What Exactly is Inflation ?

inflation written on a calculator

Inflation is the gradual loss of purchasing power, reflected in a broad rise in prices for goods and services. In other words, it is a macroeconomic term that refers to the sustained and general increase in the price level of goods and services in an economy over a period of time. It results in a decrease in the purchasing power of a unit of currency, which means that, on average, you can buy less with the same amount of money.

How is it Measured ?

Inflation is often measured using an index called the Consumer Price Index (CPI) or the Producer Price Index (PPI). These indices track the changes in the prices of a basket of goods and services over time.

What is PPI ?

The PPI (Producer Price Index) tracks changes in the prices received by producers of goods and services. It can provide insights into price changes at earlier stages of production, which can eventually affect consumer prices.

But What is The Cause of Inflation?

An increase in the supply of money is the root of it, 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.

The Role of Central Banks:

Many countries have central banks (e.g., the Federal Reserve in the United States, the European Central Bank in the Eurozone) responsible for controlling inflation. Central banks use monetary policy tools, such as adjusting interest rates and open market operations, to influence inflation rates.

Deflation :

deflation is a sustained decrease in the general price level of goods and services. While deflation may sound desirable, it can lead to reduced spending, as consumers delay purchases in anticipation of lower prices, which can negatively impact the economy.

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