1 What Is Inflation?
2 Inflation is a rise in prices, which can be translated as the decline of purchasing power over time.
3 The rate at which purchasing power drops can be reflected in the average price increase of
4 a basket of selected goods and services over some period of time. The rise in prices, which is often
5 expressed as a percentage, means that a unit of currency effectively buys less than it did in prior
6 periods. Inflation can be contrasted with deflation, which occurs when prices decline and
7 purchasing power increases.
8 KEY TAKEAWAYS
9 Inflation is the rate at which prices for goods and services rise.
10 Inflation is sometimes classified into three types: demand-pull inflation, cost-push
11 inflation, and built-in inflation.
12 The most commonly used inflation indexes are the Consumer Price Index and the
13 Wholesale Price Index.
14 Inflation can be viewed positively or negatively depending on the individual viewpoint and
15 rate of change.
16 Those with tangible assets, like property or stocked commodities, may like to see some
17 inflation as that raises the value of their assets.
18 Understanding Inflation
19 While it is easy to measure the price changes of individual products over time, human needs
20 extend beyond just one or two products. Individuals need a big and diversified set of products as
21 well as a host of services for living a comfortable life. They include commodities like food grains,
22 metal, fuel, utilities like electricity and transportation, and services like health care, entertainment,
23 and labor.
24 Inflation aims to measure the overall impact of price changes for a diversified set of products and
25 services. It allows for a single value representation of the increase in the price level of goods and
26 services in an economy over a period of time.
27 Prices rise, which means that one unit of money buys fewer goods and services. This loss of
28 purchasing power impacts the cost of living for the common public which ultimately leads to a
29 deceleration in economic growth. The consensus view among economists is that sustained
30 inflation occurs when a nation's money supply growth outpaces economic growth.
31 To combat this, the monetary authority (in most cases, the central bank) takes the necessary steps
32 to manage the money supply and credit to keep inflation within permissible limits and keep the
33 economy running smoothly.
34 Theoretically, monetarism is a popular theory that explains the relation between inflation and the
35 money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca
36 empires, massive amounts of gold and especially silver flowed into the Spanish and other
37 European [Link] the money supply rapidly increased, the value of money fell,
38 contributing to rapidly rising prices.
39 Inflation is measured in a variety of ways depending upon the types of goods and services. It is the
40 opposite of deflation, which indicates a general decline in prices when the inflation rate falls below
41 0%. Keep in mind that deflation shouldn't be confused with disinflation, which is a related term
42 referring to a slowing down in the (positive) rate of inflation.
43 Causes of Inflation
44 An increase in the supply of money is the root of inflation, though this can play out through
45 different mechanisms in the economy. A country's money supply can be increased by the
46 monetary authorities by:
47 Printing and giving away more money to citizens
48 Legally devaluing (reducing the value of) the legal tender currency
49 Loaning new money into existence as reserve account credits through the banking system
50 by purchasing government bonds from banks on the secondary market (the most common
51 method)
52 In all of these cases, the money ends up losing its purchasing power. The mechanisms of
53 how this drives inflation can be classified into three types: demand-pull inflation, cost-push
54 inflation, and built-in inflation.
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