Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.
When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index – a specific list of goods and services, which measure the average price of consumption) over time. The 2nd measure is the GDP deflator which gives an average price of output (the final goods produced in the economy) which is calculated by dividing Nominal GDP by Real GDP. Types:Hyperinflation is the most extreme inflation phenomenon, with yearly price increases of three-digits percentage points and an explosive acceleration.
High inflation could range anywhere between 50% and 100%. High inflation is a situation of price increase of 30%-50% a year. Both kinds can be stable or dangerously accelerate to enter in an hyperinflation condition.
Moderate inflation -. One could consider an inflation as moderate when it ranges from 5% to 25-30%.
Low inflation can be characterized from 1-2% to 5%. Around zero there is no inflation (price stability). Below zero, a country faces deflation.
Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Besides, according to the Phillips curve, inflation is influenced by the rate of unemployment (un-t below the natural rate leads to an increase in inflation; un-t above natural leads to a decrease in inflation) and expected inflation. This relation is expressed by a formula: πt–πt-1=-α(ut – un). Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.Today, most mainstream economists favor a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates (raising interest rates to cut down the money supply), through open market operations (selling securities in the open market), through the setting of banking reserve requirements, fiscal measures (cutting government expenditures, raising taxes to reduce people’s income), increasing savings (it will lower consumption and investment).
