an essay on inflation

Essay on Inflation: Types, Causes and Effects

Essay on Inflation!

Essay on the Meaning of Inflation:

Inflation and unemployment are the two most talked-about words in the contemporary society. These two are the big problems that plague all the economies. Almost everyone is sure that he knows what inflation exactly is, but it remains a source of great deal of confusion because it is difficult to define it unambiguously.

Inflation is often defined in terms of its supposed causes. Inflation exists when money supply exceeds available goods and services. Or inflation is attributed to budget deficit financing. A deficit budget may be financed by additional money creation. But the situation of monetary expansion or budget deficit may not cause price level to rise. Hence the difficulty of defining ‘inflation’ .

Inflation may be defined as ‘a sustained upward trend in the general level of prices’ and not the price of only one or two goods. G. Ackley defined inflation as ‘a persistent and appreciable rise in the general level or average of prices’ . In other words, inflation is a state of rising price level, but not rise in the price level. It is not high prices but rising prices that constitute inflation.

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It is an increase in the overall price level. A small rise in prices or a sudden rise in prices is not inflation since these may reflect the short term workings of the market. It is to be pointed out here that inflation is a state of disequilibrium when there occurs a sustained rise in price level.

It is inflation if the prices of most goods go up. However, it is difficult to detect whether there is an upward trend in prices and whether this trend is sustained. That is why inflation is difficult to define in an unambiguous sense.

Let’s measure inflation rate. Suppose, in December 2007, the consumer price index was 193.6 and, in December 2008 it was 223.8. Thus the inflation rate during the last one year was 223.8 – 193.6/193.6 × 100 = 15.6%.

As inflation is a state of rising prices, deflation may be defined as a state of falling prices but not fall in prices. Deflation is, thus, the opposite of inflation, i.e., rise in the value or purchasing power of money. Disinflation is a slowing down of the rate of inflation.

Essay on the Types of Inflation :

As the nature of inflation is not uniform in an economy for all the time, it is wise to distinguish between different types of inflation. Such analysis is useful to study the distributional and other effects of inflation as well as to recommend anti-inflationary policies.

Inflation may be caused by a variety of factors. Its intensity or pace may be different at different times. It may also be classified in accordance with the reactions of the government toward inflation.

Thus, one may observe different types of inflation in the contemporary society:

(a) According to Causes:

i. Currency Inflation:

This type of inflation is caused by the printing of currency notes.

ii. Credit Inflation:

Being profit-making institutions, commercial banks sanction more loans and advances to the public than what the economy needs. Such credit expansion leads to a rise in price level.

iii. Deficit-Induced Inflation:

The budget of the government reflects a deficit when expenditure exceeds revenue. To meet this gap, the government may ask the central bank to print additional money. Since pumping of additional money is required to meet the budget deficit, any price rise may be called deficit-induced inflation.

iv. Demand-Pull Inflation:

An increase in aggregate demand over the available output leads to a rise in the price level. Such inflation is called demand-pull inflation (henceforth DPI). But why does aggregate demand rise? Classical economists attribute this rise in aggregate demand to money supply.

If the supply of money in an economy exceeds the available goods and services, DPI appears. It has been described by Coulborn as a situation of “too much money chasing too few goods” .

Note that, in this region, price level begins to rise. Ultimately, the economy reaches full employment situation, i.e., Range 3, where output does not rise but price level is pulled upward. This is demand-pull inflation. The essence of this type of inflation is “too much spending chasing too few goods.”

v. Cost-Push Inflation:

Inflation in an economy may arise from the overall increase in the cost of production. This type of inflation is known as cost-push inflation (henceforth CPI). Cost of production may rise due to increase in the price of raw materials, wages, etc. Often trade unions are blamed for wage rise since wage rate is not market-determined. Higher wage means higher cost of production.

Prices of commodities are thereby increased. A wage-price spiral comes into operation. But, at the same time, firms are to be blamed also for the price rise since they simply raise prices to expand their profit margins. Thus we have two important variants of CPI: wage-push inflation and profit-push inflation. Anyway, CPI stems from the leftward shift of the aggregate supply curve.

The price level thus determined is OP 1 . As aggregate demand curve shifts to AD 2 , price level rises to OP 2 . Thus, an increase in aggregate demand at the full employment stage leads to an increase in price level only, rather than the level of output. However, how much price level will rise following an increase in aggregate demand depends on the slope of the AS curve.

Causes of Demand-Pull Inflation :

DPI originates in the monetary sector. Monetarists’ argument that “only money matters” is based on the assumption that at or near full employment, excessive money supply will increase aggregate demand and will thus cause inflation.

An increase in nominal money supply shifts aggregate demand curve rightward. This enables people to hold excess cash balances. Spending of excess cash balances by them causes price level to rise. Price level will continue to rise until aggregate demand equals aggregate supply.

Keynesians argue that inflation originates in the non-monetary sector or the real sector. Aggregate demand may rise if there is an increase in consumption expenditure following a tax cut. There may be an autonomous increase in business investment or government expenditure. Governmental expenditure is inflationary if the needed money is procured by the government by printing additional money.

In brief, an increase in aggregate demand i.e., increase in (C + I + G + X – M) causes price level to rise. However, aggregate demand may rise following an increase in money supply generated by the printing of additional money (classical argument) which drives prices upward. Thus, money plays a vital role. That is why Milton Friedman believes that inflation is always and everywhere a monetary phenomenon.

There are other reasons that may push aggregate demand and, hence, price level upwards. For instance, growth of population stimulates aggregate demand. Higher export earnings increase the purchasing power of the exporting countries.

Additional purchasing power means additional aggregate demand. Purchasing power and, hence, aggregate demand, may also go up if government repays public debt. Again, there is a tendency on the part of the holders of black money to spend on conspicuous consumption goods. Such tendency fuels inflationary fire. Thus, DPI is caused by a variety of factors.

Cost-Push Inflation Theory :

In addition to aggregate demand, aggregate supply also generates inflationary process. As inflation is caused by a leftward shift of the aggregate supply, we call it CPI. CPI is usually associated with the non-monetary factors. CPI arises due to the increase in cost of production. Cost of production may rise due to a rise in the cost of raw materials or increase in wages.

Such increases in costs are passed on to consumers by firms by raising the prices of the products. Rising wages lead to rising costs. Rising costs lead to rising prices. And rising prices, again, prompt trade unions to demand higher wages. Thus, an inflationary wage-price spiral starts.

This causes aggregate supply curve to shift leftward. This can be demonstrated graphically (Fig. 11.4) where AS 1 is the initial aggregate supply curve. Below the full employment stage this AS curve is positive sloping and at full employment stage it becomes perfectly inelastic. Intersection point (E 1 ) of AD 1 and AS 1 curves determines the price level.

Now, there is a leftward shift of aggregate supply curve to AS 2 . With no change in aggregate demand, this causes price level to rise to OP 2 and output to fall to OY 2 .

With the reduction in output, employment in the economy declines or unemployment rises. Further shift in the AS curve to AS 2 results in higher price level (OP 3 ) and a lower volume of aggregate output (OY 3 ). Thus, CPI may arise even below the full employment (Y f ) stage.

Causes of CPI :

It is the cost factors that pull the prices upward. One of the important causes of price rise is the rise in price of raw materials. For instance, by an administrative order the government may hike the price of petrol or diesel or freight rate. Firms buy these inputs now at a higher price. This leads to an upward pressure on cost of production.

Not only this, CPI is often imported from outside the economy. Increase in the price of petrol by OPEC compels the government to increase the price of petrol and diesel. These two important raw materials are needed by every sector, especially the transport sector. As a result, transport costs go up resulting in higher general price level.

Again, CPI may be induced by wage-push inflation or profit-push inflation. Trade unions demand higher money wages as a compensation against inflationary price rise. If increase in money wages exceeds labour productivity, aggregate supply will shift upward and leftward. Firms often exercise power by pushing up prices independently of consumer demand to expand their profit margins.

Fiscal policy changes, such as an increase in tax rates leads to an upward pressure in cost of production. For instance, an overall increase in excise tax of mass consumption goods is definitely inflationary. That is why government is then accused of causing inflation.

Finally, production setbacks may result in decreases in output. Natural disaster, exhaustion of natural resources, work stoppages, electric power cuts, etc., may cause aggregate output to decline.

In the midst of this output reduction, artificial scarcity of any goods by traders and hoarders just simply ignite the situation.

Inefficiency, corruption, mismanagement of the economy may also be the other reasons. Thus, inflation is caused by the interplay of various factors. A particular factor cannot be held responsible for inflationary price rise.

Essay on the Effects of Inflation :

People’s desires are inconsistent. When they act as buyers they want prices of goods and services to remain stable but as sellers they expect the prices of goods and services should go up. Such a happy outcome may arise for some individuals; “but, when this happens, others will be getting the worst of both worlds.” Since inflation reduces purchasing power it is bad.

The old people are in the habit of recalling the days when the price of say, meat per kilogram cost just 10 rupees. Today it is Rs. 250 per kilogram. This is true for all other commodities. When they enjoyed a better living standard. Imagine today, how worse we are! But meanwhile, wages and salaries of people have risen to a great height, compared to the ‘good old days’. This goes unusually untold.

When price level goes up, there is both a gainer and a loser. To evaluate the consequence of inflation, one must identify the nature of inflation which may be anticipated and unanticipated. If inflation is anticipated, people can adjust with the new situation and costs of inflation to the society will be smaller.

In reality, people cannot predict accurately future events or people often make mistakes in predicting the course of inflation. In other words, inflation may be unanticipated when people fail to adjust completely. This creates various problems.

One can study the effects of unanticipated inflation under two broad headings:

(i) Effect on distribution of income and wealth

(ii) Effect on economic growth.

(a) Effects of Inflation on Income and Wealth Distribution :

During inflation, usually people experience rise in incomes. But some people gain during inflation at the expense of others. Some individuals gain because their money incomes rise more rapidly than the prices and some lose because prices rise more rapidly than their incomes during inflation. Thus, it redistributes income and wealth.

Though no conclusive evidence can be cited, it can be asserted that following categories of people are affected by inflation differently:

i. Creditors and Debtors:

Borrowers gain and lenders lose during inflation because debts are fixed in rupee terms. When debts are repaid their real value declines by the price level increase and, hence, creditors lose. An individual may be interested in buying a house by taking a loan of Rs. 7 lakh from an institution for 7 years.

The borrower now welcomes inflation since he will have to pay less in real terms than when it was borrowed. Lender, in the process, loses since the rate of interest payable remains unaltered as per agreement. Because of inflation, the borrower is given ‘dear’ rupees, but pays back ‘cheap’ rupees.

However, if in an inflation-ridden economy creditors chronically loose, it is wise not to advance loans or to shut down business. Never does it happen. Rather, the loan- giving institution makes adequate safeguard against the erosion of real value.

ii. Bond and Debenture-Holders:

In an economy, there are some people who live on interest income—they suffer most.

Bondholders earn fixed interest income:

These people suffer a reduction in real income when prices rise. In other words, the value of one’s savings decline if the interest rate falls short of inflation rate. Similarly, beneficiaries from life insurance programmes are also hit badly by inflation since real value of savings deteriorate.

iii. Investors:

People who put their money in shares during inflation are expected to gain since the possibility of earning business profit brightens. Higher profit induces owners of firms to distribute profit among investors or shareholders.

iv. Salaried People and Wage-Earners:

Anyone earning a fixed income is damaged by inflation. Sometimes, unionized worker succeeds in raising wage rates of white-collar workers as a compensation against price rise. But wage rate changes with a long time lag. In other words, wage rate increases always lag behind price increases.

Naturally, inflation results in a reduction in real purchasing power of fixed income earners. On the other hand, people earning flexible incomes may gain during inflation. The nominal incomes of such people outstrip the general price rise. As a result, real incomes of this income group increase.

v. Profit-Earners, Speculators and Black Marketeers:

It is argued that profit-earners gain from inflation. Profit tends to rise during inflation. Seeing inflation, businessmen raise the prices of their products. This results in a bigger profit. Profit margin, however, may not be high when the rate of inflation climbs to a high level.

However, speculators dealing in business in essential commodities usually stand to gain by inflation. Black marketeers are also benefited by inflation.

Thus, there occurs a redistribution of income and wealth. It is said that rich becomes richer and poor becomes poorer during inflation. However, no such hard and fast generalizations can be made. It is clear that someone wins and someone loses from inflation.

These effects of inflation may persist if inflation is unanticipated. However, the redistributive burdens of inflation on income and wealth are most likely to be minimal if inflation is anticipated by the people.

With anticipated inflation, people can build up their strategies to cope with inflation. If the annual rate of inflation in an economy is anticipated correctly people will try to protect them against losses resulting from inflation.

Workers will demand 10 p.c. wage increase if inflation is expected to rise by 10 p.c. Similarly, a percentage of inflation premium will be demanded by creditors from debtors. Business firms will also fix prices of their products in accordance with the anticipated price rise. Now if the entire society “learns to live with inflation” , the redistributive effect of inflation will be minimal.

However, it is difficult to anticipate properly every episode of inflation. Further, even if it is anticipated it cannot be perfect. In addition, adjustment with the new expected inflationary conditions may not be possible for all categories of people. Thus, adverse redistributive effects are likely to occur.

Finally, anticipated inflation may also be costly to the society. If people’s expectation regarding future price rise become stronger they will hold less liquid money. Mere holding of cash balances during inflation is unwise since its real value declines. That is why people use their money balances in buying real estate, gold, jewellery, etc.

Such investment is referred to as unproductive investment. Thus, during inflation of anticipated variety, there occurs a diversion of resources from priority to non-priority or unproductive sectors.

b. Effect on Production and Economic Growth :

Inflation may or may not result in higher output. Below the full employment stage, inflation has a favourable effect on production. In general, profit is a rising function of the price level. An inflationary situation gives an incentive to businessmen to raise prices of their products so as to earn higher doses of profit.

Rising price and rising profit encourage firms to make larger investments. As a result, the multiplier effect of investment will come into operation resulting in higher national output. However, such a favourable effect of inflation will be temporary if wages and production costs rise very rapidly.

Further, inflationary situation may be associated with the fall in output, particularly if inflation is of the cost-push variety. Thus, there is no strict relationship between prices and output. An increase in aggregate demand will increase both prices and output, but a supply shock will raise prices and lower output.

Inflation may also lower down further production levels. It is commonly assumed that if inflationary tendencies nurtured by experienced inflation persist in future, people will now save less and consume more. Rising saving propensities will result in lower further outputs.

One may also argue that inflation creates an air of uncertainty in the minds of business community, particularly when the rate of inflation fluctuates. In the midst of rising inflationary trend, firms cannot accurately estimate their costs and revenues. Under the circumstance, business firms may be deterred in investing. This will adversely affect the growth performance of the economy.

However, slight dose of inflation is necessary for economic growth. Mild inflation has an encouraging effect on national output. But it is difficult to make the price rise of a creeping variety. High rate of inflation acts as a disincentive to long run economic growth. The way the hyperinflation affects economic growth is summed up here.

We know that hyperinflation discourages savings. A fall in savings means a lower rate of capital formation. A low rate of capital formation hinders economic growth. Further, during excessive price rise, there occurs an increase in unproductive investment in real estate, gold, jewellery, etc.

Above all, speculative businesses flourish during inflation resulting in artificial scarcities and, hence, further rise in prices. Again, following hyperinflation, export earnings decline resulting in a wide imbalance in the balance of payments account.

Often, galloping inflation results in a ‘flight’ of capital to foreign countries since people lose confidence and faith over the monetary arrangements of the country, thereby resulting in a scarcity of resources. Finally, real value of tax revenue also declines under the impact of hyperinflation. Government then experiences a shortfall in investible resources.

Thus, economists and policy makers are unanimous regarding the dangers of high price rise. But the consequence of hyperinflation is disastrous. In the past, some of the world economies (e.g., Germany after the First World War (1914-1918), Latin American countries in the 1980s) had been greatly ravaged by hyperinflation.

The German Inflation of 1920s was also Catastrophic:

During 1922, the German price level went up 5,470 per cent, in 1923, the situation worsened; the German price level rose 1,300,000,000 times. By October of 1923, the postage of the lightest letter sent from Germany to the United States was 200,000 marks.

Butter cost 1.5 million marks per pound, meat 2 million marks, a loaf of bread 200,000 marks, and an egg 60,000 marks Prices increased so rapidly that waiters changed the prices on the menu several times during the course of a lunch!! Sometimes, customers had to pay double the price listed on the menu when they observed it first!!!

During October 2008, Zimbabwe, under the President-ship of Robert G. Mugabe, experienced 231,000,000 p.c. (2.31 million p.c.) as against 1.2 million p.c. price rise in September 2008—a record after 1923. It is an unbelievable rate. In May 2008, the cost of price of a toilet paper itself and not the costs of the roll of the toilet paper came to 417 Zimbabwean dollars.

Anyway, people are harassed ultimately by the high rate of inflation. That is why it is said that ‘inflation is our public enemy number one’. Rising inflation rate is a sign of failure on the part of the government.

Related Articles:

• Essay on the Causes of Inflation (473 Words)
• Cost-Push Inflation and Demand-Pull or Mixed Inflation
• Demand Pull Inflation and Cost Push Inflation | Money
• Essay on Inflation: Meaning, Measurement and Causes

What is inflation?

Inflation refers to a broad rise in the prices of goods and services across the economy over time, eroding purchasing power for both consumers and businesses. In other words, your dollar (or whatever currency you use for purchases) will not go as far today as it did yesterday. To understand the effects of inflation, take a commonly consumed item and compare its price from one period with another. For example, in 1970, the average cup of coffee cost 25 cents; by 2019, it had climbed to $1.59. So for $5, you would have been able to buy about three cups of coffee in 2019, versus 20 cups in 1970. That’s inflation, and it isn’t limited to price spikes for any single item or service; it refers to increases in prices across a sector, such as retail or automotive—and, ultimately, a country’s economy.

Get to know and directly engage with senior McKinsey experts on inflation.

Ondrej Burkacky is a senior partner in McKinsey’s Munich office, Axel Karlsson is a senior partner in the Stockholm office, Fernando Perez is a senior partner in the Miami office, Emily Reasor is a senior partner in the Denver office, and Daniel Swan is a senior partner in the Stamford office.

In a healthy economy, annual inflation is typically in the range of two percentage points, which is what economists consider a signal of pricing stability. And there can be positive effects of inflation when it’s within range: for instance, it can stimulate spending, and thus spur demand and productivity, when the economy is slowing down and needs a boost. Conversely, when inflation begins to surpass wage growth, it can be a warning sign of a struggling economy.

Inflation affects consumers most directly, but businesses can also feel the impact. Here’s a quick explanation of the differences in how inflation affects consumers and companies:

• Households, or consumers, lose purchasing power when the prices of items they buy, such as food, utilities, and gasoline, increase.
• Companies lose purchasing power, and risk seeing their margins decline , when prices increase for inputs used in production, such as raw materials like coal and crude oil , intermediate products such as flour and steel, and finished machinery. In response, companies typically raise the prices of their products or services to offset inflation, meaning consumers absorb these price increases. For many companies, the trick is to strike a balance between raising prices to make up for input cost increases while simultaneously ensuring that they don’t rise so much that it suppresses demand, which is touched on later in this article.

How is inflation measured?

Statistical agencies measure inflation by first determining the current value of a “basket” of various goods and services consumed by households, referred to as a price index. To calculate the rate of inflation, or percentage change, over time, agencies compare the value of the index over one period to another, such as month to month, which gives a monthly rate of inflation, or year to year, which gives an annual rate of inflation.

For example, in the United States, that country’s Bureau of Labor Statistics publishes its Consumer Price Index (CPI), which measures the cost of items that urban consumers buy out of pocket. The CPI is broken down by regions and is reported for the country as a whole. The  Personal Consumption Expenditures (PCE) price index —published by the US government’s Bureau of Economic Analysis—takes into account a broader range of consumers’ expenditures, including healthcare. It is also weighted by data acquired through business surveys.

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What are the main causes of inflation.

There are two primary types, or causes, of inflation:

• Demand-pull inflation occurs when the demand for goods and services in the economy exceeds the economy’s ability to produce them. For example, when demand for new cars recovered more quickly than anticipated from its sharp dip at the beginning of the COVID-19 pandemic, an intervening shortage in the supply of semiconductors  made it hard for the automotive industry to keep up with this renewed demand. The subsequent shortage of new vehicles resulted in a spike in prices for new and used cars.
• Cost-push inflation occurs when the rising price of input goods and services increases the price of final goods and services. For example, commodity prices spiked sharply  during the pandemic as a result of radical shifts in demand, buying patterns, cost to serve, and perceived value across sectors and value chains. To offset inflation and minimize impact on financial performance, industrial companies were forced to consider price increases that would be passed on to their end consumers.

Learn more about McKinsey's Pricing  practice.

How does inflation today differ from historical inflation?

In January 2022, inflation in the United States accelerated to 7.5 percent, its highest level since February 1982, as a result of soaring energy costs , labor mismatches , and supply disruptions . But inflation is not a new phenomenon; countries have weathered inflation throughout history.

A common comparison to the current inflationary period is with that of the post–World War II era , when price controls, supply problems, and extraordinary demand fueled double-digit inflation gains—peaking at 20 percent in 1947—before subsiding at the end of the decade, according to the US Bureau of Labor Statistics. Consumption patterns today have been similarly distorted, and supply chains have been disrupted  by the pandemic.

The period from the mid-1960s through the early 1980s, sometimes called “The Great Inflation,” saw some of the highest rates of inflation, with a peak of 14.8 percent in 1980. To combat this inflation, the Federal Reserve raised interest rates to nearly 20 percent. Some economists attribute this episode partially to monetary policy mistakes rather than to other purported causes, such as high oil prices. The Great Inflation signaled the need for public trust in the Federal Reserve’s ability to lessen inflationary pressures.

How does inflation affect pricing?

When inflation occurs, companies typically pay more for input materials . One way for companies to offset losses and maintain gross margins is by raising prices for consumers, but if price increases are not executed thoughtfully, companies can damage customer relationships, depress sales, and hurt margins. An exposure matrix that assesses which categories are exposed to market forces, and whether the market is inflating or deflating, can help companies make more informed decisions.

Done the right way, recovering the cost of inflation for a given product can strengthen relationships and overall margins. There are five steps companies can take to ADAPT  (Adjust, Develop, Accelerate, Plan, and Track) to inflation:

• Adjust discounting and promotions and revisit other aspects of sales unrelated to the base price, such as lengthened production schedules or surcharges and delivery fees for rush or low-volume orders.
• Develop the art and science of price change . Don’t make across-the-board price changes; rather, tailor pricing actions to account for inflation exposure, customer willingness to pay, and product attributes.
• Accelerate decision making tenfold . Establish an “inflation council” that includes dedicated cross-functional, inflation-focused decision makers who can act nimbly and quickly on customer feedback.
• Plan options beyond pricing to reduce costs . Use “value engineering” to reimagine your portfolio and provide cost-reducing alternatives to price increases.
• Track execution relentlessly . Create a central supporting team to address revenue leakage and to manage performance rigorously.

Beyond pricing, a variety of commercial and technical levers can help companies deal with price increases in an inflationary market , but other sectors may require a more tailored response to pricing. In the chemicals industry, for instance, category managers contending with soaring prices of commodities can make the following five moves  to save their companies money:

• Gain a full understanding of supply–market dynamics and outlook . Understand and track the elements that trigger price increases and rescind these increases once those drivers are no longer applicable.
• Ensure that suppliers can clearly articulate the impact that price increases in the market have on suppliers’ prices . In times of upward price pressure, sellers often overstate the share of raw materials in input costs, taking the opportunity to inflate their margins. Using cleansheet methodology to identify and challenge these situations is important.
• View unavoidable price increases as temporary surcharges, not the new future state . This mechanism, partly psychological in nature, is very effective in dealing with the stickiness of price increases because it shifts the burden of proof to the supplier.
• Prioritize cross-functional initiatives . When prices are high, the impact of yield improvements, waste reduction, or substitutions can be amplified. If any are available, now is the time to make them a priority.
• Work with sales to pass on price increases . Category managers work closely with finance and commercial teams to shed light on pure market effects and their impact on the prices of goods sold, while ensuring that the right arguments are advanced to pass market-price increases to customers.

Learn more about our Financial Services , Advanced Electronics , Operations , and Growth, Marketing & Sales  practices.

What is the difference between inflation and deflation?

If inflation is one extreme of the pricing spectrum, deflation is the other. Deflation occurs when the overall level of prices in an economy declines and the purchasing power of currency increases. It can be driven by growth in productivity and the abundance of goods and services, by a decrease in aggregate demand, or by a decline in the supply of money and credit.

Generally, moderate deflation positively affects consumers’ pocketbooks, as they are able to purchase more with less money. However, deflation can be a sign of a weakening economy, leading to recessions and depressions. While inflation reduces purchasing power, it also reduces the value of debt. During a period of deflation, on the other hand, debt becomes more expensive. Additionally, consumers can protect themselves to an extent during periods of inflation. For instance, consumers who have allocated their money into investments can see their earnings grow faster than the rate of inflation. During episodes of deflation, however, investments, such as stocks, corporate bonds, and real-estate investments, become riskier.

A recent period of deflation in the United States occurred between 2007 and 2008, referred to by economists as the Great Recession. In December 2008, more than half of executives surveyed by McKinsey  expected deflation in their countries, and 44 percent expected to decrease the size of their workforces.

When taken to their extremes, both inflation and deflation can significantly and negatively affect consumers, businesses, and investors.

For more in-depth exploration of these topics, see McKinsey’s Operations Insights  collection. Learn more about Operations consulting , and check out operations-related job opportunities if you’re interested in working at McKinsey.

Articles referenced include:

• “ How business operations can respond to price increases: A CEO guide ,” March 11, 2022, Andreas Behrendt , Axel Karlsson , Tarek Kasah, and Daniel Swan
• “ Five ways to ADAPT pricing to inflation ,” February 25, 2022, Alex Abdelnour , Eric Bykowsky, Jesse Nading, Emily Reasor , and Ankit Sood
• “ How COVID-19 is reshaping supply chains ,” November 23, 2021, Knut Alicke , Ed Barriball , and Vera Trautwein
• “ Navigating the labor mismatch in US logistics and supply chains ,” December 10, 2021, Dilip Bhattacharjee , Felipe Bustamante, Andrew Curley, and Fernando Perez
• “ Coping with the auto-semiconductor shortage: Strategies for success ,” May 27, 2021, Ondrej Burkacky , Stephanie Lingemann, and Klaus Pototzky

Want to know more about inflation?

Related articles.

What is supply chain?

How business operations can respond to price increases: A CEO guide

Five ways to ADAPT pricing to inflation

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What Causes Inflation? 

• Walter Frick

Why your money is worth less than it used to be.

What causes inflation? There is no one answer, but like so much of macroeconomics it comes down to a mix of output, money, and expectations. Supply shocks can lower an economy’s potential output, driving up prices. An increase in the money supply can stoke demand, driving up prices. And the expectation of inflation can become a self-fulfilling cycle as workers and companies demand higher wages and set higher prices.

Since the financial crisis of 2008 and the Great Recession, investors and executives have grown accustomed to a world of low interest rates and low inflation. No longer. In 2021, inflation began rising sharply in many parts of the world, and in 2022 the U.S. saw its worst inflation in decades.

• Walter Frick is a contributing editor at Harvard Business Review , where he was formerly a senior editor and deputy editor of HBR.org. He is the founder of Nonrival , a newsletter where readers make crowdsourced predictions about economics and business. He has been an executive editor at Quartz as well as a Knight Visiting Fellow at Harvard’s Nieman Foundation for Journalism and an Assembly Fellow at Harvard’s Berkman Klein Center for Internet & Society. He has also written for The Atlantic , MIT Technology Review , The Boston Globe , and the BBC, among other publications.

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Essays on Inflation

Inflation essay topics and outline examples, essay title 1: understanding inflation: causes, effects, and economic policy responses.

Thesis Statement: This essay provides a comprehensive analysis of inflation, exploring its root causes, the economic and societal effects it generates, and the various policy measures employed by governments and central banks to manage and mitigate inflationary pressures.

• Introduction
• Defining Inflation: Concept and Measurement
• Causes of Inflation: Demand-Pull, Cost-Push, and Monetary Factors
• Effects of Inflation on Individuals, Businesses, and the Economy
• Inflationary Policies: Central Bank Actions and Government Interventions
• Case Studies: Historical Inflationary Periods and Their Consequences
• Challenges in Inflation Management: Balancing Growth and Price Stability

Essay Title 2: Inflation and Its Impact on Consumer Purchasing Power: A Closer Look at the Cost of Living

Thesis Statement: This essay focuses on the effects of inflation on consumer purchasing power, analyzing how rising prices affect the cost of living, household budgets, and the strategies individuals employ to cope with inflation-induced challenges.

• Inflation's Impact on Prices: Understanding the Cost of Living Index
• Consumer Behavior and Inflation: Adjustments in Spending Patterns
• Income Inequality and Inflation: Examining Disparities in Financial Resilience
• Financial Planning Strategies: Savings, Investments, and Inflation Hedges
• Government Interventions: Indexation, Wage Controls, and Social Programs
• The Global Perspective: Inflation in Different Economies and Regions

Essay Title 3: Hyperinflation and Economic Crises: Case Studies and Lessons from History

Thesis Statement: This essay explores hyperinflation as an extreme form of inflation, examines historical case studies of hyperinflationary crises, and draws lessons on the devastating economic and social consequences that result from unchecked inflationary pressures.

• Defining Hyperinflation: Thresholds and Characteristics
• Case Study 1: Weimar Republic (Germany) and the Hyperinflation of 1923
• Case Study 2: Zimbabwe's Hyperinflationary Collapse in the Late 2000s
• Impact on Society: Currency Devaluation, Poverty, and Social Unrest
• Responses and Recovery: Stabilizing Currencies and Rebuilding Economies
• Preventative Measures: Policies to Avoid Hyperinflationary Crises

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What is inflation, and should we worry? An economist explains

Inflation is a concern. Hyperinflation is a disaster. A high-denomination banknote from the late 2000s. Image:  Robin Pomeroy

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Stay up to date:, geo-economics.

• Inflation was low for decades in much of the developed world before COVID.
• A surge in demand, some problems of supply and soaring energy costs have caused a big jump in inflation rates.
• Is this a blip, or is inflation back to stay, and what can be done?
• UBS Chief Economist Paul Donovan talks to the Radio Davos podcast.

As the world emerges from COVID, economies are revving back to life - but so is something that many parts of the world have not seen much of for decades - inflation.

So what is inflation and why has it suddenly reared up around the world?

UBS Chief Economist Paul Donovan , author of The Truth About Inflation , spoke to Radio Davos.

Have you read?

Why do oil prices matter to the global economy an expert explains, what is the impact of inflation on low-income households, 7 chief economists on how to solve the pandemic’s labour market paradox, what is inflation, and should we worry an interview with paul donovan.

Robin Pomeroy: Inflation is something everyone has been talking about and you even wrote a book about it called The Truth About Inflation , which is exactly what we want to get to in this interview: What is inflation? What is true, what is false about it? Why is inflation for you, as an economist and as an individual, such an important issue?

We have this idea that there is a single inflation number which affects us all. And that just isn't true.

Paul Donovan: It's important because I think it's it's very often misunderstood. We have this idea that there is a single inflation number which affects us all. And that just isn't true. The inflation experienced by older people tends to be higher. The inflation experienced by lower income people tends to be higher because of what they buy. Older people buy healthcare, lower income people are buying food, energy and housing in disproportionate amounts. And that gives them a higher inflation rate. So really, if you want to avoid inflation, you need to be young and rich.

Investors also, I think, get very confused about aspects of inflation. So consumer price inflation, which is the number most people look at, actually is not a very good guide to corporate pricing power because companies tend not to sell to consumers - companies sell to other companies. So it's a different measure - producer price inflation - that gives us a better indication of pricing power. Costs are driven by wage inflation. So this idea that there's a single nice statistic that tells us everything we need to know about price changes just isn't true, and we need to really understand the detail of what's going on to properly be able to assess the economic consequences of inflation moving up or inflation moving down.

Do we believe the inflation rate?

Robin Pomeroy: Individuals, we as people, sometimes find it hard to accept the official inflation rate because of biases we may have. Could you explain that a little bit?

Paul Donovan: People never believe the official inflation statistics, and they tend to believe that inflation is higher than it actually is. Why is that? Well, it's two behavioural economic concepts which are actually very well understood. So the first is loss aversion, and this is the fact that we are genetically programmed to remember and react to bad news more than good news. We run away from the sabre tooth tiger three times as fast as we run towards our next meal. So because of loss aversion, which is this sort of ancient behavioural trait, people remember price increases and they forget about the price cuts. And so you end up with this sort of bias that you're ignoring the fact that your flat screen TV fell in price last year, and you're remembering the fact that the price of your Snickers bar has gone up over the course of the last year.

Because of loss aversion, which is this ancient behavioural trait, people remember price increases and they forget about the price cuts.

But then we have this second behavioural trait, which is frequency bias, and this is a really big problem. People remember the price of something they buy frequently - that means food and fuel. The result is you get a very distorted view of what's driving inflation. So, for example, if I come into my office and I see that the price of a Snickers bar in a vending machine here has gone from 50 pence to 60 pence, I know I'm going to get colleagues coming up to me all the time and saying, 'inflation's out of control, we've got 20% inflation'. Now, with the best will in the world, my colleagues can only consume so many chocolate bars in a 24-hour period - it's not a major part of their overall budget. But every single time they go to the vending machine, they're reminded the price has gone up by 20% and that sticks in the mind. And so what we then have is this combination that we are focused on high-frequency purchases, and we tend to remember the price increases not the price declines. And that can give us a very distorted view of what's going on with average prices in the economy.

What's happening with inflation now?

Robin Pomeroy: So what is happening with inflation now globally? Everyone's talking about a resurgence in inflation. It seems that in many parts of the world there's not been inflation that's been above a point that we would consider problematic in many parts of the world, but now perhaps we are at a point where that's the case. Could you tell us - is that true what I'm saying, that there has been this historical period? And what is happening now?

Is this really inflation? That's that's where economists start to disagree.

Paul Donovan: In developed economies, by and large, we have had a 20-25 year period of pretty low inflation. Now there's been the odd spike, but generally speaking, prices have come in sort of around a 1.5-3-3.5% range of increase every year on an average index. And that, of course, is perfectly fine.

What we're now seeing is inflation rates come in quite a way above that. So in the United States, the latest inflation number for headline CPI - consumer price inflation - is 7% year over year, which is a very high number. Now is this really inflation? Well, that's that's where economists start to disagree a little bit. Because inflation is a general increase in prices, lots of prices rising by a large amount, all at the same time. And that's important because if lots and lots of prices are rising, that's telling you that there's an imbalance in the overall economy and that's something that policymakers need to address. But if you've got one or two prices rising a lot and other prices behaving more or less normally, then that's telling you that there's a problem in one or two markets, but not in the economy at large. We have got slightly stronger inflation for most of the economy and one or two price increases that are really quite extraordinary. And that's a pattern that we're seeing pretty much globally. Energy is behind a lot of the headline numbers. The used car market, the new car market, has also had some distortions because there have been problems with supply there over the last year. This is what's really pushing up the the headline inflation rate.

Inflation - the policy makers

Robin Pomeroy: At a recent conversation at the Davos Agenda , we had senior economists and central bankers talking about inflation. The head of the IMF, the head of the Bank of Japan, the head of the European Central Bank. I'd like to play you a clip from Christine Lagarde, the governor of the European Central Bank, with her view on where inflation is at right now.

Christine Lagarde (speaking at the Davos Agenda 2022 ): We have to ask ourselves, where is it [inflation] coming from? Is it likely to last? And we are trying to figure out how long it will last, because that is going to be critical in really composing the policy response that will be needed. And what do we see under the numbers? Well, we see 50% energy prices. It is not just the recovery, it is also geopolitical factors that are critically important at the moment, unfortunately. It is also some idiosyncratic factors. It is some weather-related factors. And the rest, essentially, taking out a few base effects that will eventually clear out in the next month, actually, we see a lot of this super-strong recovery that has outpaced supply, which was constrained. And as a result of that, you all, we all, talk about the bottlenecks, the congestion of ports, the lack of truck drivers and what have you. So then you ask yourself: these two big factors, are they going to be with us for the long term? Are they going to affect this inflation number and make it sustainable? And will that dictate our monetary policy response?

We are not seeing this sustainable movement that would lead to inflation spiralling out of control. On the contrary, we assume — and again, lesson of humility here, there is a lot of uncertainty about it — but we assume for the moment that energy prices will stabilise in the course of '22, that those bottlenecks and those congested ports and drivers missing in action, and all the rest of it, will also stabilise in the course of '22, and that gradually those inflation numbers will decline.

Robin Pomeroy: Christine Lagarde, governor of the European Central Bank, seemingly cautiously optimistic that inflation will start to come back under control because the things she mentioned are transitory problems there. Do you agree with her forecast?

Paul Donovan: Broadly, I would agree with President Lagarde that inflation is going to come down because the increase in the oil price is slowing, and that means the contribution of the oil price to inflation is slowing. And other factors, I think, are also going to be coming down. Demand, which has been quite extraordinary, is going to normalise as we go through this year.

We're hearing a lot from policymakers about supply chain problems and supply chain bottlenecks. This is politics - it's not economics. Because when we look at what's happened with global supply, global supply simply surged last year. Global manufacturing output: all time record high. Global volume of trade: up 11% on the World Trade Organisation's numbers. The volume of shipping through the Suez Canal: all-time record high, even with ships going sideways , they still get an all-time record high volume of shipping! So we're seeing supply chains work wonderfully throughout 2021. This idea that supply chains are crumbling ruins around the world is complete nonsense.

You've got to go back to the end of wartime rationing to see so strong a surge in demand for durable goods.

But what we had last year was a simply extraordinary level of demand. In the United States, demand for durable goods surged in the strongest increase we have seen since 1946. You've got to go back to the end of wartime rationing to see so strong a surge in demand for durable goods. And why was that? Well, that was because, during the pandemic, people saved money and once they were released from the restrictions around COVID and were able to go out and spend the money, they went out and spent the money. So you've had this extraordinary, extraordinary surge in demand, which has overwhelmed a valiant effort by supply to meet that demand. So here we have a bit of an imbalance in the economy. Demand is a lot stronger than supply, and that has pushed up some prices of goods. But of course, that surge in demand cannot last, and we're already starting to see it fade in the US and possibly also in the UK. Because once the savings are spent, you have to go back to normal levels of demand. And that seems to be where we're moving to. And as we normalise demand, we're going to normalise inflation rates with a little bit of a lag because prices take a little while to adjust, but normalising inflation seems to me very, very likely this year.

Robin Pomeroy: So we should all take a deep breath and kind of ride this wave. I guess the question is with inflation is: will it spiral? Let me play this little clip from someone else on that panel at the Davos Agenda week. This is Brazilian Economy Minister Paulo Guedes.

Paulo Guedes (speaking at the Davos Agenda 2022 ) : I don't think inflation will be transitory at all. I think these supply adverse shocks will fade away gradually, but there's no arbitrage anymore to be exploited by the Western side. So I think the central banks are sleeping at the driver wheel. They should be aware. And I think inflation will be a problem, a real problem, very soon for the Western world.

Inflation - what causes a spiral?

Robin Pomeroy: So that was Paulo Guedes, the economy minister of Brazil, taking the other opinion, saying that things will spiral out of control. What are the risk factors that do push inflation to spiral upwards? What are the policy levers available and whether they might or might not be useful this time around?

Labour costs in a developed economy are about 70% of inflation.

Paul Donovan: So the simple answer is labour costs. Now, labour costs in a developed economy are about 70% of inflation. We all focus on things like commodity prices. Commodities really aren't that important to inflation - about 15% is down to commodities. Labour costs are the big one. And it's important to recognise here that we're not talking about wages. So wages is how much you take home. But actually what a company is interested in when it's setting prices is, 'how much do I have to spend on labour entirely to produce a unit of output?' The wage rate going up is not all we've got to consider. We've also got to consider how hard are people working, because if people are working harder, then they should be paid more money, something I repeatedly remind my bosses of. If you've got people who are working harder, they're producing more output - paying them more money isn't necessarily inflationary. So the US restaurant sector is a really good example of this. If we look at the data for December, restaurant sales in the United States were over 19% higher than they were in January of 2020. But you've achieved that increase in restaurant sales with 2.3% fewer staff. So in that situation, of course, what's happening is staff are working harder or in some restaurants staff have been replaced by computers. The only thing the restaurant employee does is actually prepare the food for you. So this automation means that you can use fewer people to achieve more output, and so therefore you can afford to pay those people a little bit more. So the way that economists look at this is through something called unit labour costs. Now the problem with unit labour costs is this is data that's revised very, very often, and it's not a very stable statistic, to be perfectly honest. But that's really what we're looking at. If we start to see wages increasing more rapidly than output is increasing, that would be something that would start to be problematic because then those wage costs would be passed on in higher prices and then workers may respond with increased wage demands.

I think it's very unlikely to happen. It happened in the 1970s in a very, very different world. The US president, President Nixon, was setting wages and prices personally, it was a state control. The price of hamburger in the United States was personally set by President Nixon in the Oval Office. Quite remarkable. And that whole collapse of that pricing structure led to an inflation bout. The unionised nature of wage bargaining also led to increased inflation pressure. We're nowhere near any of that now.

Inflation, wages and productivity

Robin Pomeroy: You're talking about this word 'productivity' there aren't you? That's the term economists use. So 'it's OK to increase wages if productivity increases'. I just wonder, I mean, in a hamburger restaurant that might apply, but what about lots of areas where the output is quite difficult to measure? What about the millions of people who work in schools and in hospitals? How do you measure the productivity of a teacher or of a nurse? You know, a nurse who's worked her fingers to the bone, or his, through the pandemic, who deserves a pay rise, who's got to deal with these inflationary pressures. There will be pressure, won't there, to increase wages for millions of people around the world, very often low paid people who have tough jobs. But it's very hard to measure, I would have thought, productivity increases for them, isn't it?

Paul Donovan: It is. There are ways that you can try and do this and you have to come up with, you know: 'What is the value of healthcare?', 'What is the value of education?' It's controversial. The UK, for example, measures the value of education based on the number of students that are taught, whereas France measures the value of education based on how much they pay their teachers. There are more and more sophisticated ways of measuring output, which is helpful and which does allow us to see a little bit more about what's going on in terms of productivity and the value of what people are producing in the economy. But we've got to recognise that the pandemic has accelerated an awful lot of structural change, and data is scrambling to keep up with this. But things like working from home change productivity, change efficiency. The increase of self-employment, we've seen a massive increase in self-employment in many, many developed economies in the aftermath of the pandemic. That's not necessarily being captured in the data, but it's still output and productivity and income. So it's becoming a lot more complicated as we go through this structural upheaval in the economy.

The inflation policy levers

Robin Pomeroy: So let's talk a bit about the policies now. We've quoted central bankers who are in charge of setting interest rates. Could you just take us back to the basics and say what is it that policymakers are looking out for and what is it they can do, at least in theory, to control inflation?

There's a limit to what central bankers can do. There's some prices that they've got to sit there and say: 'You know what? Sit it out for 12 months and this is going to stop being a problem'.

Paul Donovan: We have fiscal policy, we have monetary policy, and inflation is generally put down to the monetary policy makers. That's not always entirely practical. So if we look at some of the current inflation, there's nothing Fed Chair Powell can do to change global oil prices. He is not a used car sales person. There's nothing he can do to change the price of a 2001 Honda Civic. So there's a limit to what central bankers can do. There's some prices that they've really got to sit there and say, 'You know what? Sit it out for 12 months and this is going to stop being a problem'. And that's effectively what central bankers are having to do. But there are other prices that they can influence, and they can influence to some extent wage growth, indirectly, they can influence some other cyclical prices by influencing the cost of credit in the economy. And by raising the cost of credit - raising interest rates - what of course you are doing is limiting the ability of people to demand goods and therefore you bring supply and demand into balance, and that helps reduce inflation pressures. You may also give people an incentive to save money rather than spend money if you've raised the interest rate. But we have to recognise the limitations. We've just got to burn through this demand and then after that see where we are. And so that's what I think is is happening. Central banks know that inflation is going to be coming down this year because the technical factors are going to fade. So what they are looking to do is not to sort of squeeze inflation out of the system - they're not looking to create a recession. What they're looking to do is have interest rates that are a level that allow growth after this demand surge to settle back into a more normal pattern. And that's quite a less aggressive policy than when you're trying to actually push down on inflation. Central banks are saying, 'Look, inflation's coming down, and once it's down, we want to keep it there'. That's a slightly different approach that they're going to be taking.

Hyperinflation

Robin Pomeroy: Let's just go back to inflation as this kind of bogeyman that some people fear. And you've got countries, haven't you, that have this collective memory of something far worse than that - of hyperinflation? We know that the Germans, even people who aren't old enough to remember it, there's still this kind of societal memory of hyperinflation there. Could you remind us what hyperinflation is and how bad inflation can get and why we should be so scared of it in those circumstances.

In a hyperinflation episode people can lose everything.

Paul Donovan: There isn't really a formal definition of what hyperinflation is. I would say that once you're talking about a 50% inflation rate, you're getting pretty close to a hyperinflation scenario. And it's where prices are changing constantly. That becomes socially disruptive. You're changing social status of people. You're changing the relative value of jobs, of positions in society, of incomes. Normally, a hyperinflation episode involves a huge transfer of wealth from savers to borrowers. Borrowers benefit, savers suffer. And that's what people remember. Again, it's that loss aversion. In a hyperinflation episode people can lose everything - they lose their social status, they lose their income. And that's why hyperinflation episodes tend to be remembered for multi-generations. So Germany had two hyperinflation episodes: 1923 and then immediately after the Second World War. Singapore is another interesting society where there's a very strong fear of inflation coming, not from Singapore's hyperinflation episode, but from the hyperinflation of nationalist China after the war and then a lot of emigres from nationalist China went and settled in Singapore and they took with them the memory of the very, very destructive power of a very, very high inflation rate. So hyperinflation tends to cause considerable concern.

If you've got an economist running a central bank, you will not have hyperinflation.

It's something which happens deliberately, to be perfectly honest. If you've got an economist running a central bank, you will not have hyperinflation because hyperinflation is essentially caused by printing too much money. In 1923, the Reichsbank 's President Havenstein in Germany, who wasn't an economist, he was a lawyer, responded to the German economic situation just simply printing more and more money. And this famous occasion where he gave a speech saying, 'Don't worry, we've ordered more printing presses. We're going to be able to print even more money and it will all be fine. And that will get rid of the inflation.' Complete misunderstanding of what was going on, to the extent that by the end of the hyperinflation episode, the central bank was printing money where they only printed one side of the banknote, the other side was blank paper because there wasn't enough time to print both sides of the banknote before the money devalued and lost all sense of value.

We've seen that more recently in places like Zimbabwe, the worst hyperinflation episode ever was in Czechoslovakia after the Second World War. So we've had all of these these episodes. It's caused by a complete failure to observe the laws of economics. As long as you observe the laws of economics, you maintain some semblance of balance between money supply and money demand.

Robin Pomeroy: That's a reassuring note, perhaps on which to end it. Paul Donovan, thanks very much for explaining inflation to us. We're going to keep a close eye on it. Thanks for joining us on Radio Davos.

Paul Donovan: Thanks so much for your time.

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Economic essays on inflation

• Definition – Inflation – Inflation is a sustained rise in the cost of living and average price level.
• Causes Inflation – Inflation is caused by excess demand in the economy, a rise in costs of production, rapid growth in the money supply.

• Costs of Inflation – Inflation causes decline in value of savings, uncertainty, confusion and can lead to lower investment.

• Problems measuring inflation – why it can be hard to measure inflation with changing goods.
• Different types of inflation – cost-push inflation, demand-pull inflation, wage-price spiral,
• How to solve inflation . Policies to reduce inflation, including monetary policy, fiscal policy and supply-side policies.
• Trade off between inflation and unemployment . Is there a trade-off between the two, as Phillips Curve suggests?
• The relationship between inflation and the exchange rate – Why high inflation can lead to a depreciation in the exchange rate.
• What should the inflation target be? – Why do government typically target inflation of 2%
• Deflation – why falling prices can lead to negative economic growth.
• Monetarist Theory – Monetarist theory of inflation emphasises the role of the money supply.
• Criticisms of Monetarism – A look at whether the monetarist theory holds up to real-world scenarios.
• Money Supply   – What the money supply is.
• Can we have economic growth without inflation?
• Predicting inflation
• Link between inflation and interest rates
• Should low inflation be the primary macroeconomic objective?

See also notes on Unemployment

Inflation: What It Is, How It Can Be Controlled, and Extreme Examples

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What Is Inflation?

Understanding inflation, types of price indexes.

• Pros and Cons

Controlling Inflation

Hedging against inflation, the bottom line.

What you need to know about the purchasing power of money and how it changes

Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom.

Inflation is a rise in prices, which can be translated as the decline of purchasing power over time. The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over some time. The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. Inflation can be contrasted with deflation, which occurs when prices decline and purchasing power increases.

Key Takeaways

• Inflation is the rate at which prices for goods and services rise.
• Inflation is sometimes classified into three types: demand-pull inflation, cost-push inflation, and built-in inflation.
• The most commonly used inflation indexes are the Consumer Price Index and the Wholesale Price Index.
• Inflation can be viewed positively or negatively depending on the individual viewpoint and rate of change.
• Those with tangible assets, like property or stocked commodities, may like to see some inflation as that raises the value of their assets.

While it is easy to measure the price changes of individual products over time, human needs extend beyond just one or two products. Individuals need a big and diversified set of products as well as a host of services for living a comfortable life. They include commodities like food grains, metal, fuel, utilities like electricity and transportation, and services like healthcare , entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of products and services. It allows for a single value representation of the increase in the price level of goods and services in an economy over a specified time.

Prices rise, which means that one unit of money buys fewer goods and services. This loss of purchasing power impacts the cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.

Investopedia / Ellen Lindner

The increase in the Consumer Price Index For All Urban Consumers (CPI-U) over the 12 months ending February 2024. Prices rose 0.4% on a seasonally adjusted basis in February from the previous month.

To combat this, the monetary authority (in most cases, the central bank ) takes the necessary steps to manage the money supply and credit to keep inflation within permissible limits and keep the economy running smoothly.

Theoretically, monetarism is a popular theory that explains the relationship between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and silver flowed into the Spanish and other European economies. Since the money supply rapidly increased, the value of money fell, contributing to rapidly rising prices.

Inflation is measured in a variety of ways depending on the types of goods and services. It is the opposite of deflation , which indicates a general decline in prices when the inflation rate falls below 0%. Keep in mind that deflation shouldn't be confused with disinflation , which is a related term referring to a slowing down in the (positive) rate of inflation.

Investopedia / Julie Bang

Causes of Inflation

An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy. A country's money supply can be increased by the monetary authorities by:

• Printing and giving away more money to citizens
• Legally devaluing (reducing the value of) the legal tender currency
• Loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market (the most common method)

In all of these cases, the money ends up losing its purchasing power. The mechanisms of how this drives inflation can be classified into three types: demand-pull inflation, cost-push inflation, and built-in inflation.

Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and credit stimulates the overall demand for goods and services to increase more rapidly than the economy's production capacity. This increases demand and leads to price rises.

When people have more money, it leads to positive consumer sentiment. This, in turn, leads to higher spending, which pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices.

Melissa Ling {Copyright} Investopedia, 2019

Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the production process inputs. When additions to the supply of money and credit are channeled into a commodity or other asset markets, costs for all kinds of intermediate goods rise. This is especially evident when there's a negative economic shock to the supply of key commodities.

These developments lead to higher costs for the finished product or service and work their way into rising consumer prices. For instance, when the money supply is expanded, it creates a speculative boom in oil prices . This means that the cost of energy can rise and contribute to rising consumer prices, which is reflected in various measures of inflation.

Built-in Inflation

Built-in inflation is related to adaptive expectations or the idea that people expect current inflation rates to continue in the future. As the price of goods and services rises, people may expect a continuous rise in the future at a similar rate.

As such, workers may demand more costs or wages to maintain their standard of living. Their increased wages result in a higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.

Depending upon the selected set of goods and services used, multiple types of baskets of goods are calculated and tracked as price indexes. The most commonly used price indexes are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) .

The Consumer Price Index (CPI)

The CPI is a measure that examines the weighted average of prices of a basket of goods and services that are of primary consumer needs. They include transportation, food, and medical care.

CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them based on their relative weight in the whole basket. The prices in consideration are the retail prices of each item, as available for purchase by the individual citizens.

Changes in the CPI are used to assess price changes associated with the cost of living , making it one of the most frequently used statistics for identifying periods of inflation or deflation. In the U.S., the Bureau of Labor Statistics (BLS) reports the CPI on a monthly basis and has calculated it as far back as 1913.

The CPI-U, which was introduced in 1978, represents the buying habits of approximately 88% of the non-institutional population of the United States.

The Wholesale Price Index (WPI)

The WPI is another popular measure of inflation. It measures and tracks the changes in the price of goods in the stages before the retail level.

While WPI items vary from one country to another, they mostly include items at the producer or wholesale level. For example, it includes cotton prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing.

Although many countries and organizations use WPI, many other countries, including the U.S., use a similar variant called the producer price index (PPI) .

The Producer Price Index (PPI)

The PPI is a family of indexes that measures the average change in selling prices received by domestic producers of intermediate goods and services over time. The PPI measures price changes from the perspective of the seller and differs from the CPI which measures price changes from the perspective of the buyer.

In all variants, the rise in the price of one component (say oil) may cancel out the price decline in another (say wheat) to a certain extent. Overall, each index represents the average weighted price change for the given constituents which may apply at the overall economy, sector , or commodity level.

The Formula for Measuring Inflation

The above-mentioned variants of price indexes can be used to calculate the value of inflation between two particular months (or years). While a lot of ready-made inflation calculators are already available on various financial portals and websites, it is always better to be aware of the underlying methodology to ensure accuracy with a clear understanding of the calculations. Mathematically,

Percent Inflation Rate = (Final CPI Index Value ÷ Initial CPI Value) x 100

Say you wish to know how the purchasing power of $10,000 changed between January 1975 and January 2024. One can find price index data on various portals in a tabular form. From that table, pick up the corresponding CPI figures for the given two months. For September 1975, it was 52.1 (initial CPI value) and for January 2024, it was 308.417 (final CPI value).

Plugging in the formula yields:

Percent Inflation Rate = (308.417 ÷ 52.1) x 100 = (5.9197) x 100 = 591.97%

Since you wish to know how much $10,000 from January 1975 would worth be in January 2024, multiply the inflation rate by the amount to get the changed dollar value:

Change in Dollar Value = 5.9197 x $10,000 = $59,197

This means that $10,000 in January 1975 will be worth $59,197 today. Essentially, if you purchased a basket of goods and services (as included in the CPI definition) worth $10,000 in 1975, the same basket would cost you $59,197 in January 2024.

Advantages and Disadvantages of Inflation

Inflation can be construed as either a good or a bad thing, depending upon which side one takes, and how rapidly the change occurs.

Individuals with tangible assets (like property or stocked commodities) priced in their home currency may like to see some inflation as that raises the price of their assets, which they can sell at a higher rate.

Inflation often leads to speculation by businesses in risky projects and by individuals who invest in company stocks because they expect better returns than inflation.

An optimum level of inflation is often promoted to encourage spending to a certain extent instead of saving. If the purchasing power of money falls over time, there may be a greater incentive to spend now instead of saving and spending later. It may increase spending, which may boost economic activities in a country. A balanced approach is thought to keep the inflation value in an optimum and desirable range.

Disadvantages

Buyers of such assets may not be happy with inflation, as they will be required to shell out more money. People who hold assets valued in their home currency, such as cash or bonds, may not like inflation, as it erodes the real value of their holdings.

As such, investors looking to protect their portfolios from inflation should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts (REITs). Inflation-indexed bonds are another popular option for investors to profit from inflation .

High and variable rates of inflation can impose major costs on an economy. Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and planning decisions.

This introduces an additional source of uncertainty into the economy, because they may guess wrong about the rate of future inflation. Time and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices. That's opposed to real economic fundamentals, which inevitably represent a cost to the economy as a whole.

Even a low, stable, and easily predictable rate of inflation, which some consider otherwise optimal, may lead to serious problems in the economy. That's because of how, where, and when the new money enters the economy.

Whenever new money and credit enter the economy, it is always in the hands of specific individuals or business firms. The process of price level adjustments to the new money supply proceeds as they then spend the new money and it circulates from hand to hand and account to account through the economy.

Inflation does drive up some prices first and drives up other prices later. This sequential change in purchasing power and prices (known as the Cantillon effect) means that the process of inflation not only increases the general price level over time. But it also distorts relative prices , wages, and rates of return along the way.

Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and Austrian economists even believe this process to be a major driver of cycles of recession in the economy.

Leads to higher resale value of assets

Optimum levels of inflation encourage spending

Buyers have to pay more for products and services

Impose higher prices on the economy

Drives some prices up first and others later

A country’s financial regulator shoulders the important responsibility of keeping inflation in check. It is done by implementing measures through monetary policy , which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money supply.

In the U.S., the Fed's monetary policy goals include moderate long-term interest rates, price stability, and maximum employment. Each of these goals is intended to promote a stable financial environment. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation , which is thought to be beneficial to the economy.

Price stability or a relatively constant level of inflation allows businesses to plan for the future since they know what to expect. The Fed believes that this will promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change.

For this reason, the Fed doesn't set a specific goal for maximum employment, and it is largely determined by employers' assessments. Maximum employment does not mean zero unemployment, as at any given time there is a certain level of volatility as people vacate and start new jobs.

Hyperinflation is often described as a period of inflation of 50% or more per month.

Monetary authorities also take exceptional measures in extreme conditions of the economy. For instance, following the 2008 financial crisis, the U.S. Fed kept the interest rates near zero and pursued a bond-buying program called quantitative easing (QE) .

Some critics of the program alleged it would cause a spike in inflation in the U.S. dollar, but inflation peaked in 2007 and declined steadily over the next eight years. There are many complex reasons why QE didn't lead to inflation or hyperinflation , though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects.

Consequently, U.S. policymakers have attempted to keep inflation steady at around 2% per year. The European Central Bank (ECB) has also pursued aggressive quantitative easing to counter deflation in the eurozone, and some places have experienced negative interest rates . That's due to fears that deflation could take hold in the eurozone and lead to economic stagnation.

Moreover, countries that experience higher rates of growth can absorb higher rates of inflation. India's target is around 4% (with an upper tolerance of 6% and a lower tolerance of 2%), while Brazil aims for 3.25% (with an upper tolerance of 4.75% and a lower tolerance of 1.75%).

Stocks are considered to be the best hedge against inflation , as the rise in stock prices is inclusive of the effects of inflation. Since additions to the money supply in virtually all modern economies occur as bank credit injections through the financial system, much of the immediate effect on prices happens in financial assets that are priced in their home currency, such as stocks.

Special financial instruments exist that one can use to safeguard investments against inflation . They include Treasury Inflation-Protected Securities (TIPS) , low-risk treasury security that is indexed to inflation where the principal amount invested is increased by the percentage of inflation.

One can also opt for a TIPS mutual fund or TIPS-based exchange-traded fund (ETF). To get access to stocks, ETFs, and other funds that can help avoid the dangers of inflation, you'll likely need a brokerage account. Choosing a stockbroker can be a tedious process due to the variety among them.

Gold is also considered to be a hedge against inflation, although this doesn't always appear to be the case looking backward.

Examples of Inflation

Since all world currencies are fiat money , the money supply could increase rapidly for political reasons, resulting in rapid price level increases. The most famous example is the hyperinflation that struck the German Weimar Republic in the early 1920s.

The nations that were victorious in World War I demanded reparations from Germany, which could not be paid in German paper currency, as this was of suspect value due to government borrowing. Germany attempted to print paper notes, buy foreign currency with them, and use that to pay their debts.

This policy led to the rapid devaluation of the German mark along with the hyperinflation that accompanied the development. German consumers responded to the cycle by trying to spend their money as fast as possible, understanding that it would be worth less and less the longer they waited. More money flooded the economy, and its value plummeted to the point where people would paper their walls with practically worthless bills. Similar situations occurred in Peru in 1990 and in Zimbabwe between 2007 and 2008.

What Causes Inflation?

There are three main causes of inflation: demand-pull inflation, cost-push inflation, and built-in inflation.

• Demand-pull inflation refers to situations where there are not enough products or services being produced to keep up with demand, causing their prices to increase.
• Cost-push inflation, on the other hand, occurs when the cost of producing products and services rises, forcing businesses to raise their prices.
• Built-in inflation (which is sometimes referred to as a wage-price spiral) occurs when workers demand higher wages to keep up with rising living costs. This in turn causes businesses to raise their prices in order to offset their rising wage costs, leading to a self-reinforcing loop of wage and price increases.

Is Inflation Good or Bad?

Too much inflation is generally considered bad for an economy, while too little inflation is also considered harmful. Many economists advocate for a middle ground of low to moderate inflation, of around 2% per year.

Generally speaking, higher inflation harms savers because it erodes the purchasing power of the money they have saved; however, it can benefit borrowers because the inflation-adjusted value of their outstanding debts shrinks over time.

What Are the Effects of Inflation?

Inflation can affect the economy in several ways. For example, if inflation causes a nation’s currency to decline, this can benefit exporters by making their goods more affordable when priced in the currency of foreign nations.

On the other hand, this could harm importers by making foreign-made goods more expensive. Higher inflation can also encourage spending, as consumers will aim to purchase goods quickly before their prices rise further. Savers, on the other hand, could see the real value of their savings erode, limiting their ability to spend or invest in the future.

Why Is Inflation So High Right Now?

In 2022, inflation rates around the world rose to their highest levels since the early 1980s. While there is no single reason for this rapid rise in global prices, a series of events worked together to boost inflation to such high levels.

The COVID-19 pandemic led to lockdowns and other restrictions that greatly disrupted global supply chains, from factory closures to bottlenecks at maritime ports. Governments also issued stimulus checks and increased unemployment benefits to counter the financial impact on individuals and small businesses. When vaccines became widespread and the economy bounced back, demand (fueled in part by stimulus money and low-interest rates) quickly outpaced supply, which still struggled to get back to pre-COVID levels.

Russia's unprovoked invasion of Ukraine in early 2022 led to economic sanctions and trade restrictions on Russia, limiting the world's supply of oil and gas since Russia is a large producer of fossil fuels. Food prices also rose as Ukraine's large grain harvests could not be exported. As fuel and food prices rose, it led to similar increases down the value chains. The Fed raised interest rates to combat the high inflation, which significantly came down in 2023, though it remains above pre-pandemic levels .

Inflation is a rise in prices, which results in the decline of purchasing power over time. Inflation is natural and the U.S. government targets an annual inflation rate of 2%; however, inflation can be dangerous when it increases too much, too fast. Inflation makes items more expensive, especially if wages do not rise by the same levels of inflation. Additionally, inflation erodes the value of some assets, especially cash. Governments and central banks seek to control inflation through monetary policy.

U.S. Bureau of Labor Statistics. " CONSUMER PRICE INDEX - FEBRUARY 2024 ," Page 1.

Edo, Anthony and Melitz, Jacques. " The Primary Cause of European Inflation in 1500-1700: Precious Metals or Population? The English Evidence ." CEPII Working Paper , October 2019, pp. 13-14. Download PDF.

U.S. Bureau of Labor Statistics. " Consumer Price Index: Overview ."

U.S. Bureau of Labor Statistics. " Chapter 17. The Consumer Price Index (Updated 2-14-2018) ," Page 2.

U.S. Bureau of Labor Statistics. " Consumer Price Index Chronology ."

U.S. Bureau of Labor Statistics. " Producer Price Index Frequently Asked Questions (FAQs) ," Select "4. How does the Producer Price Index differ from the Consumer Price Index?"

U.S. Bureau of Labor Statistics. " Producer Price Index Frequently Asked Questions (FAQs) ," Select "3. When did the Wholesale Price Index become the Producer Price Index?"

U.S. Bureau of Labor Statistics. " Producer Price Indexes ."

U.S. Bureau of Labor Statistics. " Consumer Price Index Historical Tables for U.S. City Average ."

U.S. Bureau of Labor Statistics. " Historical CPI-U ," Page 3.

Adam Smith Institute. " The Cantillion Effect ."

Foundation for Economic Education. " The Current Economic Crisis and the Austrian Theory of the Business Cycle ."

Board of Governors of the Federal Reserve System. " Review of Monetary Policy Strategy, Tools, and Communication ."

Board of Governors of the Federal Reserve System. " What is the Lowest Level of Unemployment that the U.S. Economy Can Sustain? "

Fischer, Stanley and et al. " Modern Hyper- and High Inflations ." Journal of Economic Literature , vol. 40, no. 3, September 2002, pp. 837.

Federal Reserve History. " The Great Recession and its Aftermath ."

Federal Reserve Bank of New York. " Liberty Street Economics: Ten Years Later—Did QE Work? "

Congressional Budget Office. " How the Federal Reserve’s Quantitative Easing Affects the Federal Budget ."

Board of Governors of the Federal Reserve System. " FAQs: Why Does the Federal Reserve Aim for Inflation of 2 Percent Over the Longer Run? "

European Central Bank. " How Quantitative Easing Works ."

Reserve Bank of India. " Monetary Policy ," Select "The Monetary Policy Framework."

Central Bank of Brazil. " Inflation Targeting Track Record ."

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University of Illinois, Urbana-Champaign. " 1920s Hyperinflation in Germany and Bank Notes ."

Rossini, Renzo (Editors Alejandro M. Werner and Alejandro Santos). " Staying the Course of Economic Success: Chapter 2. Peru’s Recent Economic History: From Stagnation, Disarray, and Mismanagement to Growth, Stability, and Quality Policies ." International Monetary Fund, September 2015.

Kramarenko, Vitaliy and et al. " Zimbabwe: Challenges and Policy Options after Hyperinflation ." International Monetary Fund , June 2010, no. 6.

The World Bank. " Inflation, Consumer Prices (Annual %) ."

Federal Reserve Bank of St. Louis, FRED. " Consumer Price Index for All Urban Consumers: All Items in U.S. City Average ."

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• Inflation: What It Is, How It Can Be Controlled, and Extreme Examples 1 of 41
• 10 Common Effects of Inflation 2 of 41
• How to Profit From Inflation 3 of 41
• When Is Inflation Good for the Economy? 4 of 41
• History of the Cost of Living 5 of 41
• Why Are P/E Ratios Higher When Inflation Is Low? 6 of 41
• What Causes Inflation? 7 of 41
• Understand the Different Types of Inflation 8 of 41
• Wage Push Inflation: Definition, Causes, and Examples 9 of 41
• Cost-Push Inflation: When It Occurs, Definition, and Causes 10 of 41
• Cost-Push Inflation vs. Demand-Pull Inflation: What's the Difference? 11 of 41
• Inflation vs. Stagflation: What's the Difference? 12 of 41
• What Is the Relationship Between Inflation and Interest Rates? 13 of 41
• Inflation's Impact on Stock Returns 14 of 41
• How Does Inflation Affect Fixed-Income Investments? 15 of 41
• How Inflation Affects Your Cost of Living 16 of 41
• How Inflation Impacts Your Savings 17 of 41
• How Inflation Impacts Your Retirement Income 18 of 41
• What Impact Does Inflation Have on a Dollar's Value Over Time? 19 of 41
• Inflation and Economic Recovery 20 of 41
• What Is Hyperinflation? Causes, Effects, Examples, and How to Prepare 21 of 41
• Why Didn't Quantitative Easing Lead to Hyperinflation? 22 of 41
• Worst Cases of Hyperinflation in History 23 of 41
• How the Great Inflation of the 1970s Happened 24 of 41
• What Is Stagflation, What Causes It, and Why Is It Bad? 25 of 41
• Understanding Purchasing Power and the Consumer Price Index 26 of 41
• Consumer Price Index (CPI): What It Is and How It's Used 27 of 41
• Why Is the Consumer Price Index Controversial? 28 of 41
• Core Inflation: What It Is and Why It's Important 29 of 41
• What Is Headline Inflation (Reported in Consumer Price Index)? 30 of 41
• What Is the GDP Price Deflator and Its Formula? 31 of 41
• Indexation Explained: Meaning and Examples 32 of 41
• Inflation Accounting: Definition, Methods, Pros & Cons 33 of 41
• Inflation-Adjusted Return: Definition, Formula, and Example 34 of 41
• What Is Inflation Targeting, and How Does It Work? 35 of 41
• Real Economic Growth Rate: Definition, Calculation, and Uses 36 of 41
• Real Gross Domestic Product (Real GDP): How to Calculate It, vs. Nominal 37 of 41
• Real Income, Inflation, and the Real Wages Formula 38 of 41
• Real Interest Rate: Definition, Formula, and Example 39 of 41
• Real Rate of Return: Definition, How It's Used, and Example 40 of 41
• Wage-Price Spiral: What It Is and How It’s Controlled 41 of 41

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A $550 Million Loaf of Bread?

If you were born within the last three decades in the United States, Canada, or many other countries in the developed world, you probably have no real experience with a high rate of inflation. Inflation is when most prices in an entire economy are rising. But there is an extreme form of inflation called hyperinflation. This occurred in Germany between 1921 and 1928, and more recently in Zimbabwe between 2008 and 2009. In November of 2008, Zimbabwe had an inflation rate of 79.6 billion percent. In contrast, in 2014, the United States had an average annual rate of inflation of 1.6%.

Zimbabwe’s inflation rate was so high it is difficult to comprehend. So, let’s put it into context. It is equivalent to price increases of 98% per day. This means that, from one day to the next, prices essentially double. What is life like in an economy afflicted with hyperinflation? Not like anything you are familiar with. Prices for commodities in Zimbabwean dollars were adjusted several times each day . There was no desire to hold on to currency since it lost value by the minute. The people there spent a great deal of time getting rid of any cash they acquired by purchasing whatever food or other commodities they could find. At one point, a loaf of bread cost 550 million Zimbabwean dollars. Teachers were paid in the trillions a month; however this was equivalent to only one U.S. dollar a day. At its height, it took 621,984,228 Zimbabwean dollars to purchase one U.S. dollar.

Government agencies had no money to pay their workers so they started printing money to pay their bills rather than raising taxes. Rising prices caused the government to enact price controls on private businesses, which led to shortages and the emergence of black markets. In 2009, the country abandoned its currency and allowed foreign currencies to be used for purchases.

How does this happen? How can both government and the economy fail to function at the most basic level? Before we consider these extreme cases of hyperinflation, let’s first look at inflation itself.

Chapter Objectives

Introduction to Inflation

In this chapter, you will learn about:

• Tracking Inflation
• How Changes in the Cost of Living are Measured
• How the U.S. and Other Countries Experience Inflation
• The Confusion Over Inflation
• Indexing and Its Limitations

Inflation is a general and ongoing rise in the level of prices in an entire economy. Inflation does not refer to a change in relative prices. A relative price change occurs when you see that the price of tuition has risen, but the price of laptops has fallen. Inflation, on the other hand, means that there is pressure for prices to rise in most markets in the economy. In addition, price increases in the supply-and-demand model were one-time events, representing a shift from a previous equilibrium to a new one. Inflation implies an ongoing rise in prices. If inflation happened for one year and then stopped—well, then it would not be inflation any more.

This chapter begins by showing how to combine prices of individual goods and services to create a measure of overall inflation. It discusses the historical and recent experience of inflation, both in the United States and in other countries around the world. Other chapters have sometimes included a note under an exhibit or a parenthetical reminder in the text saying that the numbers have been adjusted for inflation. In this chapter, it is time to show how to use inflation statistics to adjust other economic variables, so that you can tell how much of, say, the rise in GDP over different periods of time can be attributed to an actual increase in the production of goods and services and how much should be attributed to the fact that prices for most things have risen.

Inflation has consequences for people and firms throughout the economy, in their roles as lenders and borrowers, wage-earners, taxpayers, and consumers. The chapter concludes with a discussion of some imperfections and biases in the inflation statistics, and a preview of policies for fighting inflation that will be discussed in other chapters.

Principles of Economics Copyright © 2023 by Waleed Muhammad / Hajlatech LLC. All Rights Reserved.

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Increasing Inflation Impact on Individuals Essay

Inflation refers to a general increase in the prices of basic commodities and services, usually taken to represent an average spending pattern (Mankiw, 2012). In simpler terms, inflation is the rise in the cost of living due to an exaggerated increase in commodity prices. As inflation sets in, both individuals, corporations, and the government usually feels its impacts. However, a significant increase in the level of inflation will cause numerous impacts on me as an individual.

Since inflation means a rise in prices of common and basic goods, my purchasing power will reduce since the income shall remain constant as prices rise up (Sexton, 2007). This is because the rate of inflation affects the currency’s purchasing power. As inflation rises, the value of the currency reduces proportionately or even at a higher rate pattern (Mankiw, 2012). Generally, the prevailing rate of inflation dictates the number of goods that I will be able to afford. As the cost of basic such as fuel prices, its trickle-down effects are manifold. The energy prices will increase the prices of foodstuffs such as grains since the machinery costs used in production shall have increased.

Because of a rise in the cost of living, it will lead to lower standards of living since inflation negatively influences the comfort of life. To demonstrate this impact, clearly, there shall be a shift from spending on leisure activities toward basic commodities.

Inflation influences budgeting and planning for investment. Ordinarily, inflation is a phenomenon that happens without the prior and perfect knowledge of an individual, and as such, planned budgets are affected. The confusion created by an uncertain increase in both costs and prices eventually hampers the planning process (Sexton, 2007). Similarly, the amount planned for investment will reduce hence causing a detriment in my overall investment base.

Inflation causes money to lose its value due to a rise in the price level. Since I am a regular saver, the rising inflation will affect me in the sense that I will lose confidence in the currency as a measure of value. This is because the rate of savings will be lower than the inflation resulting in a negative real interest rate on savings (Madura, 2006). For instance, if the per year inflation rate is at 6% while the nominal rate on savings is 3%, it means that the real interest rate on my savings is -3%.

The other effect of inflation will be tendencies of food shortages on the market occasioned by hoarding by sellers. Market analysis shows that an anticipated increase in inflation stimulates hoarding since sellers withhold goods with a view to selling at a higher price. Sellers will begin to cause physical scarcity of food and other products on the market since they would be anticipating better prices in the future (Sexton, 2007). As an individual, it will become difficult to access basic items, and if available, their prices will be excessively farther than what I can afford.

However, I will also be able to benefit from the government intervention plans and policy adjustments geared towards addressing inflation (Madura, 2006). The government’s policy to amend the nominal rates in order to cushion the savers will automatically be advantageous to me. As such, I will be motivated to increase my savings and investment in order to meet my future investment objectives.

Madura, J. (2006). Introduction to business . New York, NY: Cengage Learning.

Mankiw, N.G. (2012). Principles of macroeconomics (6 th .). Mason, OH: South-Western, Cengage Learning.

Sexton, R. L. (2007). Exploring Economics . New York, NY: Cengage Learning.

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Essay on Inflation in Pakistan for Students

by Pakiology | Mar 22, 2024 | Essay | 0 comments

In this essay on inflation in Pakistan, we will look at the causes, effects, and solutions to this issue that has been affecting the country for decades. The term ‘inflation’ refers to a sustained rise in the prices of goods and services in an economy. In Pakistan, inflation has been a major concern since the late 1990s, with the Consumer Price Index (CPI) reaching a peak in 2023. We will explore the various factors that have contributed to inflation in Pakistan, its economic effects, and what can be done to address the issue.

Page Contents

Essay on Inflation Outlines

Causes of inflation in pakistan, effects of inflation, solution to control inflation.

• Introduction

Inflation in Pakistan is caused by several factors, which can be divided into two main categories: domestic and external. The main domestic causes of inflation are an increase in money supply, an increase in government spending, an increase in indirect taxes, and a decrease in economic growth.

The most significant contributor to inflation in Pakistan is an increase in the money supply. When there is too much money chasing after too few goods, prices rise, creating a situation known as demand-pull inflation. An increase in the money supply can be caused by the central bank printing more money or by the government borrowing more money from the public.

In addition, higher government spending can lead to inflation. This occurs when the government prints more money to finance its expenditure or borrows from the public and transfers the cost of this additional spending to businesses and consumers. This leads to higher prices for goods and services. Indirect taxes are another major factor that contributes to inflation in Pakistan. When indirect taxes are increased, prices of goods and services also increase, leading to an overall rise in prices.

Finally, low economic growth can also cause inflation in Pakistan. A weak economy reduces people’s purchasing power, forcing them to buy less, which reduces demand and leads to lower prices. However, when economic growth stalls, businesses are unable to sell their products at the same price as before, leading to a rise in prices.

Overall, inflation in Pakistan is caused by a combination of domestic and external factors. These include an increase in money supply, higher government spending, increases in indirect taxes, and a decrease in economic growth.

The effects of inflation on the economy can be both positive and negative. Inflation erodes the purchasing power of money, meaning that each unit of currency is worth less than it was before. This means that, as the cost of living increases, people can purchase fewer goods and services for the same amount of money. As a result, their standard of living decreases.

Inflation also reduces the real return on investments and savings, which can have a detrimental effect on economic growth. When inflation is high, people prefer to save their money rather than invest in a business or other activities. This reduces the availability of capital and results in slower economic growth.

In addition to decreasing standards of living, inflation can lead to unemployment if companies are not able to increase wages at the same rate as prices rise. This can lead to an increase in poverty, as people struggle to afford necessities. Furthermore, when prices rise faster than wages, it puts pressure on government budgets and can increase public debt.

Inflation can also cause the value of the local currency to depreciate against foreign currencies. This has a direct impact on the cost of imports and makes domestic goods less competitive in international markets. It can also have an indirect impact on exports, as it reduces the competitiveness of local producers in foreign markets.

Inflation is a serious issue in Pakistan, and it needs to be addressed to improve the country’s economic conditions. The following are some of the measures that can be taken to control inflation in Pakistan:

1. Fiscal policy: A strong fiscal policy is necessary for controlling inflation. The government should increase its revenue by implementing taxes on the wealthy and reducing public spending. This will help reduce budget deficits, which will result in lower inflation.

2. Monetary policy: The State Bank of Pakistan should adopt a tighter monetary policy to control inflation. It should raise interest rates so that investors have an incentive to save rather than spend, thus curbing demand-pull inflation.

3. Supply-side measures: There should be an increase in the production of essential commodities and products to meet the demand of consumers. This will help reduce prices and inflation in the long run.

4. Subsidies: The government should provide subsidies to those who are suffering due to the high prices of essential items. This will help them cope with the rising cost of living and ensure that they have access to essential goods and services.

5. Stabilizing exchange rate: A stable exchange rate between foreign currencies and the rupee is necessary for controlling inflation. The State Bank of Pakistan should strive to keep the rupee’s value stable by using currency swaps and other methods.

These measures can go a long way in controlling inflation in Pakistan. By taking these measures, the government can help improve the country’s economic condition and create an environment conducive to investment and growth.

What is inflation in simple words?

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time.

What are the 4 main causes of inflation?

The 4 main causes of inflation are: Demand-pull inflation: when there is an increase in demand for goods and services that outstrip the economy’s ability to produce them. Cost-push inflation: when the cost of production increases, causing companies to raise prices to maintain their profit margins. Built-in inflation: when businesses expect prices to rise and build that expectation into their prices, causing a self-fulfilling cycle of inflation. Imported inflation: when the cost of imported goods increases, leading to higher prices for consumers.

What are the 5 main causes of inflation?

The 4 main causes of inflation are: 1. Demand-pull inflation 2. Cost-push inflation 3. Built-in inflation 4. Imported inflation 5. Monetary inflation

What is inflation introduction?

Inflation is a phenomenon that has been observed throughout history. It refers to the sustained increase in the general price level of goods and services in an economy over a period of time.

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New Questions on How a Key Agency Shared Inflation Data

A government economist had regular contact with “super users” in finance, records show, at a time when such information keenly interests investors.

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By Ben Casselman and Jeanna Smialek

The Bureau of Labor Statistics shared more information about inflation with Wall Street “super users” than previously disclosed, emails from the agency show. The revelation is likely to prompt further scrutiny of the way the government shares economic data at a time when such information keenly interests investors.

An economist at the agency set off a firestorm in February when he sent an email to a group of data users explaining how a methodological tweak could have contributed to an unexpected jump in housing costs in the Consumer Price Index the previous month. The email, addressed to “Super Users,” circulated rapidly around Wall Street, where every detail of inflation data can affect the bond market.

At the time, the Bureau of Labor Statistics said the email had been an isolated “mistake” and denied that it maintained a list of users who received special access to information.

But emails obtained through a Freedom of Information Act request show that the agency — or at least the economist who sent the original email, a longtime but relatively low-ranking employee — was in regular communication with data users in the finance industry, apparently including analysts at major hedge funds. And they suggest that there was a list of super users, contrary to the agency’s denials.

“Would it be possible to be on the super user email list?” one user asked in mid-February.

“Yes I can add you to the list,” the employee replied minutes later.

A reporter’s efforts to reach the employee, whose identity the bureau confirmed, were unsuccessful.

Emily Liddel, an associate commissioner at the Bureau of Labor Statistics, said that the agency did not maintain an official list of super users and that the employee appeared to have created the list on his own.

“It is not something that the program office assembled or maintained or sanctioned at all,” she said.

In responding to The New York Times’s records request, the Labor Department redacted the names of the email recipients. But their employers are visible in some cases. Many of the recipients appear to have been in-house economists at large investment banks such as Barclays, Nomura and BNP Paribas.

Others work for private research firms, which sell their analysis to investors. And some recipients appear to have been analysts at large hedge funds such as Millennium Capital Partners, Brevan Howard and Citadel, which trade directly on their research.

Brevan Howard and Citadel declined to comment. Millennium did not immediately provide comment.

There is no evidence in the emails that the employee provided early access to coming statistical releases or directly shared other data that wasn’t available to the public. In several instances, the employee told users that he couldn’t provide information they had requested because it would require disclosing nonpublic data.

But the emails show that the employee did engage in extended, one-on-one email exchanges with data users about how the inflation figures are put together. Such details, though highly technical, can be of significant interest to forecasters, who compete to predict inflation figures to hundredths of a percentage point. Those estimates, in turn, are used by investors making bets on the huge batches of securities that are tied to inflation or interest rates.

Analysts regularly interact with government economists to make sure that they understand the data, but “when such access can move markets, the process for that access needs to be transparent,” said Jeff Hauser, executive director of the Revolving Door Project in Washington. “This stuff is so valuable, and then someone just emails it out.”

In at least one case, emails to super users appear to have shared methodological details that were not yet public. On Jan. 31, the employee sent an email to his super users describing coming changes to the way the agency calculates used car prices, at the time a crucial issue for inflation watchers. The email included a three-page document providing detailed answers to questions about the change, and a spreadsheet showing how they would affect calculations.

“Thank you all for your very difficult, challenging and thoughtful questions,” the email said. “It is your questions that help us flesh out all the potential problems.”

The Bureau of Labor Statistics had announced the change in a news release in early January, but did not publish details about it on its website until mid-February, two weeks after the email from the employee.

Ms. Liddell said it “wasn’t appropriate” to be sharing information that wasn’t public and hadn’t been fully vetted.

“When matters like this happen, it really undermines our credibility not just with the public but with the people who have placed their trust in us to give us data,” she said.

It isn’t clear when the employee began providing information to super users, or whether he was the only economist at the agency to do so. Several of his emails were also sent to an internal Bureau of Labor Statistics email alias, suggesting that he did not believe his actions to be inappropriate.

The super users issue came to light in February, when the employee emailed the group saying that he had identified a technical change that explained an unexpected divergence between rental and homeownership costs in a recent data release. “All of you searching for the source of the divergence have found it,” he wrote.

About an hour and a half after that email went out, a follow-up told recipients to disregard it. In a subsequent online presentation, Bureau of Labor Statistics economists presented evidence that the change identified in the employee’s email was not, in fact, the source of the divergence.

It wasn’t the first time that the employee had provided information that later proved unreliable. In an email in mid-February, he told users that rent and homeownership cost estimates were based on separate data sets. A few days later, he followed up to say his understanding had been incorrect.

“Because of this misinterpretation I am now training as a shelter economist,” he wrote. “Hopefully, this training will prevent future misinterpretations” of the housing cost calculations.

Omair Sharif, founder of Inflation Insights and a recipient of some of the emails, said that the practice of emailing super users was relatively new, and that it probably evolved alongside increased interest in inflation data.

After years of remaining low and stable, inflation started to take off in 2021, and it has remained a major news story ever since. Because it influences Federal Reserve policy, it is a major driver of market trading.

“I just think the volume of questions has increased so much,” Mr. Sharif said. “The staffing has not. They are almost certainly overwhelmed.”

Ben Casselman writes about economics with a particular focus on stories involving data. He has covered the economy for nearly 20 years, and his recent work has focused on how trends in labor, politics, technology and demographics have shaped the way we live and work. More about Ben Casselman

Jeanna Smialek covers the Federal Reserve and the economy for The Times from Washington. More about Jeanna Smialek

Essay on Inflation In Philippines

Students are often asked to write an essay on Inflation In Philippines in their schools and colleges. And if you’re also looking for the same, we have created 100-word, 250-word, and 500-word essays on the topic.

Let’s take a look…

100 Words Essay on Inflation In Philippines

What is inflation.

Inflation means the prices of things we buy are going up. In the Philippines, when prices rise, it becomes harder for people to afford food, clothes, and other items. This can happen when there’s too much money to spend but not enough goods, or when the cost to make products goes higher.

Inflation in the Philippines

The Philippines often experiences inflation. This can be due to natural disasters affecting crops, changes in global oil prices, or government actions. When inflation occurs, Filipino families might struggle to buy what they need, which can be tough for everyone.

Effects on Daily Life

Because of inflation, families in the Philippines might have to change how they spend money. They may buy less food or cheaper items to save money. Sometimes, even going to school or getting healthcare can become more expensive, making life challenging for many people.

250 Words Essay on Inflation In Philippines

Understanding inflation in the philippines.

Inflation means the increase in prices of things we buy, like food, clothes, and toys. In the Philippines, just like in other countries, prices can go up over time. This can make life hard for families, especially if they don’t have a lot of money.

Causes of Inflation

In the Philippines, inflation can happen for many reasons. Sometimes, if there’s a problem with growing food or if there’s a big storm, there might not be enough of it, and this can make prices go up. Also, if the money in the Philippines becomes less valuable compared to other countries’ money, things that come from other countries can become more expensive.

Effects of Inflation

When prices go up, it’s tough for people. They might not be able to buy as much with their money, and this can be stressful. Parents might have to work more to earn more money, and sometimes, kids might not get new toys or clothes as often.

What the Government Does

The government in the Philippines tries to control inflation. They can change how much money is in the economy or make rules about prices to help keep them from going up too fast. They do this because they want to make sure that people can afford what they need.

Inflation in the Philippines is a challenge that affects everyone. It’s important to understand why it happens and how it changes the way people live. While it can be tough when prices go up, the government works to manage inflation for the good of the country.

500 Words Essay on Inflation In Philippines

Inflation is when the prices of things we buy go up. Imagine you could buy a toy car for one peso last year, but this year the same car costs two pesos. That’s inflation: the money you have buys less than before. This can happen with toys, food, clothes, and almost everything. In the Philippines, like in many countries, inflation affects how people live because they need more money to buy the same things.

Causes of Inflation in the Philippines

In the Philippines, inflation happens for a few reasons. Sometimes, when there are not enough goods like rice or vegetables, prices go up because many people want these items but there aren’t enough for everyone. This is called “demand-pull inflation.” Another reason is “cost-push inflation,” which is when the cost to make products goes up. For example, if the price of gas increases, it costs more to deliver goods to stores, so the prices of these goods go up.

Also, when the money value in the Philippines goes down compared to other countries’ money, things we buy from other countries become more expensive. This is known as “imported inflation.”

Effects of Inflation on People

Inflation can make life hard for families. Parents have to spend more money on the same things, so they might have less money left for saving or for fun activities. Kids might notice that their allowance doesn’t buy as much candy or toys as it used to. If inflation is high, people might worry about prices going up even more and rush to buy things, which can make inflation worse.

How the Government Handles Inflation

The government of the Philippines tries to control inflation to make sure prices don’t rise too fast. The Central Bank of the Philippines can change interest rates, which is like changing the cost of borrowing money. If it’s more expensive to borrow money, people and businesses might spend less, and this can help slow down inflation.

The government can also use policies to help make sure there is enough supply of goods. For example, they can encourage farmers to grow more rice or make it easier for stores to get products from other countries when there’s not enough supply in the Philippines.

What Can People Do?

People can also do things to handle inflation. Families can plan their spending and look for better prices before buying something. It’s important to learn about money and how to use it wisely, especially when prices are going up.

Inflation in the Philippines is when prices rise and money buys less. It can be caused by not enough goods, higher costs to make products, or the country’s money value changing. Inflation affects how people live, but the government and people can take steps to manage it. By understanding what inflation is and how it works, even school students can be better prepared to deal with it in their daily lives.

That’s it! I hope the essay helped you.

If you’re looking for more, here are essays on other interesting topics:

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