What is Inflation?

Inflation is defined as a sustained increase in the general level of prices for goods and services in an economy over a period of time. Put simply, inflation refers to an overall rise in prices of goods and services in an economy that, in turn, leads to an erosion of the purchasing power of each unit of currency, including cash, over time.

Inflation is usually measured by the price index, which is the most commonly used and accepted measure of inflation. The price index, also referred to as a price level indicator, is tracked over time to determine the overall rate of inflation in an economy. The purchasing power of each unit of currency is then evaluated against the price index.

What are the Causes of Inflation?

There are several causes that can lead to an economy experiencing an increase in prices, otherwise known as inflation. Generally, inflation is caused by an increase in the demand for goods and services that result in an increase in the prices of those goods and services. In an economy where demand for goods and services increases relative to their supply, there is competition for their acquisition, and that competition results in increased prices.

In some cases, inflation is caused by an increase in the money supply—otherwise known as monetary inflation—in an economy. When money supply in an economy increases relative to its production of goods and services—the money chasing after fewer goods and services—the overall price level in the economy will rise. This is known as demand-pull inflation.

In other cases, inflation can be caused by the cost of production increasing. This type of inflation is known as cost-push inflation. When production costs increase, it makes it more expensive to produce goods and services, and the companies selling those goods and services must pass their added costs on to the consumer, resulting in higher prices and inflation.

What are the Effects of Inflation?

Inflation typically has a number of effects on an economy. When prices rise and the purchasing power of each unit of currency erodes, it can cause economic hardship for individuals and businesses that are unable to keep up with the increasing prices. This can lead to an overall decrease in consumer spending and investment, as well as an increase in unemployment and poverty.

Inflation also has an effect on the money supply in an economy, as the money supply will typically rise as prices continue to increase. This type of inflationary environment can lead to a decrease in the value of currency against other asset classes, such as stocks and bonds.

Lastly, it can lead to high levels of uncertainty and unpredictability in an economy, as prices can be highly volatile and change erratically from one month or year to the next. This can lead to businesses and consumers being unable to plan for the future, increasing their risk and resulting in a decrease in economic activity.

Conclusion

Inflation is a sustained increase in the general level of prices for goods and services in an economy over a period of time and is caused by an increase in demand, resulting in competition for those goods and services, or an increase in the money supply—otherwise known as monetary inflation. Inflation can have a number of effects on an economy, resulting in economic hardships, an increase in unemployment and poverty, a decrease in consumer spending and investment, a decrease in the value of currency against other asset classes, and high levels of uncertainty and unpredictability.