What Is Inflation and Its Type

Five different types of inflation

• Commodity inflation
• Wage inflation
• Monetary inflation
• Fiscal inflation
• Foreign exchange inflation

INFLATION

Inflation is a rise in the general price level and is reported in rates of change. Essentially what this means is that the value of your money is going down and it takes more money to buy things.


A less common, but more volatile form of inflation is commodity inflation, better known as cost-push inflation. We can see it today in commodity prices such as energy and metals. Energy and food price changes are excluded from "core" inflation because of their period-to-period volatility. But over time, oil price rises have averaged 6% a year, higher than other forms of inflation, and assuming that they don’t cause inflation is really assuming away the problem. Other commodities such as timber rise at 3% a year "real" (above the rate of calculated inflation)

The inflation that most American economists remember best (from the 1960s and later) is wage inflation, otherwise known as demand-pull inflation. Workers observe rising prices and demand compensation in the form of higher wages, which creates a vicious cycle of more inflation and more wage demands. This has not been happening until recently in the United States, due to the absence of labor unions, and to what Karl Marx called the "reserve army of the unemployed" in "offshore" markets. This appears to be the form of inflation that the Fed and other U.S. government authorities are focusing on, and it has indeed been benign up to now.

Monetary inflation was most famously seen in Weimar Germany during the 1920s, when the German government went crazy with the printing presses to the point where it took billions of marks to equal one dollar. This wiped out the savings of the middle class, most members of which were compensated with (worthless) "million mark" notes, and eventually led to the rise of Hitler. Nothing of this sort has happened in the western world since, but it is a worry when the United States has a chairman of the Federal Reserve who has talked (hopefully facetiously) of dropping money out of helicopters.

Fiscal inflation is due to excess government spending, for which the budget deficit is a reasonably good proxy. It originated in the "guns and butter" spending of President Lyndon Baines Johnson in the 1960s, and similar spending of today’s President George W. Bush. We have war spending without a "war economy" e.g. rationing or wage and price controls, and if the 1960s are any guide, we will be paying the price later this decade and in the 2010s.

The last type of inflation, foreign exchange inflation, is particularly scary to me, someone who lived in Mexico before and during the peso crisis in 1994. This happens when the local currency (pesos in this case) falls dramatically against other world currencies, thereby sharply raising the price of imported goods, and hence the overall price level.