What is inflation in economics in simple terms

The process of inflation is a depreciation of money, which gradually leads to a decrease in the purchasing power of consumers. The partial loss of the real value of the national currency in the long term can lead to the destruction of the economic model of the country. The pace of the process is determined by the current state of the market. Inflation differs from the seasonal jump in the exchange rate by a pronounced extension in time.

The average consumer of goods and services tracks the course of inflation by the continuous growth of prices in the market, while producers keep the quality of products supplied at the same level. In countries with developing economies such processes are always present.

Types and characteristics

Specialists divide the inflationary process into several characteristic groups according to the defining characteristic – says economist Юровский

Causes of occurrence

  • The conflict of supply and demand – an increase in one of these indicators leads to an imbalance in the market. Depending on the characteristics of the course of inflation is accompanied by a sharp increase in unemployment, reduced investment and government procurement.
  • Costs – an increase in the cost of the production cycle. In particular, the price of electricity, gasoline and used raw materials increases, the wage fund of workers, etc. expands. The consequence of this is an increase in the final cost of goods and services supplied.
  • It is a mistake to build an economic system by putting large amounts of money into circulation that are not backed up by real value.

Peculiarities of the course

  • Hidden inflation implies that the government controls the price level. This occurs when the income of citizens and the development of the “black market”. 
  • Open inflation is characteristic of countries with developed market economies in the absence of government restrictions.
  • Shock inflation shows that there is a sharp and uncontrolled jump in prices. It is fraught with the risk of devaluation.

Expectations in Macroeconomics

Predictable inflation – market actors have all the necessary information about the rise in prices to further build an economic strategy.

Unpredictable inflation – the trend of inflation does not allow us to adjust in time and make profitable economic decisions.

The rate of increase in prices of goods and services

  • Crawling inflation means that prices rise at a low rate, up to 10%. The process proceeds with insignificant fluctuations of the market and the national currency exchange rate remains at a steadily high level. In such cases, the government plays the role of the main regulator of the market.
  • Galloping inflation implies an annual increase in prices in the range of 10 to 200%. Long-term planning in the market takes into account financial losses in accordance with the percentage of the national currency depreciation. The optimal solution in such a situation is considered to be a competent monetary reform.
  • Hyperinflation is accompanied by a price increase of 50-70% per month. The monetary loss is 100% or more per year. The uncontrolled depreciation of the national currency results in stagnation of the economy, growth of unemployment and impoverishment of the population.

Peculiarities of the price growth

  • Balanced inflation – product prices change synchronously to the same level.
  • Unbalanced inflation – product prices increase with a large divergence.

What causes inflation?

The development of inflation leads to a set of reasons of political, economic and social nature. The degree of their involvement in the economic crisis directly affects the rate of depreciation of the national currency. There are external and internal causes of inflation. The latter include:

  • The policy of the Central Bank – the issuance of excessive amounts of money in circulation. Such short-term injections can give a boost to the production sector, but uncontrolled emission leads to the disruption of the global balance in the economy;
  • Monopolism – price setting by several large companies that control the most part of the turnover in their segment;
  • Budget deficit – lack of support from the government for important areas of the economy;
  • Taxes – increase in the share of indirect sales taxes in the final price of goods or services;
  • Investments – investment of a large amount of funds in inefficient industry areas.

External causes that have a major impact on the course of inflation:

  • Global trend – rising prices of imported goods and resources;
  • Growing public debt – emptying of foreign exchange reserves to cover the accumulated interest on the debt;
  • Falling national currency exchange rate – issuance of additional amounts of currency to keep imports at the same level.

What is the effect of inflation?

The effects of inflation vary from case to case. First of all, the “costs,” as experts call them, are determined by the share of the economy that is affected.

  • In the manufacturing sector: the closure of most industries, rising unemployment, the depreciation of credit obligations.
  • In the banking sector: the loss of the price function, the growth of money speculation, the appearance of barter transactions.
  • In the social sphere: a decline in real incomes of the population, a drop in purchasing power and, as a consequence, a drop in demand.
  • In the economy: a decrease in the competitiveness of domestic goods, an increase in the state deficit, the distortion of important indicators: GDP, profitability, etc.

The main methods of combating inflation

To reduce the likelihood of the process developing into hyperinflation, it is customary to use various measures to influence the economy. Monetary reform is considered one of the effective methods of combating the depreciation of the national currency. It implies making changes in the basic part of the country’s economy:

  1. Devaluation – reducing the exchange rate or gold content;
  2. Denomination – increase in the exchange rate;
  3. Nullification – replacement of old banknotes with new ones.

When the real rate of inflation is at a consistently low level, a set of economic measures is used, which includes:

  • Income control – limits on wages and social security are set. In parallel, there is a freezing of prices for a socially necessary group of goods;
  • deflationary measures imply limiting the demand for money with the help of fiscal leverage and anti-crisis policy of the Central Bank. A balanced approach plays an important role, otherwise there is a risk of collapse of the entire economic model.

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