Inflation: Causes & Effects

Inflation is a sustained rise in the general level of prices in the economy over time. The inflation rate measures how fast prices are rising as a percentage of the previous period.

Three pieces of the definition that earn marks:

• Sustained. A one-off price rise (e.g. a sudden tax increase one quarter) is not inflation. Inflation is ongoing.
• General price level. Inflation is about all prices on average, not the price of one good. A rise in the price of bananas alone is not inflation; a rise in the average of food, rent, energy, transport, clothing and so on is.
• Real-world reality. Some inflation is normal in any growing economy. The aim (topic 12) is low and stable inflation, not zero.

A related concept worth naming:

Deflation is a sustained fall in the general price level (a negative inflation rate). It is rare but dangerous: consumers delay purchases waiting for prices to fall further, firms cut output, and unemployment rises.

A more extreme concept:

Hyperinflation is an extremely high and accelerating inflation rate, typically more than 50% per month. It destroys confidence in the currency; people switch to barter or foreign currencies. Famous historical examples include Weimar Germany in the 1920s and Zimbabwe in 2008.