Inflation

The rate of inflation in the US from 1920-2010

What is inflation?

Inflation is a sustained, rapid increase in prices, as measured by for example the Consumer Price Index over years, and mirrored in the correspondingly decreasing purchasing power of the currency.

It has its worst effect on the fixed-wage earners, and it is definitely discouraging for you to save.

As a result of inflation, the purchasing power of a unit of currency falls. For example, if the inflation rate is 2%, then a chocolate bar that costs $1 in a given year will cost $1.02 the next year. As goods and services require more money to purchase, the implicit value of that money falls.

Types of inflation

Modern economic theory describes three types of inflation:

(1) Cost-push inflation is due to wage increases that cause businesses to raise prices to cover higher labor costs, which leads to demand for still higher wages (the wage-price spiral),

(2) Demand-pull inflation results from increasing consumer demand financed by easier availability of credit;

(3) Monetary inflation caused by the expansion in money supply (due to printing of more money by a government to cover its deficits).

For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and especially silver flowed into the Spanish and other European economies. Since the money supply had rapidly increased, prices spiked and the value of money fell, contributing to economic collapse.

 

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