What is Inflation? Definition, Causes, & Types

With the economical challenges in today’s world, no thanks to the inflationary situation, an average citizen may not understand what is indeed going on, especially as regards inflation.

Inflation is simply an economic situation that occurs when consumers’ spending power declines because the prices of commodities have gone up.

When you think of inflation, think of it as a measure of purchasing power. It is the rate at which the prices of products and services change over a particular period.

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Take for instance; there was a time when a particular product is sold at $1.50 but over time the same product is being sold for $3.85 that is;  inflation. When prices go up, people can’t afford to buy as much just like what is happening in most countries today.

One thing about inflation is that it also devalues a currency because the same amount of money buys fewer goods.

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Inflation can be expected especially when you know that the cost of things we buy every day is likely to increase over time. However, when economists record higher levels of inflation and it leads to economic volatility it becomes unexpected.

Types of Inflation

There are different kinds of inflation based on the level it affects the economy, here are the major types of inflation:

1.  Hyperinflation:

 When it comes to this type of inflation the price level of things increases at a very fast rate. In this case, the price of commodities is expected to increase, in fact, every hour, and as such it leads to the demonetization of an economy.

Hyperinflation is a devastating kind of inflation because of its rapid increase which usually is out of control.

One will wonder what actually leads to this hyperinflation. Well, there are two main causes of this kind of inflation. First, when there is an increase in the money supply that is not supported by the economic growth it increases inflation.  

Secondly, demand-pull inflation in which demand outstrips supply. These two causes are related since they both overload the demand side of the supply/demand equation.

One of the major things that result in hyperinflation is when the government injects too much money into the economy. Hyperinflation can be very fiscally catastrophic to a nation. The act of government printing excess money that people don’t know what to do with can cause hyperinflation.

2.  Stagflation:

Usually, inflation is correlated to economic growth, however, stagflation is an economic situation where there’s high inflation plus economic stagnation.

Stagflation causes some kind of havoc to the economic adversity by combining poor economic growth, high unemployment, and severe inflation all at once.

When associated with fiscal and monetary policy, the risks are increased because of the difficult stagflation poses to central banks.

If the central bank decides to combat inflation in order to raise the interest it might lead to a growing rate of unemployment.

Central banks will find it difficult to decrease the interest rates when stagnation rises up because they are limited in their ability in which case the inflation grows even higher

3. Creeping Inflation:

Creeping Inflation, which is also known as moderate inflation, happens when the price level persistently rises over a long period of time. Mild inflation that is less than 10% or a single digit, is usually considered a creeping Inflation.

Consumers who want to beat higher future prices may decide to buy on time. People will start to buy more than necessary to avoid unknown prices in the future.

Where prices of products rise by 3% or less per year, countries are faced with a creeping Inflation because when prices of things increase by 2%, the economy benefits and grows, and as such it makes consumers expect the rise in prices of commodities in other to boost demand.

 4. Galloping Inflation:

Galloping Inflation is inflation where the annual rate of inflation is in the double-triple digits (10% and above).

With Creeping Inflation, there is less than a 10% annual rise in inflation but when the rate rises to 10% or more it is absolutely trouble for the economy.

Money begins to lose its value so rapidly that it put business owners and employees on the level of an income that they cannot keep up because of the costs.

Why do you think foreign investors avoid countries with such inflation? It is for the simple reason that such a country’s economy is unstable.

Deflation

On the other hand, there is deflation as opposite to inflation. Taking a quick sneak at it deflation tells us that there is a fall in prices of commodities or services.

In the world of the economists, there is a comparison in the changes of a basket of diverse goods and products of an index. Just imagine when the index in one period is lower than in the prices falls, which shows the condition (deflation) of the economy.

In the case of deflation, consumers are happy because there is a decrease in the price of things and as much consumers purchasing power increases.

Look at inflation this way “too much money chasing few goods in the economy”. However, deflation becomes  “too many goods and services chased by a slower-growing supply of money”.

Inasmuch as there are beautiful sides to deflation, the increase in consumer spending power, there are also ugly sides. When prices reduce consumption by inducing consumers to pay lower prices in the future it affects the economy too.

How Inflation is Measured

When it comes to the rate at which inflation is being measured one has to understand that inflation takes into consideration many factors likely the overall cost of living in a country to more specific needs like fuel, groceries, and some other basic needs.

These products and services track specific segments of the economy. Economists create indexes of prices by comparing the price of goods and services over different periods of time.

For index prices, here are two examples created by the US Bureau of Labor statistics and it reflects consumer and wholesale goods.

  • Consumer Price Index (CPI) measures changes in prices of goods and services to the final consumer. Prices of goods and services like food prices as well as housing, clothing, and automobiles.
  • Wholesale Price Index (WPI) tracks the change in prices of bulk transactions of goods and services in the stage before they get to the final consumers.

Causes of Inflation

Most people have a really difficult time trying to find out what actually are the causes of inflation, well here are some major causes of inflation:

  1. Growing Economy: In an expanding economy where unemployment drops and wages usually rise as a result of this, more people find themselves with more money in their pocket, which they are willing to spend on luxuries as well as necessities. A growing economy can lead to an increase in consumer spending and demand, it is considered a form of demand-pull inflation. Looking at this context, inflation is considered a positive thing.
  2. Expansion of Money Supply: This happens when the Fed prints money at a rate higher than the growth rate of the economy. With more money in circulation, demands grow and prices go up. Prices go up, you have inflation.
  3. National Debt Management: When the national debt goes high, the government is left with two main options. They either raise taxes to make their debt payment. Because companies are likely to shift the burden to consumers through higher prices. Or they print more money, an idea which many will like. However, it can result in demand-pull inflation. If the government decides to make use of these approaches to tackle the national debt, it may affect both demand-pull and cost-push inflation.
  4. Changes in Exchange Rates: Imagine when the value of the US dollar dips in relation to foreign currency, it has less purchasing power. It goes to say that the majority of consumer goods bought in America will become more expensive to buy. Their cost will definitely go up.
  5. Government Regulations: When government impose new laws or tariffs that make it more expensive for companies to produce goods or import them. The companies can pass the increase in their expenses to consumers in the form of increased prices.

Forms of Inflation

Basically all these causes of inflation can be grouped under two main forms of inflation that cover the reasons for inflation.

Cost-push inflation:

This has to do with the general increases in the costs of the factors of production. Such as capital, land, labor, and entrepreneurship these things are necessary inputs that are required to produce goods and services.

Now when these factors arise in cost producers then tend to increase the price of their goods and services in other to retain their profits margin.

When these products rise, it will definitely lead to an increase in consumer prices as a producer will be pushed up by means of production costs.’

Demand-pull inflation:

Demand-Pull inflation happens when there is an excess of aggregate demand as related to aggregate supply. In other words, when there is a demand for a popular product that in turn outstrips the supply, the price of the product would have to increase because there is a high demand for that product but a less supply of it.

On a broader scale, a rise in demand of products can lead to inflation.

Bottom Line

As a result of the effects of inflation or deflation most countries’ economists try to study the country’s economy in other to keep up with it economical stability not undermining the benefits of either inflation or deflation to a country’s growth.

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