What is Inflation

One of the economic indicators is that of inflation. Inflation is the general increase in prices that is somewhat variable. It is the general level of prices in an economy over a given time period.

Today, U.S. inflation is measured by the CPI. The CPI provides details on the inflation increases or decreases in percentages. For example, you might hear that U.S. inflation is currently at 2.0% or 1.5%. Those inflation stats were from this U.S. inflation web page. That has to be considered a low rate of inflation when compared to the heady days of the ’80s when it hit up to, and over, the 10% mark.

Some might note that there are a few minus figures included on that page. During notable economic downturns, it’s not unheard of for a general decrease in prices to emerge. That’s when inflation becomes deflation.

Economists of today generally favor keeping inflation as close to the 0% mark as possible. The economic impact of a sustained period of inflation, otherwise hyperinflation, can be considerable. When Germany was a republic they had to introduce a new currency to resolve the postwar hyperinflation. The real value of their original currency was wiped out by the inflationary spiral.

Another advantage of lower inflation rates is that it will boost savings. There’s no point in investing in a saving account if the interest rate is not going to eclipse the prevailing rate of inflation. If inflation is higher, then the interest rate will not actually grow the savings in the account. Inflationary spirals can wipe out the value of savings altogether.

The main factor behind inflation (but not the only) lies with supply and demand economics. If demand exceeds supply then that will certainly bring about an increase in inflation. If there is excess supply then inflation will likely drop. To reduce inflation, therefore, demand also has to be curbed.

An effective monetary policy will do just that. The prevailing national interest rates can be increased or decreased by central banks. When they are increased interest rates on loans and bank accounts will be higher, and thus bank lending through loans will likely be reduced. It will also give a notable boost to saving account rates which should then increase in accordance with the set interest rate. By increasing the interest rates, inflation should then gradually fall to a lower level.

Of course, if the interest rate is slashed then you can expect inflation to increase. Increases in inflation can bring some advantages such as increased investment. However, if inflation increases too much then it will have to be curbed.

Fiscal policies can also reduce inflation. By adjusting direct or indirect taxation rates, inflation can be curbed. Increasing taxes can slow down an overheating economy, and that, in turn, will reduce inflation.

Either fiscal or monetary policies can keep inflation in check. So long as inflation remains at reasonably steady levels (preferably below 5%) a productive economy can be sustained.