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  • Essay / Inflation - 951

    Inflation is defined as an increase in the price you pay or a decrease in the purchasing power of money. In other words, price inflation occurs when prices rise or more money is required to purchase the same item. Interest rates are raised to moderate demand and inflation and lowered to stimulate demand. Monetary policy aims to influence the overall level of monetary demand in the economy so that it grows overall in line with the economy's ability to produce goods and services. This prevents production from increasing too quickly or too slowly. If rates are set too low, this can encourage the build-up of inflationary pressures; if they are too high, demand will be less than what is needed to control inflation. Changes in demand and production then impact the labor market – employment levels and wage costs – which, in turn, influence producer and consumer prices. When the Fed raises the discount rate, it has no immediate impact on the stock market. Changes in the official bank rate then affect the full range of interest rates set by commercial banks, building societies and other financial institutions for their own savers and borrowers. This will influence the interest rates charged on overdrafts and mortgages, as well as savings accounts. A change in the official discount rate will also tend to affect the price of financial assets such as bonds and stocks, as well as the exchange rate. These changes in financial markets affect consumer and business demand and, therefore, production. It takes time for changes to the official bank rate to have their full impact on the economy and inflation. Some influences, such as those on the exchange rate, act very quickly. In January 2003, the price of oil increased by 76.82% compared to the previous January. There has been speculation recently about the correlation between a sharp rise in the price of oil and a sharp decline in stock prices. The theory is that a large increase in oil prices, on the order of 50-100% per year, has historically led to a sharp decline in stock prices..