Inflation

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Definition

Inflation is defined as an increase in the general price level of an economy. Quantitatively, inflation is a measure of the increase in the general price level of an economy.

Inflation is typically measured in the context of a time period, i.e., comparing an initial time point with a final time point.

Some notes (need to be made more systematic):

  • One way of trying to quantify inflation is by measuring the fractional change to the consumer price index (which is a good proxy for a cost-of-living index).
  • Core inflation is a measure of inflation that uses a consumer price index but excludes items with highly volatile seasonal price movements, such as food and oil. In the short run, it provides a more accurate estimate of inflationary trends.

Causes of inflation

Inflation is a result of the interplay of three factors:

  • An increase in the money supply, resulting in more money chasing a given set of goods, services, and commodities. This may be brought about by the issuing of new currency (in economies that use fiat money with a central bank having the power to issue new currency) or by the discovery of money (in economies where the money is measured by some physical commodity such as gold, the discovery of a new gold mine can be inflationary).
  • Changes in the real availability of factors of production: land, labor, capital, and technology.

Generally, technological changes are deflationary, i.e., they tend to push costs down, as more efficient processes are discovered and implemented. The changes in other factors of production may be either inflationary or deflationary, though overall, the trend based on factors of production has tended to be deflationary since 1800. That inflation occurs despite all these is typically a result of an increase in the money supply that outstrips the deflationary changes brought about by technological improvement. There are, however, some sectors of the economy where the deflationary trend of technological progress is so strong that the price level falls despite an increase in the money supply. Computers and electronics have been one such sector of the economy.

Extreme cases

Further information: Hyperinflation

Hyperinflation is a case of extremely rapid inflation. While there is debate surrounding whether inflation in the ordinary sense is always harmful, and the magnitude of the harm is not large, hyperinflation is considered unambiguously harmful to the economy and has very clear real costs associated to it.