There is a continuous cycle of rising prices for goods and services. Every year, your hard-earned money buys you fewer and fewer things. This phenomenon is called inflation. What exactly is it, and why isn’t it abolished?
What is inflation
Inflation is an increase in most prices across the economy. It means that the purchasing power of money is falling. To give you an idea, let us take an example. Fill an imaginary basket with a few groceries and toiletries. Today, you will pay a higher price for this basket than it would have cost you, say, a year ago. Inflation over a specific period is called the inflation rate, and it is measured by the Czech Statistical Office. You can find details of the measurements and specific data on its website.
In September 2020, the inflation rate over the previous 12 months was 3.3%.
Inflation targeting
Inflation targeting is a supporting tool to regulate inflation. The Czech National Bank (ČNB) sets an inflation target that it aims to achieve. It then works towards this figure using various tools at its disposal. For example, the Czech National Bank (ČNB) has an inflation target set at 2%. If the inflation rate moves away from this figure, the Czech National Bank (ČNB) artificially raises or lowers inflation.
Causes of inflation
What causes inflation in the economy? Generally speaking, money is behind it. Let us explain this in more detail.
An enormous increase in the money supply
Experts agree that the most common cause of a high inflation rate is an enormous increase in the money supply. This phenomenon can occur for several reasons. We will give one example. For instance, the Czech National Bank (ČNB) lowers interest rates. As a result, taking out a loan suddenly becomes an affordable option for many people. People start borrowing money from banks on a large scale. They then spend this money, which increases the amount of money in the economy. That subsequently leads to inflation.
Demand-side causes
Let us jump straight into an example. Suppose everyone receives an across-the-board pay rise. Suddenly, everyone will have more money and will therefore want to spend more. That means an increase in demand for goods and services. However, producers were not prepared for this situation and do not have enough goods. As a result, they raise the price. And there you have inflation. In practice, we do not see massive across-the-board pay rises. However, the market can be shaken up in this way by, for example, an influx of foreign investors or a sharp increase in actively working people.
Supply-side causes
Reasons can also emerge on the supply side. It could be an increase in the cost of extracted resources. Their quantity is limited, and various extraction obstacles may arise. Consequently, the costs of further production go up, and with them the final price of goods. Furthermore, prices can be pushed up by, for example, a rise in the non-productive population relative to the productive population. If there is a shortage of employees to perform the work, companies raise wages to attract workers. This once again increases the overall production and process costs. The final price goes up.
Types of inflation
There are several types of inflation, ranging from mild to hyperinflation, which can reach unimaginable levels.
Mild inflation (creeping)
Prices rise at a slow pace. The inflation rate is a single-digit number. People trust money. They save, spend, and do not hoard supplies.
Trotting inflation (galloping)
The inflation rate is in double or triple digits. If this pace is not stopped in time, there is a risk of serious economic problems. People begin to lose trust in money. Prices of goods are rising, so people start hoarding non-perishable food at home. Financial markets face problems because people do not want to invest money.
Hyperinflation
Hyperinflation is already an extremely extreme case. It can reach 10,000% or more. In Hungary after the Second World War, hyperinflation exceeded 42 quadrillion percent. It manifested itself as a doubling of goods prices every 15 hours. In such cases, things reach such extremes that you pay more than a million for a loaf of bread. Everyone is suddenly a millionaire, but piles of money have no value. You can buy almost nothing with your millions. In interwar Germany, people used banknotes to wallpaper walls and light cigarettes. That is how worthless money can become.
Consequences of inflation
The consequences of inflation are not the same for everyone. Some profit from inflation, while others lose out.
- It reduces the value of money
- It increases the value of non-monetary assets (property, shares, gold…)
- Higher inflation creates uncertainty among people about what will happen next
- A loss of the purpose of saving
- During high inflation, people hoard supplies, which leads to goods shortages
- Strategic planning and price calculations are nearly impossible for businesses during high inflation
- Under very high hyperinflation, goods can become more expensive practically every day
Other terms:
Deflation
This is the opposite of inflation. It refers to a situation where the price of most products in the economy is falling. Today, you can therefore buy your imaginary basket of groceries and toiletries for less money than it cost you a year ago. The Czech National Bank (ČNB) uses its tools to prevent this phenomenon. Some economists disagree with this regulation and argue that deflation would be natural for today’s advanced era.
Disinflation
While inflation is rising, it can have drops here and there. This phenomenon is called disinflation, or a decrease in the rate of inflation.
Most experts agree that maintaining a low rate of inflation is best for favourable economic development. They do not recommend zero inflation or deflation. Understanding the economy and the market at this level is not simple at all. Therefore, focus instead on what inflation does to you.
If you keep your money in a savings account with 2% annual interest and the inflation rate is 3%, your money in the savings account will have less purchasing power in a year. Still, it is better for you than keeping it under the mattress at home. The ideal approach is to dive deeper into the world of investing and choose products that yield around 5% on your money.
For example, buying property in a suitable location can significantly appreciate your money.
