Inflation, Causes & Types

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Inflation

The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index and the Producer Price Index. Over time, as the cost of goods and services increase, the value of a dollar is going to fall because a person won't be able to purchase as much with that dollar as he/she previously could. While the annual rate of inflation has fluctuated greatly over the last half century, ranging from nearly zero inflation to 23% inflation, the Fed actively tries to maintain a specific rate of inflation, which is usually 2-3% but can vary depending on circumstances.

Opposite of deflation inflation is a broad increase in prices. In practical terms, inflation means goods and services are being valued as more desirable than money. This also affects wages; periods of high inflation tend to be marked by increases in average income. Inflation can be caused by either too few goods offered for sale, or too much money in circulation. The most common measure of inflation is the consumer price index (CPI). Prior to Bretton Woods and the elimination of the gold standard, persistent inflation was relatively rare. In the US, for example, inflation for the entire period from Revolution through to 1914 was four percent. The move from currencies backed by hard assets to floating currencies backed by the "full faith and credit" of governments has nearly eliminated deflation by removing impediments to printing more currency. Consequently, excessive inflation has become the primary concern of central banks.

Causes of inflation

Inflation refers to a rise in prices that causes the purchasing power of a nation to fall. Inflation is a normal economic development as long as the annual percentage remains low; once the percentage rises over a pre-determined level, it is considered an inflation crisis.

There are many causes for inflation, depending on a number of factors. For example, inflation can happen when governments print an excess of money to deal with a crisis. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. This is called the demand-pull, in which prices are forced upwards because of a high demand.

Another common cause of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, which in turn leads to the company increasing prices to maintain steady profits. Rising labor costs can also lead to inflation. As workers demand wage increases, companies usually chose to pass on those costs to their customers.

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

Finally, inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced. Wars are often cause for inflation, as governments must both recoup the money spent and repay the funds borrowed from the central bank. War often affects everything from international trading to labor costs to product demand, so in the end it always produces a rise in prices.

There is only one cause of inflation and everything else happens as a result of that one major cause. In other words, everything else that happens becomes inflationary but not the cause of inflation. Rising prices are inflationary for sure but not the cause of inflation. Only the manufacture of more money than the total available yesterday causes inflation. Rising prices are a reaction to this extra money in the system. Manufacturing money out of thin air eventually puts more money in the ordinary person's pocket yet this endless production of extra paper money...done by the central banks, does not require any extra effort on behalf of the worker so he ends up with more money in his pocket to buy "things" at no extra cost to him. That sounds nice but with more money to buy things, the money becomes worth less and to compensate.... the "things" go up in price or else they would become cheaper for no real reason. The value of money is determined by dividing the number of "things" available by the total amount of money available. As the amount of money available increases, the value of "things" would go down if the system did not compensate by putting the value of those "things" up....hence an inflationary reaction to the extra amount of money available. This is not a complicated operation but rather hard to explain when money and the value of money are talked about. The value of money is different than the total amount of money available. The value of money rises or falls with the total amount of money available. If the central bank manufactures, out of thin air, more money than yesterday's total, then the value of money would go down...which would be seen as prices of "things" going up to compensate for the extra amount of money available.

Inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced.

"...Manufacturing money out of thin air eventually puts more money in the ordinary person's pocket yet this endless production of extra paper money...done by the central banks, does not require any extra effort on behalf of the worker so he ends up with more money in his pocket to buy "things" at no extra cost to him. That sounds nice but with more money to buy things, the money becomes worth less and to compensate..."

Manufacturing money out of thin air...is the only way to do it because money is abstraction like number. The major problem with money is who should issue it! *Not* any bank or any government but the buyer who is also the seller of goods or service. Inflation is only caused by the growing cost of raw materials caused by growing interest to borrow money. The increasing amount of money on the market does not cause inflation!

The moment someone says we need more money to do trade; bankers and economists are using this purely theoretical inflation formula to scare public and that is why they get away with so call tight budget that is causing recession, endless bankruptcies and homes foreclosure. Remember we do not know how many things are available and total amount of money available. Bankers pretend to know and use it to their advantage.

Cost-Push Inflation vs. Demand-Pull Inflation

The first is "supply-shock" inflation. That happens when oil prices go up, because a company selling you, say, plastic storage containers must pay more for the oil it needs to make the plastic, heat its factory, run its machines and fill up its trucks. The company must then pass along those higher costs to consumers through higher prices. (Incidentally, Rubbermaid has just sharply raised the prices of its storage containers, citing a 60 per cent increase in resin costs.) This often leads to "stagflation," where you have a stagnating economy as prices soar.

Then there's "demand-pull" inflation, which you get when your economy overheats and workers are in short supply. This more dangerous and entrenched form of inflation pushes up wages and other business costs, which pushes up prices. "It's like if you want to get a deck built at your house right when everyone else is getting a deck built," Ragan says. "You have to wait longer, and you have to pay more."

Supply-side inflation, due to a leftward shift in aggregate supply, is a different story, as the shift has caused the economy to be below potential (that is, slow economic growth or a recession). The Fed has three options here - First,it could cut the money supply, which eliminates the inflation problem but causes the economy to get worst. Second, it could increase the money supply, which benefits the economy but makes the inflation problem worse. Or it can do nothing and let the economy get back to equilibrium on its own.