Inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The opposite of inflation is deflation, a decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index.
Changes in inflation are widely attributed to increases in the money supply, fluctuations in real demand for goods and services, changes in available supplies such as during energy crises, significant decreases in interest rates set by the central bank, or changes in inflation expectations, which may be self-fulfilling. Moderate inflation affects economies in both positive and negative ways. The negative effects would include an increase in the opportunity cost of holding money; uncertainty over future inflation, which may discourage investment and savings; and, if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity, allowing the central bank greater freedom in carrying out monetary policy, encouraging loans and investment instead of money hoarding, and avoiding the inefficiencies associated with deflation.
Today, most economists favour a low and steady rate of inflation. Low inflation reduces the likelihood of economic recessions by enabling the labor market to adjust more quickly and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy, while also avoiding the costs associated with high inflation. The task of keeping the rate of inflation low and stable is usually given to central banks that control monetary policy, normally through the setting of interest rates and by carrying out open market operations.
Terminology
The term originates from the Latin inflare. Conceptually, inflation refers to the general trend of prices, not changes in any specific price. For example, if people choose to buy more cucumbers than tomatoes, cucumbers consequently become more expensive and tomatoes less expensive. These changes are not related to inflation; they reflect a shift in tastes. Inflation is related to the value of currency itself. When currency was linked with gold, if new gold deposits were found, the price of gold and the value of currency would fall, and consequently, the prices of all other goods would become higher.Classical economics
By the nineteenth century, economists categorised three separate factors that cause a rise or fall in the price of goods: a change in the value or production costs of the good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private banknote currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable banknotes outstripped the quantity of metal available for their redemption. At that time, the term inflation referred to the devaluation of the currency, and not to a rise in the price of goods. This relationship between the over-supply of banknotes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate what effect a currency devaluation has on the price of goods.Related concepts
Other economic concepts related to inflation include: deflationa fall in the general price level; disinflationa decrease in the rate of inflation; hyperinflationan out-of-control inflationary spiral; stagflationa combination of inflation, slow economic growth and high unemployment; reflationan attempt to raise the general level of prices to counteract deflationary pressures; asset price inflationa general rise in the prices of financial assets without a corresponding increase in the prices of goods or services; and agflationan advanced increase in the price for food and industrial agricultural crops when compared with the general rise in prices.More specific forms of inflation refer to sectors whose prices vary semi-independently from the general trend. "House price inflation" applies to changes in the house price index while "energy inflation" is dominated by the costs of oil and gas.
History
Overview
Inflation has been a feature of history during the entire period when money has been used as a means of payment. One of the earliest documented inflations occurred in Alexander the Great's empire 330 BC. Historically, when commodity money was used, periods of inflation and deflation would alternate depending on the condition of the economy. However, when large, prolonged infusions of gold or silver into an economy occurred, this could lead to long periods of inflation.The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Rapid increases in the money supply have taken place a number of times in countries experiencing political crises, producing hyperinflationsepisodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyperinflation in the Weimar Republic of Germany is a notable example. The hyperinflation in Venezuela is the highest in the world, with an annual inflation rate of 833,997% as of October 2018.
Historically, inflations of varying magnitudes have occurred, interspersed with corresponding deflationary periods, from the price revolution of the 16th century, which was driven by the flood of gold and particularly silver seized and mined by the Spaniards in Latin America, to the largest paper money inflation of all time in Hungary after World War II.
However, since the 1980s, inflation has been held low and stable in countries with independent central banks. This has led to a moderation of the business cycle and a reduction in variation in most macroeconomic indicatorsan event known as the Great Moderation.
Ancient Europe
Alexander the Great's conquest of the Persian Empire in 330 BC was followed by one of the earliest documented inflation periods in the ancient world. Rapid increases in the quantity of money or in the overall money supply have occurred in many different societies throughout history, changing with different forms of money used. For instance, when silver was used as currency, the government could collect silver coins, melt them down, mix them with other, less valuable metals such as copper or lead and reissue them at the same nominal value, a process known as debasement. At the ascent of Nero as Roman emperor in AD 54, the denarius contained more than 90% silver, but by the 270s hardly any silver was left. By diluting the silver with other metals, the government could issue more coins without increasing the amount of silver used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage. This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes lower, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced. Again at the end of the third century AD during the reign of Diocletian, the Roman Empire experienced rapid inflation.Ancient China
China introduced the practice of printing paper money to create fiat currency. During the Mongol Yuan dynasty, the government spent a great deal of money fighting costly wars, and reacted by printing more money, leading to inflation. Fearing the inflation that plagued the Yuan dynasty, the Ming dynasty initially rejected the use of paper money, and reverted to using copper coins.Medieval Egypt
During the Malian king Mansa Musa's hajj to Mecca in 1324, he was reportedly accompanied by a camel train that included thousands of people and nearly a hundred camels. When he passed through Cairo, he spent or gave away so much gold that it depressed its price in Egypt for over a decade, reducing its purchasing power. A contemporary Arab historian remarked about Mansa Musa's visit:Medieval age and "price revolution" in Western Europe
There is no reliable evidence of inflation in Europe for the thousand years that followed the fall of the Roman Empire, but from the Middle Ages onwards reliable data do exist. Mostly, the medieval inflation episodes were modest, and there was a tendency for inflationary periods to be followed by deflationary periods.From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution", with prices on average rising perhaps sixfold over 150 years. This is often attributed to the influx of gold and silver from the New World into Habsburg Spain, with wider availability of silver in previously cash-starved Europe causing widespread inflation. European population rebound from the Black Death began before the arrival of New World metal, and may have begun a process of inflation that New World silver compounded later in the 16th century.