While we hear news that inflation in the manufacturing sector has moved to its highest level since 1995, many people are starting to ask what inflation actually means to them. So what are the positive points and negative points of inflation?

Inflation is the change in the cost of an item or items over a given time span, normally 12 months, showing how the price of the said item has changed over the period. While it is safe to say that prolonged high inflation will ruin an economy, it is also safe to say that negative inflation or zero inflation also has the potential to cause major problems. Here we list some of the positive and negative aspects of inflation :-

Positive Aspects

Controlled inflation in any economy allows manufacturers and services providers to move the cost of the goods / service higher without pricing themselves out of the market. Inflation is a direct result of the supply and demand levels for a particular product. i.e. if there is little demand then the potential to move prices higher is smaller, yet if there is high demand and few providers, then those in the market can afford to increase their prices.

Increased prices mean increased income and so long as costs are kept under control it also allows the companies involved to increase the salaries of their workers. As incomes rises, more people will spend and the economy will continue to grow.

Inflation is also very important to the property market because inflation will allow rental charges to grow, and because the value of property is normally directly related to the rental income, this will keep the property market moving forward. Again, it is a controlled rate of inflation which is essential because when rental inflation moves out of synch with the market this can cause major problems.

Negative Aspects

While a controlled rate of inflation is good for the economy, a run away rate can have serious implications with costs racing ahead to levels which are unsustainable. The problem seems to occur when people have excess money in their pockets to spend and demand for products is pushed higher and higher. As the cost of the products moves higher there is a natural increase in costs with each element of the production chain wanting a share of the rise – including the workers.

When demand starts to fall many companies are left high and dry with costs which are unsustainable against the falling price of goods and competition. As more companies struggle we see more and more price reductions with many companies forced to sell goods at knock down prices. This can then move the economy into a vicious circle, where cost cutting means more jobs are lost, meaning less money for people to spend which then transfers into reduced sales then to more costs cutting, etc, etc.

Summary

While governments around the world will use different techniques to control inflation, one of the main tools in the UK has been interest rates where the authorities look to make borrowing more expensive to curb overspending, hence reducing demand and prices to acceptable levels. Where demand is falling the authorities would look to reduce interest rates to make borrowing cheaper, giving the consumer the opportunity to borrow and spend – increasing demand. At the moment we are in a very difficult situation in the UK because the cost of oil has increased, which has been passed down the line into business and onto consumers. So prices are rising while the economy is under pressure – a very very tricky situation.

As the economic squeeze continues to tighten on the UK consumer more and more people are experiencing what they hope will be short term financial problems. This has prompted many consumers to look at ways to help them through these difficulties with loans and overdrafts by far and away the most popular products at the moment. So should you go for a loan or an overdraft?

The key to any financial planning is the bigger picture rather than just finding a short term solution to what could turn into a long term problem. If you are experiencing difficulties at the moment you need to be realistic, you need to be sensible and you need to ensure that the product which you choose is the best option for you. We hereby list some pros and cons for overdrafts and loans :-

Loans

Pros

A fixed loan will ensure that your payments remain constant and you know exactly what is required, when it is required and you can actually see the end picture – the full repayment of the loan.

In general the loan market in the UK is very flexible and normally you will be able to choose the length of the loan period to fit in with your personal situation.

Cons

Many loans will have fairly hefty late payment charges if you either miss you payment date or fall into further financial difficulties. Do not rely on the recent trend of reclaiming charges to cover you if you are charged in the future.

While the trend towards setup charges for loans has diminished as competition has increased, some lenders will still charge you some form of fee for setting up and agreeing the arrangement. You also need to be very wary of companies who require money up front before they agree a loan because very often the loan application will be turned down and you will have lost your money.

Overdrafts

Pros

Overdrafts are a lot more flexible than loans in that you can take out and repay money at your own discretion as long as you do not go over your agreed limit.

Very often an overdraft will be agreed quicker than a loan if you have banked with one company for a number of years. You may also receive a ”free overdraft” facility whereby you are not charged interest on the first £100 you go overdrawn.

Cons

Sometimes overdrafts can be too easy and too accessible with many people suddenly using their overdraft as an extension of their income and adding the facility into their everyday figures.

It can be very easy to use your overdraft facility without actually repaying money and very quickly find yourself up to your limit and probably in more financial trouble than you were when you applied for the overdraft!

If you exceed your overdraft facility you can find yourself on the end of some fairly hefty interest charges, and quickly getting deeper and deeper into trouble.

Summary

While there is no right and wrong option many people find the structure of a loan more favourable with regards to their financial planning, although those who have the discipline to stay within their limits and make repayments might find an overdraft is a better option. Either way it is essential that you know the pros and cons for each product and the implications for your financial well being.