Inflation: what is it – Dictionary of Economics

Definition of Inflation

Inflation is the generalized and sustained increase in the prices of goods and services in a country over a sustained period of time, usually one year. When the general price level rises, each unit of currency buys fewer goods and services. In other words, inflation reflects the decrease in the purchasing power of the currency: a loss of the real value of the internal medium of exchange and unit of measure of an economy. Indices are used to measure the growth of inflation, which reflect the percentage growth of a weighted ‘basket of goods’. The inflation measurement index is the Consumer Price Index (CPI).

Causes of Inflation

There are three types of inflation:

Inflation by consumption or demand. This inflation obeys the law of supply and demand. If the demand for goods exceeds the capacity to produce or import goods, prices tend to rise.

cost inflation. This inflation occurs when the price of raw materials (copper, oil, energy, etc.) increases, which makes the producer, seeking to maintain his profit margin, increase his prices.

self-constructed inflation. This inflation occurs when a strong future increase in prices is anticipated, and then they begin to be adjusted beforehand so that the increase is gradual.

Inflation generated by inflation expectations (vicious circle). This is typical in countries with high inflation where workers ask for wage increases to offset the effects of inflation, which gives rise to price increases by employers, causing a vicious circle of inflation.

Classification of inflation by its magnitude

Inflation according to the magnitude of the increase is usually classified into different categories:

Moderate inflation: Moderate inflation refers to the slow increase in prices. When prices are relatively stable, people rely on it, putting their money in bank accounts. Whether in current accounts or low-yield savings deposits because this will allow your money to be worth as much as in a month or a year. In itself, people are willing to commit their money to long-term contracts, because they think that the price level will not move far enough away from the value of a good that they can buy or sell.

Runaway Inflation: Runaway inflation occurs when prices increase by double- or triple-digit rates of 30, 120, or 240% over an average one-year period. When rampant inflation sets in, great economic changes arise. Many times in contracts it can be related to a price index or it can also be to a foreign currency, such as the dollar. Since money loses its value very quickly, people try not to have more than they need; that is, they maintain enough to live with what is essential for the sustenance of family members.

Hyperinflation: It is an abnormal inflation in which the price index increases by 50% per month, that is, an annualized inflation of almost 13,000%. This type of inflation announces that a country is experiencing a severe economic crisis; as money loses its value, purchasing power (the ability to buy goods and services with money) declines rapidly and people seek to spend money before it becomes totally worthless; When hyperinflation occurs, it becomes essential to increase wages in a matter of days or even daily. This type of inflation is usually due to the fact that governments finance their expenses with the issuance of inorganic money without any type of control, or because there is no good system that regulates the income and expenses of the State.

How is inflation stopped?

To stop inflation, central banks tend to increase the interest rate on public debt. In this way, interest rates on consumer loans (credit cards, mortgages, etc.) increase. By increasing the interest rates of consumption, the demand for products is slowed down.

The negative side of this control is that by curbing the demand for products, it curbs the industry that produces them, which can lead to economic stagnation and unemployment.

See also