Partner Insight: UK inflation hit a six-month high of 2.7% in September, having held steady earlier this year. The rise is not good news for consumers - slowing the recovery in spending power.
At a very basic level, if inflation is limited, it encourages people to spend sooner, which is good for economic growth and what central banks targeting a specific inflationary level want. But at the other end of the scale, if consumers or businesses anticipate that prices will fall in the future, they are likely to hold off on spending and which is not good for the economy.
Many economists, businessmen, and politicians maintain that moderate inflation levels are needed to drive consumption - operating under the larger, overarching assumption that higher levels of spending are crucial for economic growth. The US Fed typically targets an annual rate of inflation, believing that a slowly increasing price level keeps businesses profitable, and prevents consumers from waiting for lower prices before making purchases. There are some, in fact, who believe that the primary function of inflation is simply to prevent deflation.
Others, however, argue that inflation is less important and even a net drag on the economy. Rising prices make savings harder, driving individuals to engage in riskier investment strategies to increase or even maintain their wealth. Others claim that inflation benefits some businesses or individuals at the expense of those poorer than them.
AXA Investment Managers Jonathan Baltora believes one scenario that could play out given current economics is that inflation is normalising.
He explains: "I am not saying that we are entering a period of super high inflation, that's not our scenario; I am just saying inflation is normalising and we are seeing risk to the upside when we look at the balance of risks. Basically politics, the resistance against globalisation, so free trade is potentially in danger and that could increase the price of goods."
Find out more about the murky and complex world of inflation and what it means for the economy by listening to AXA IM's exclusive podcast: Fear and the inflation game: Explaining inflation
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