Definition of Inflation
Inflation is the sustained increase in the general price level of goods and services in an economy over a period of time. When inflation occurs, each unit of currency buys fewer goods and services, resulting in a decrease in the purchasing power of money. It is typically measured by indices like the Consumer Price Index (CPI), which tracks changes in the cost of a basket of consumer goods.
Key Causes and Types of Inflation
Inflation can arise from demand-pull factors, where aggregate demand exceeds supply, pushing prices up; cost-push factors, such as rising production costs from wages or raw materials; and built-in inflation from adaptive expectations, like workers demanding higher wages to keep up with past price increases. Common types include moderate inflation (around 2-3% annually), hyperinflation (over 50% monthly), and deflation (negative inflation).
Practical Example: Inflation During Economic Recovery
Consider the post-2008 financial crisis recovery in the United States, where central banks implemented quantitative easing to stimulate growth. This increased money supply led to moderate inflation around 2%, which encouraged spending and investment but also raised costs for essentials like housing and food, illustrating how controlled inflation can support economic expansion while challenging household budgets.
Effects of Inflation on Economy and Individuals
Inflation erodes savings and fixed incomes by reducing real value, but it can benefit debtors by making loans easier to repay with devalued currency. High inflation disrupts economic planning, increases uncertainty for businesses, and widens inequality if wages lag behind prices. Conversely, low, stable inflation promotes growth by incentivizing consumption over hoarding cash, though unchecked inflation can lead to hyperinflation, destabilizing entire economies.