What is

Inflation - Explanation and definition of inflation

What is inflation

Inflation is an economic phenomenon that is defined as the increment or prolonged general increase over time in the prices of products and services in an economy.

All agencies and governments monitor the evolution of prices in the economy over time in order to adjust their monetary and fiscal policies needed to preserve and improve the overall economy of the country or region.

There are several indicators that show that price increase, among them the most common are:

  • CPI

  • GDP deflator

When the resulting magnitude of the calculation of these indicators is positive it said that exist inflation, however if it is zero or negative is said to exist disinflation, if endures over time disinflation then the economy entered a period of deflation.

CPI - Consumer Price Index.

CPI or Consumer Price Index is calculated from a set of representative goods and services in an economy, it's like a list or basket of products and services that we buy and use regularly in our homes and therefore the evolution of these prices directly affect our economy, such as bread, milk, meat, gasoline and services such as public transport, telephone communications or hotel accommodations are part of the basic list or market basket.

Monthly economic, technical collect the prices of all the products and services considered in this list or market basket along the different towns and establishments of the country or region, with these data and after applying a series of weights is calculated CPI that allows to know the inflation.

But citizens do not always buy the same, consumption habits are considered by governments adding or removing products and services within the basic list and modifying the weights, for example in 1985 did not consider the price of the cells mobiles and now this concept is part of the CPI calculation, technological developments and market acceptance varies the CPI in any economic region of the world and therefore varies inflation.

Thus the CPI shows the evolution of the prices of all products and services purchased by residents of a country or region, ie changes in the cost of living, thus if the annual CPI has increased by 3 % we can say that we have to spend 3% more money than last year if we purchase products and services from market basket t or what is the same the cost of living has increased by 3%. It is of such importance and relevance of the indicator CPI is used to set wages, pensions, debts...

CPI is part of unique set of key macroeconomic indicators that all governments continuously measure in order to know the evolution of the economy.

GDP deflator.

GDP is a macroeconomic indicator representing the monetary value of all goods and services produced by an economy over a set period of time, this period is usually 1 year.

Nominal GDP is the value of all goods and services produced calculated from market prices in the time period considered, moreover real GDP is calculated at constant prices based on a specific year, ie real GDP does not account inflation.

GDP deflator is calculated by dividing nominal GDP between real GDP, in this way we obtain a percentage that represents the evolution of prices of all goods and services produced in the country.

Many economists advocate the use of this indicator against the CPI as a tool for calculating inflation given that the CPI only shows the price development of a list of products and services representative while the GDP deflator shows the evolution of prices of all products and services.

Inflation classification

Several factors can cause inflationary periods in an economy, such excess consumption by the population leads to higher prices without sufficient supply to meet demand, an increase in production costs due to the lack of any raw material or a runaway increase in wages generates a final increase in the price of goods or services produced, on the other the creation of speculative bubbles generates a rise in prices or inflation.

Depending on the size or value of inflation obtained we can classify into the following types:

  • Moderate inflation - Refers to a relatively small increase in prices, leading to inflation below 5% and an economy with stable prices where people and governments maintain confidence in its economy by promoting investments that stimulate economic growth.

  • Galloping or runaway inflation - Makes references to rapid inflation rates without limits where higher prices exceed 20% and even 150%, in this situation if governments and agencies in the field do not take appropriate measures can lead to a large and deep economic crisis.

  • Hyperinflation - Refers to increases inflated prices leading to inflation rates of 500%, 800% or even 1000%, in this situation the price of money is devalued at an alarming rate leading to an overall distrust of the economy generating a deep economic crisis, social and political upheavals. In Germany during the period between 1921 and 1923 there were a scenario where the monthly inflation was above 29,500% in this situation the value of money is despised at an alarming rate leading to situations where citizens burned mountains of bills to generate heat because it was cheaper than timber.

Now that you know what is inflation, did you know that Hungary was the country with the highest hyperinflation in modern economic history ?, during the years 1945 and 1946 Hungary monthly inflation reached more than 42 trillion percent or so it's the same 4.2 x 1016, under this economic scenario the value of its currency Peng depreciated every second reaching to emit bills for the value of 100 trillion Pengs.

what is inflation