Inflation

Inflation is an important economic concept that affects the daily lives of individuals and entire economies. In this article, we will explore various definitions and types of inflation, how it is measured, its impacts, and ways to protect against it.

What Is Inflation

Inflation is the increase in the price level of goods and services in the economy over time. Simply put, inflation reduces the purchasing power of money because for the same amount of money, we can buy less goods or services than, for example, a year ago. Inflation is primarily caused by the growth of the money supply in circulation.

Figure 1: Inflation Burning the Value of Money (source: Craiyon)

Definition of Inflation

Different economic schools have different definitions and explanations of inflation. For example, classical economics argues that inflation is caused by an excessive growth of the money supply. According to classical economists, inflation occurs when the central bank prints more money than is needed to cover economic growth.

The Austrian economic school considers inflation a result of money inflation – the "inflating" of the money supply (inflate = to expand). It argues that inflation is caused by an increase in the money supply in the market, leading to a decrease in the value of money and an increase in the prices of goods and services.

Measuring Inflation

Inflation is measured using various indicators, the most common of which is the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) deflator.

The Consumer Price Index tracks changes in the prices of a selected basket of goods and services that consumers regularly purchase.

On the other hand, the GDP deflator measures the rate of change in the prices of all products and services in a given economy over time. It is the ratio between nominal and real GDP, serving to eliminate the impact of inflation on economic growth. The GDP deflator is an indicator of the overall price level in the economy and helps analyze inflationary pressures in the economy.

Inflation Targeting

The average inflation rate varies among different economies and periods. Central banks often try to maintain or target the inflation rate at an acceptable level, usually around 2% per year. Since 2022, inflation worldwide has significantly exceeded this target, likely as a consequence of nearly two decades of loose monetary policies by central banks (money printing). Excessively high inflation rates can lead to economic instability and a decline in the value of money.

Types of Inflation

There are various types of inflation that differ in intensity and impact on the economy and individuals. Below are three main types of inflation:

1. Mild Inflation

Mild inflation is a moderate increase in the price level of goods and services in the economy. It typically ranges in single digits per year (up to 10%). Mild inflation is often considered acceptable and even desirable because some believe it supports economic growth and business.

2. Galloping Inflation

Galloping inflation is a situation where the inflation rate becomes high and unpredictable. Prices rise significantly, and the value of money sharply decreases. Galloping inflation usually reaches values up to 100% per year. Galloping inflation is associated with a loss of trust in the currency and economic instability. In extreme cases, it can lead to hyperinflation.

3. Hyperinflation

Hyperinflation is an extreme form of inflation characterized by extremely high and rapid price growth. The inflation rate in a hyperinflationary environment exceeds 100% per year, possibly reaching thousands or millions of percent. The unsustainable inflationary spiral leads to rapid currency devaluation and loss of trust in it. Hyperinflation has catastrophic impacts on the economy, including the collapse of the payment system, massive devaluation of savings, and social unrest.

The consequences of hyperinflation are devastating and can last long after inflation ends. A country that experienced hyperinflation must deal with enormous economic and social problems and restore confidence in its currency.

Special Inflation Phenomena

Within the realm of inflation, there are distinct phenomena that deserve attention: stagflation and shrinkflation.

• Stagflation represents a rare and challenging economic scenario marked by stagnant growth, high unemployment, and rising prices.
• Shrinkflation refers to the subtle reduction in product sizes or quantities while maintaining the same price, often employed by producers grappling with inflationary pressures.

Historical Excursion

High inflation, including hyperinflation, was one of the factors that contributed to the worsening political and economic situation in Germany during the interwar period and influenced the rise of Adolf Hitler to power. After World War I, Germany found itself in a difficult economic situation, mainly due to war reparations and the economic consequences of the Treaty of Versailles.

One of the main factors leading to hyperinflation in Germany was the excessive printing of money, which was used to finance war reparations and budget deficits. This led to the rapid devaluation of the German currency, the Reichsmark, and a dramatic increase in the prices of goods and services.

Hyperinflation had devastating effects on the German economy and society. Savings and the monetary value of citizens quickly lost their value. People lost their savings, and the standard of living rapidly declined. Socioeconomic instability increased, leading to unrest and dissatisfaction with the existing political system.

In this unstable situation, Adolf Hitler's Nazi Party became popular among the population, who sought strong leadership and promises of recovery and stability. Hitler became a channel for expressing frustration and hatred towards the existing political establishment, which was responsible for the economic crisis.

Although hyperinflation cannot be considered the sole reason for Hitler's rise to power, it contributed to creating an environment in which extremist political forces could succeed. Hitler and the Nazis exploited the unrest and dissatisfaction of the population caused by economic instability, promising renewal and national strength. This gained them support and gradually gained influence, allowing them to come to power.

However, it is essential to emphasize that Hitler's rise to power was the result of many complex factors, including political, social, and historical circumstances. Inflation, including hyperinflation, was one of these factors that contributed to the emergence of instability and dissatisfaction that Hitler and the Nazis used to their advantage.

Impacts of Inflation

Inflation has an impact on savings and investments. With increasing inflation, the value of money decreases, meaning that cash savings gradually lose purchasing power. People holding their savings in cash may be forced to seek alternative ways to preserve the value of their savings and protect them from inflation. This can lead to increased interest in investing in assets that have the potential for growth above the inflation rate.

Inflation does not affect everyone equally; it disproportionately affects people with fixed incomes, such as retirees. Inflation affects savers and creditors, while benefiting debtors.

Another consequence of inflation is uncertainty and disruption of economic stability. High inflation rates can lead to unpredictable changes in prices, complicating planning and decision-making for individuals, businesses, and governments. Inflation can also trigger speculation in financial markets and disrupt the balance and trust in the economy.

Finally, inflation can affect international trade. If inflation in one country rises faster than in others, goods and services in that country become more expensive compared to other countries. This can lead to a decline in competitiveness and restrictions on exports. Conversely, if inflation in a country is lower than in other countries, it may mean increased competitiveness of its export products.

How to Protect Against Inflation

There are several ways to protect against inflation. One possible way is to invest in assets that are resistant to inflation, such as real estate, commodities, especially physical gold and silver, or stocks, including shares of gold and silver mining companies. Gold and silver have a long-standing reputation as stores of value and are considered natural hedges against inflation.

Another option is to maintain a diversified investment portfolio, which can minimize the impact of inflation on overall savings. Some people also opt for investments in bonds or funds that focus on inflation protection.

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Based on the original Czech article: Inflace – co je, jak se měří a jak se proti ní chránit.