Inflation is a general increase in the prices of goods and services in an economy over a period of time.
When we hear that there has been inflation means that prices have risen or are "inflated", hence its name.
Inflation exists when the prices of all goods and services in an economy rise steadily. That is, when the average of the prices of all goods and services in a country rises.
Next, we are going to see the importance of knowing well the meaning of inflation.
Why is the meaning of inflation so important?
It is a phenomenon that occurs in almost all countries, in fact, central banks always try to ensure that there is some inflation in their country, usually between two and three percent.
If there were no inflation, prices would fall (deflation), which is the fear of any economic responsible for a country. Deflation can slow consumption and economic growth. It may also lead to a deflationary spiral with dire consequences for the country’s economy.
Inflation is one of the most important aspects in the study of macroeconomics and in the monetary policy of central banks. For example, the main objective of the European Central Bank (ECB) is to achieve price stability, maintaining an inflation rate of 2% per year.
One of the functions of prices is to allow buyers to indicate the amount of product they want to buy based on the market price and entrepreneurs to determine the amount of product they want to sell at each price. Prices ensure that resources are efficiently allocated to achieve market equilibrium and thus resources can be efficiently allocated. However, the most common is that prices rise, causing what is called inflation.
Consequences of inflation
Many times it is said that inflation is good, but it is not that it is good in itself, but that although prices in an economy rise, wages also tend to rise according to that price increase. Thus, in the end the purchasing power of citizens remains stable.
The consequences of inflation can be positive or negative:
- The rise in prices helps reduce the value of debts , both for households, companies and the Government. This is because if there is inflation in an economy and our wages rise at the same rate, but the debt remains the same as before, the real value of the debt will be lower than before prices rose.
- The rise in prices also causes people to prefer to consume now rather than later , because then the prices will be more expensive. This is essential for money to circulate and for the transmission of goods in an economy. It is the gear of capitalism.
- Loss of purchasing power: If the rise in wages is not at least equal to the rise in prices, the purchasing power will drop. We could be happy if they raise our salary 10% in a year, but if inflation has been 20%, we can actually buy 10% less with that salary.
- Saving decreases: Inflation causes money to lose value, so it will motivate to consume and spend the money, instead of saving it, since if the money is going to be worth less in the future, citizens and investors will prefer to spend it now.
In the following link, you can consult in detail all the consequences of inflation.
How is inflation calculated?
Given the difficulty of calculating the variation of all prices in an economy, there are two main indicators to know how much prices are rising:
- A rough indicator is the consumer price index (CPI), which is made up of groups of goods and services, from food, clothing, medicine to communications, transportation, housing and leisure.
- Another way to calculate inflation is through the GDP deflator, which takes into account the variation in prices of all goods and services produced in a country.
Causes of inflation
Inflation can occur for four reasons:
- Due to an increase in demand.
- When raw material costs increase.
- By own expectations.
- Increases in the money supply.
To see the causes of inflation in detail, we recommend that you access the following link.
Types of inflation
According to the percentage of increase, we could say that there are the following levels:
- Deflation: This is negative inflation. That is, when prices go down instead of going up.
- Moderate inflation: When the price increase does not reach 10% per year.
- Galloping inflation: It occurs in the event of excessive inflation. We are even talking about two and three digits.
- Hyperinflation: These are price increases that exceed 1000% in one year. They cause serious economic crises.
In addition, when talking about price increases, a certain terminology is usually used to describe the different forms of price increase. Other terms related to inflation are:
- Stagflation: It occurs when there is inflation and also a decrease in GDP.
- Underlying inflation: It is the rise in prices that excludes energy products.
To know more about the types of inflation, it is recommended to read:
The rise in prices causes the loss of purchasing power of citizens. Or put another way, if there is inflation it means that with the same money we can buy less things than before. For example, if the price of oranges is € 2 per kilo, a person with € 10 can buy 5 kilos, but if the price rises to € 2.5 he will only be able to buy 4 kilos.
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Price stability: why is it important to you?