Inflation

Definition

Inflation is defined as a sustained increase in the general price level of goods and services in an economy over a period of time.
It’s measured as an annual percentage increase.

Demand-Pull Inflation: Occurs when demand for goods and services exceeds their supply. This typically occurs in growing economies.
Cost-Push Inflation: When costs of production increase, causing producers to raise prices to maintain their profit margins. This could be due to rising labour or raw materials costs.

The most widely used measure is the Consumer Price Index (CPI), which compares the price of a fixed basket of goods and services with the price of the same basket in a previous period.
The Retail Price Index (RPI) is another measure used, which includes housing costs such as mortgage interest payments.

Monetary inflation: Occurs when the money supply grows faster than the economic output.
Commodity price inflation: Caused by rising input prices, such as oil or food costs.
Built-in inflation: When businesses and people expect prices to keep rising, it can create a self-perpetuating inflation spiral.

Redistribution of income: Inflation can redistribute income from savers to borrowers, as the real value of outstanding loans decreases.
Reduced purchasing power: With higher prices, the value of money falls, reducing consumer purchasing power.
Uncertainty: High inflation can create uncertainty, particularly for businesses trying to forecast their costs and revenues.

Monetary policy: Central banks can use interest rates or other monetary policy tools to control inflation. An increase in interest rates can slow down the demand for goods and services.
Fiscal policy: Government can use its taxation and expenditure policy to control inflation, by reducing the level of demand in the economy.
Supply-side policies: Longer-term measures to increase productivity and efficiency can help to control inflation by increasing the supply of goods and services.

Inflation is a key indicator of the state of the economy and plays a significant role in decision-making for businesses, consumers, and governments.
Studying inflation helps in understanding the value of money, interest rates, and general economic policy. Understanding inflation is key for macroeconomic analysis and economic forecasting.

Inflation measurement can be skewed by changes in quality and not just price.
Not all items in the economy increase by the same amount, CPI and RPI are just averages.
Inflation targets by central banks and governments are not always achieved, highlighting the difficulties in controlling inflation.