Inflation, causes and effects on the economy

Inflation, causes and effects on the economy

definition of inflation

Inflation is the continuous and widespread growth of prices of goods and services and factors of production of an economy over time. Other definitions explain it as the persistent upward movement of the general prices and the decrease in the purchasing power of every unit of money.

In practice, the evolution of inflation is measured by the change in the Consumer Price Index (CPI). This index is calculated through an extensive research of all economic factors and it’s current cost and prices on an annual basis. To understand the phenomenon of inflation, one must distinguish between generalized price increases that happen once and for all goods and services, from those price increases that are persistent over time. Among the latter we can also make a distinction as to the degree of increase. There are countries where inflation is controlled below 10% a year, others with average inflation of no more than 20% a year. There are countries where sustained price growth has exceeded 100% (CPI) per year. When the variation in prices reaches 50% (CPI) a month is called hyperinflation.
In germany after The World War II there was an hyperinflation situation where every day the price of bread and all products was recalculated (increased). Some African countries have suffered from this too. It destroys the capacity of the country to impose trust in the international market, and the labor to maintain stability. The consumer is the most affected because the money earn keeps losing value at a very fast rate.

What does it Cause inflation?

Inflation, as an economic phenomenon that has causes and effects. The definition of its causes is not a simple matter because widespread price increases often become a complex cycle, which is not easy to determine the current factors driving the price increase. This difficulty in determining the causes of inflation, has been the driving force behind a various tests and different theoretical explanations of the inflationary processes. Consumer rates on consumption, cost of production, cost of labor, unemployment rate… All these rates are calculated in a annual basis, as well as the Consumer price index, but every month there are corrections done in the predictions, being the government the calculator.

Explanatory theories are usually grouped into 3 categories. One is about demand, so there are those that consider inflation as an explanation of excess aggregate demand, or demand inflation. The second one is about the supply, there are those who point to the aggregate as a trigger of supply inflation, this is what is called inflation costs. Finally, there is a group of theorists who understand inflation as the result of social rigidities, this is what is called core inflation.

Effects of inflation on the economy of a country

The effects of inflation are to some extent surprising, because high inflation rates generate an environment of instability and distrust among investors. When talking about a high inflation rate we mean above 25% a year… it has been proved that many countries have suffered from levels of inflation around 15% for many years and the economy has been able to continue functioning. But in general, high inflation brings up all costs of operation. If money loses value when it’s into a bank account then you need to be very careful where to invest your money in.

The continuous increase in the general price index has redistributive effects in favor of debtors, in the distributive employees and all those who depend on fixed nominal income fall in real incomes. Finally, as has been studied by Olivera-Tanzi, inflation also results in costs to the exchequer due to the delay between the time when the expenditure and tax collection are made.