The Basics of Inflations
The basic definition of inflation is the change in an important measure of money, usually meaning a depreciation of value. This happens for numerous reasons. First, an increase in prices compared to the value of the currency causes inflation. Also, increasing the supply of money can cause inflation.
Price inflation usually refers to the “cost of living,” comparing the prices of two consumer items at different places in time. This is not considered raw inflation because it is a measurement which is adjusted for changing expectations of the consumers, making it more of a measurement of the value of money in terms of realistic purchasing power. Contrarily, raw inflation measures a change in the prices of goods, not adjusting for consumer expectations.
There are many different means of measuring price inflation, including consumer and producer inflation, and prices indexes, which measures inflation in an economy. In general, price inflation reflects a decrease in the overall purchasing power of an economy’s currency. Currency devaluation is similar, but it refers to a fall in the overall market value of currency between economies, in accordance to a rise in prices. Both of these measurements are typically the result of an increased money supply in an economy, also known as currency inflation.
How to Measure Inflation
To measure the amount of inflation in an economy, one must observe government data and pinpoint the change in prices of numerous goods and services. From this data one can construct a price index that reveals the average price level of a basket of products. This measured price then undergoes a hedonic adjustment, which accounts for specific changes in the basket of goods.
The inflation rate is the percentage increase in the index. Prices might be rising, but the rate of inflation measures how quickly they are rising.
How Effective is Inflation?
Often with a steady rate of inflation it is difficult to retreat prices back to an equilibrium average price. Therefore, when certain sectors strive to achieve a zero inflation rate, the other sectors suffer from a reduction in prices, profits, and often employment. Attempts at maintaining price stability may also cause deflation, which may lead to bankruptcy for certain companies who fail to react to the price trends.
A Few Helpful Terms
Deflation is simply the opposite of inflation. It refers to an overall increase in purchasing power, and the corresponding decrease in prices. Disinflation, on the other hand, describes inflation that is seemingly “slowing down,” where prices are rising, but at a slower rate.