The Basics of Inflation

Summary:

Inflation is the sustained rise in the general price level or a fall in the value of money. It refers to changes in the overall level of prices rather than individual prices. Inflation can be measured using price index numbers, which compare prices in a given year to prices in a base period. The inflation rate is calculated by subtracting the previous year’s price index from the current year’s index, dividing by the previous year’s index, and multiplying by 100.

Inflation can have different degrees of severity. Creeping or mild inflation refers to low-level inflation, typically between 1% and 3% per year. Galloping inflation is more intense, reaching high levels like 100% or even 300% annually. Hyperinflation is the most severe form, with inflation rates of 500% per year and above.

There are different types of inflation. Demand-pull inflation occurs when total spending exceeds the economy’s production capacity, increasing prices. Cost-push inflation arises from increases in production costs, such as wages or raw material prices, which result in higher prices for goods and services. Stagflation is a combination of high inflation and stagnant economic growth.

The effects of inflation vary. Fixed-income receivers, savers, and creditors are negatively affected by inflation as the value of their income or savings decreases. Flexible-income receivers and debtors may benefit from inflation by adjusting their incomes or repayments to reflect rising prices.

Excerpt:

The Basics of Inflation

Introduction

Inflation can be defined as a sustained or continuous rise in the general price level or, alternatively, as a sustained or continuous fall in the value of money. Several things should be noted about this definition. First, inflation refers to the movement in the general level of prices. It does not refer to changes in one price relative to other prices. These changes are common even when the overall level of prices is stable. Second, the prices are those of goods and services, not assets. Third, the rise in the price level must be somewhat substantial and continue over a period longer than a day, week, or month.