Inflation Definition

Inflation is the word economists use in reference to a situation where the general levels of prices within an economy is rising over a sustained period. Inflation is an aggregated result occurring across the economy as a whole – indeed, some goods may even fall in price and we’d still call it inflation with the overall trend being upward.

Inflation isn’t always a bad thing – for example, monetary inflation helped relieve enormous public debt in the aftermath of the Second World War – and some inflation is natural. Nonetheless, no-one wants too much inflation for a simple reason: none of us like paying higher prices! Most people’s income remains roughly the same, perhaps in the form of a wage or salary, while an economy is in constant transition. If the economy inflates 0.5% while you are being paid the same amount, your wages are now worth 0.5% less. In other words, your ‘real wages’ have decreased by 0.5%.

With that being said, imagine how people feel when inflation really gets out of hand, as it has more than a few times in the last century. When inflation hits 10, 20, or even 30 percent, it becomes known as hyperinflation, and causes massive depreciation in the value of a currency. The difficulty hyperinflation causes to a population can often lead to major political strife and upheaval. One tragic reminder of this comes in the form of the hyperinflation in the Weimar Republic of Germany in the 1920s, which aided Hitler’s rise to power due to the mass discontent and resentment it inspired.

What Are The Causes Of Inflation?

The causes of inflation are a constantly recurring topic of debate amongst economists, who are always coming up with new theories as to the source of inflationary woes. However, amidst all the madness, a consensus on two major types of inflation causes has been reached. These are known as Demand-Pull and Cost-Push inflation respectively.

Demand-Pull Inflation describes a situation where demand exceeds supply, or, more broadly, there is too much money chasing too few goods or services. This is common in economies enjoying growth, and may be stimulated by a central bank printing more money (more on that later).

Cost-Push Inflation is the other main type of inflation, caused by a rise in costs to companies, forcing them to raise their prices and thus cause inflation. This was a major factor in the hyperinflation faced by 1920s Germany. The economy was in massive trouble. Not only was the country suffering from vastly depleted resources due to the war effort, it was also heavily indebted to Allied forces due to debts imposed by the post-war Treaty of Versailles. Companies were having to pay more for their stocks, and these cost increases were passed onto their customers so that profit margins could be maintained. The result, alongside the effects of a rapid increase in money supply, was a currency so low in value that it was used as wallpaper!

How Can Inflation Be Controlled?

Nowadays, economists and governments generally have a much better idea of how to control inflation, based on the ominous lessons of the past. One major way in which central banks can control inflation is by moderating the monetary supply; in other words, by carefully controlling the amount of money in circulation. To consider an example, let’s imagine there’s a nation which does not print extra money. This nation is growing, meaning it has more people to spend the same amount of money it had as a smaller economy. This will naturally cause money to increase in value, causing prices to drop so that transactions can continue to be made: a deflation will take effect. To address this (because, remember, a small amount of inflation is no bad thing), governments can print more money. This means people have more money with which to buy goods and services, meaning too much money chasing too few goods, which in turn leads to price rises… and inflation. Thus, excess money is a third major cause inflation.

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