Inflation

When economists talk about inflation they mean that the general level of prices is going up. Inflation means that more money will need to be paid for the same goods and services. Inflation is measured regularly, and the inflation rate is one of the most important indicators of the state an economy is in. A high inflation means trouble. If inflation goes the other way (you get more goods for your money), it is called deflation and is equally problematic. Economists generally prefer stable prices. There are also other kinds of inflation like hyperinflation and stagflation.

One sure way to create inflation is to increase the money supply too rapidly thus devaluing the currency. In this instance, price inflation is simply the flip-side of monetary deflation. This is usually what economists fear most when they see general price inflation.

There is no one cause of inflation that everyone agrees on, but there are at least two Neo-Keynesian theories that are generally accepted: Demand-Pull inflation and Cost-Push inflation.

The Demand-Pull inflation theory can be said simply as "too much money chasing too few goods." In other words, if the will of buying goods is growing faster than amount of goods that have been made, then prices will go up. This most likely happens in economies that are growing fast.

The Cost-Push inflation theory says that when the cost of making goods (which are paid by the company) go up, they have to make prices higher to still make profit out of selling that very product. The higher costs of making goods can include things like workers' wages, taxes to be paid to the government or bigger costs of getting raw materials from other countries.

Almost everyone thinks inflation is bad. Inflation affects different people in different ways. It also depends on whether inflation is expected or not. If the inflation rate is equal to what most people are expecting (anticipated inflation), then we can adjust and the cost is not as high. For example, banks can change their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up.

Problems arise when there is unanticipated inflation:

· Creditors lose and debtors gain if the lender does not guess inflation correctly. For those who borrow, this is similar to getting an interest-free loan.

· Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run.

· People living off a fixed income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living.

· The entire economy must absorb repricing costs ("menu costs") as price lists, labels, menus and more have to be updated.

· If the inflation rate is greater than that of other countries, domestic products become less competitive.