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Inflation is a sustained increase in the cost of goods and services, which can lead to a loss of purchasing power for consumers. It can be caused by rising costs such as labor and energy, and can become a vicious circle as consumers ask for wage increases and employers raise prices. While some inflation is desirable in a growing economy, hyperinflation can be a critical threat to national security. The inflation rate is closely monitored and reported, with the Consumer Price Index (CPI) being widely accepted as the official measure.
Inflation is a sustained increase in the cost of goods and services within a definable economy, such as that of a region, nation, or continent. It happens for a number of reasons, one of the most common being traders raising their prices to maintain profit margins in the face of rising costs such as labor and energy. The percentage by which these costs increase, the inflation rate, is carefully measured and regularly reported.
From the perspective of the average consumer, the immediate effect of inflation is that the currency loses some of its purchasing power; the higher the inflation rate, the greater the loss. That is, if the annual rate of inflation is 2% per year, the consumer will need $1.02 US dollars (USD) to buy what cost $1 USD a year earlier.
Inflation can become a vicious circle: the consumer who needs $1.02 today to buy what cost him $1 a year ago will ask his employer for a wage increase to make up for the loss in purchasing power. The employer who grants the raise in turn faces increased labor costs, which can be recouped by raising the prices of goods or services.
Although some people consider any inflation to be bad for the economy, the fact is that most economists consider it desirable in a dynamic and growing economy. Although there is no consensus on what the ideal inflation rate should be, governments and central banks around the world try to manage the supply and cost of money to keep it at a reasonable rate, but not to eliminate it entirely. An annual inflation rate of less than 5% would probably please most financial authorities.
Inflation has profound effects on areas of an economy other than the purchasing decisions of the average consumer. For example, investors are concerned about inflation because it reduces the real return they receive on their investments. An investor who experiences a return of 10% on his investments in one year in an economy whose inflation rate is 4% has obtained real growth of 6%; If the rate is higher than 10%, the investor has actually lost because his purchasing power has decreased.
There is also a strong relationship between the inflation rate and the cost of credit, or interest rates. Interest rates on borrowed money will always be higher than the inflation rate because otherwise the lender would be losing purchasing power. Therefore, in an economy with low inflation, the interest rates charged on borrowed money will also be low, making credit more affordable. However, in an economy with a high rate of inflation, the interest charged on borrowed funds will be high. High credit costs tend to stifle an economy because business expansion is often financed with borrowed money. Also, some businesses and governments are sometimes required to borrow funds to cover their operating costs due to irregular cash flow.
Inflation also occurs when the government simply prints too much money, often leading to a phenomenon called hyperinflation. This occurred in various countries at different times during the 20th century. At one point in 1923, the Weimar Republic of Germany printed banknotes with a face value of 100 trillion DM, and $1 USD was worth 4 trillion (4,000,000,000,000) DM. The highest inflation rate measured worldwide in the 20th century was in Hungary, in July 1946, measured at more than 41 quintillion percent a month & emdash; a rate at which prices doubled every thirteen hours. The most severe case of hyperinflation seen in the 21st century, by contrast, was in Zimbabwe in 2008, where the rate was about 5,500% per month, and prices were doubling about every five days. Hyperinflation is a critical threat to the national security of any country, because the population loses confidence in the nation’s currency and the government that issued it.
Inflation is closely monitored in the United States, with primary responsibility for measuring and reporting the falling rate of inflation to the government’s Department of Labor. They do this by calculating the average cost of a market basket of typical consumer goods and services, including housing and energy costs. The inflation rate is calculated by comparing this data with that collected previously. By pulling this data from sources across the country, the department is also able to identify regional inflation rates, which can vary greatly due to the different costs of things like energy and housing in different parts of the country. This data is compiled and reported monthly as the Consumer Price Index (CPI), which is widely accepted as the official measure of the inflation rate.
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