Inflation is the increase in the
general level of prices of goods and services. As inflation
rises, the consumers’ purchasing power decreases. With higher
prices, each unit of particular currency buys fewer goods and
services, this is also known as a decrease in the real value of
money.
Inflation is measured and
expressed in the form of an annual percentage increase, and
sometimes, albeit very rarely, as a decrease – when the general
level of prices of goods and services declines (known as
deflation). This annual percentage increase or decrease is based
off of a price index for a specific area of the market over a
certain period of time.
There are several types of
inflation, each with varying consequences for the national
economy:
- Deflation
– a decline in the general price level of goods and services
over a period of time. This results in an increase in the real
value of money, which at first glance may seem like a good
thing, but in reality carries with it severe negative
connotations in the form of a possible recession and in dire
cases - a great depression.
- Disinflation
– a decrease in the rate of inflation. Not to be confused with
deflation – where inflation becomes negative, disinflation
simply implies a decline in the rate of increase in the general
level of prices over a period of time. However, if a period of
disinflation is sustained long enough, it can in turn lead to
deflation.
- Hyperinflation
– a rare form of very rapid, out-of-control inflation. It
results in a drastic devaluation of a country’s currency and can
lead to a complete collapse of the monetary system. Once
hyperinflation sets in, it becomes very hard to halt it as the
country becomes trapped in a vicious circle where an increase in
inflation results in an even bigger increase the following
month.
- Stagflation
– a result of slow economic growth, high unemployment and
inflation over a prolonged period of time.
Nowadays, most developed
countries sustain a stable inflation rate of roughly 3%. This is
usually a sign of a healthy and growing national economy. There
is need for concern when the rate of inflation exceeds the rate
of increase in wages and/or when the rate of inflation is
reported to be higher than anticipated.
A low and stable inflation rate
(read: higher than 0%) allows countries to combat potential
recessions through various monetary policies, for example the
setting of interest rates by the central banks, without the risk
of a liquidity trap and enables labor markets to be more
responsive to downturns.
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