices were tightened. Thus, while price liberalisation is likely to have had some effects on inflation, it is difficult to argue that it has been a dominant factor. The IMF staff's empirical analysis suggests that an overheating of the economy probably played a considerable role in the recent inflation episode. The 2005 inflation spike coincided with an increase of the output gap, which is measured by the difference between actual output and estimated potential output and is widely used as an indicator of excess demand. The staffs econometric work also shows that Vietnam's inflation has an inertia component higher than in the other countries in the region. This suggests that once inflationary expectations are entrenched, it is more difficult to control inflation. The higher inertia may be rooted in the public's memory of high inflation that lasted until the early 1990s. What factors could affect demand pressures? Recent empirical work points to the growth of monetary and credit aggregates as potentially important factors. While previous empirical studies found little evidence of a robust link between monetary growth and inflation in Vietnam, this could be due to the rapid structural transformation of the economy during the early phases of doi moi and the associated increases in private saving and money demand. However, the correlation between money and inflation seems to have become positive and strong beginning in 2002. The growth of credit to the economy appears to be even more highly correlated with inflation during this recent period. During 2006, in particular, the substantial reduction in the rate of growth of credit to the economy from the levels reached in 2004-2005 is likely to have contributed to the easing of inflation. Of course, these findings need to be viewed with caution, as a high correlation is not proof of the cause.

The exchange rate is another factor affecting inflation dynamics. The authorities have pursued a policy of a de facto peg of the dong to the US dollar in recent years. As a result, the exchange rate has been an important anchor of stability and has helped contain increases in import prices, especially during periods in which the US dollar was stable or strengthened relative to other major currencies. Indeed, the nominal effective appreciation of the dong during 2000-2001 is likely to have played an important role in reducing inflation to negative levels during that period. Similarly, the nominal effective depreciation of the dong during 2006 is likely to have slowed the moderation of inflationary pressures. External developments bode well for a continuing moderation of inflation in 2007, provided that the authorities pursue a prudent mix of macroeconomic policies. International oil prices have declined significantly in recent months, and domestic gasoline prices have already been reduced by about 15% from the peak levels reached in August 2006. Average oil prices are now projected to fall or, at worst, stabilise in 2007. Non-fuel commodity prices are also projected to ease in 2007, after having increased by double-digit rates over the past three years. These developments provide a favorable environment for a further decline of inflation from the rate reached in late-2006, if the authorities exercise adequate restraint in their conduct of monetary and fiscal policies. The State Bank's monetary programme for 2007 is encouraging in this regard as it envisages a further deceleration of credit growth to 20% by end-2007. Vietnam's WTO accession can be expected to lead to decreases in import tariffs, and an opening up of previously protected industries. Increasing foreign competition, together with the falling prices of commodity imports, should help offset the inflationary effects of the recent increase in electricity prices and planned increases in other key administered prices. However, there are also some upside risks. Continuing large increases in the minimum wage could spur inflation, especially if they are accompanied by a significant easing of fiscal policy. In addition, the pursuit of the State Bank's monetary policy objectives could be frustrated by difficulties in dealing with the ongoing surge in capital inflows. However, the authorities are mindful of these challenges. In particular, the recent widening of the trading band of the dong versus the US dollar clearly signals the authorities' intention to move toward greater exchange rate flexibility, which would be an important step towards the establishment of monetary policy geared to providing an anchor for inflation and inflation expectations.