What is inflation?
In economics, 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 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) over time.
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, 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.
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 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, through open market operations, and through the setting of banking reserve requirements.
High levels of inflation hamper any country’s economic performance thus making it mandatory to indentify the causing factors. Following are some of the reasons that cause Inflation:
1. Excess printing of money.
2. Rise in production and labor costs.
3. High lending levels & Currency devaluation.
4. High level of taxes
The general cause of inflation that has been agreed among most economists is when there is an increase in the money supply or a decrease in the quality of goods being supplied. Money supply plays a larger role in inflationary pressure, the more money injected in the economy the more will be the inflation. If the money supply is not adequately controlled by the Federal Reserve then it may actually grow at the rate faster than that of the potential output in the economy, or real GDP.