Written by Inflation is a general and continuous increase in the prices of goods and services in an economy.
It refers to the continuous rise in the general level of prices of goods and services in an economy over a particular period of time.
Inflation means there is a persistent and sustained increase in the price level of goods and services in an economy.
Simply put, it means that on average, the prices of goods and services in the economy are increasing.
There are two things to note about inflation.
First, a rise in the price of a single commodity in the economy does not constitute inflation but a rise in the average prices of goods and services constitutes inflation.
Secondly, the rises in the average prices of goods must be continuous for it to be called inflation.
Short-term spikes in prices do not qualify as inflation because they are not part of a long-term trend.
For example, a one-time increase in oil prices does not constitute inflation unless it leads to a sustained rise in the overall price level of goods and services throughout the economy.
Characteristics of Inflation
1. Persistent increase in the general price level: Inflation is a situation where the general price of goods and services continues to rise over time.
This means that over time, the things we buy, like food, clothing, and electronics, will become more and more expensive.
When this happens, our money doesn’t go as far as it used to, because we have to spend more money to buy the same things we used to buy for less.
The reason is that the purchasing power of our money has decreased.
2. It is a monetary phenomenon: Inflation is mostly caused by the increase of the amount of money in circulation.
The more money that is in circulation, the less valuable each individual unit of money becomes.
When there is too much money in circulation, people may choose to spend more money than they usually would, because they have more to spend.
This leads to an increase in demand for goods and services, which can cause prices to rise.
This is why governments and central banks sometimes try to control the amount of money in circulation to prevent inflation from getting out of hand.
3. It is a post-full employment phenomenon: Inflation is often associated with periods of full employment.
When the stage of full employment is reached, any increase in the supply of money, which results in an increase in income will cause a rise in the general price level.
4. Causes: Inflation is usually caused by an excess of aggregate demand over aggregate supply.
When there is more demand for goods and services than there is supply, businesses may raise their prices in order to make more money.
Alternatively, if the supply of all goods and services decreases in relation to demand, prices may also increase.
5. It is a state of disequilibrium: Inflation occurs when the economy is out of balance, with the demand for goods and services in an economy higher than the supply.
This causes a mismatch between the amount of money people have to spend and the amount of goods and services available in the market.
This mismatch can be destabilizing to the economy and can lead to further imbalances and problems.
Classification of inflation
Based on severity, inflation can be classified into creeping inflation, walking inflation, running inflation and hyperinflation.
1. Creeping inflation: This occurs when the prices of goods and services increase at a slow rate.
It is used to describe a slow and gradual increase in the general price level of goods and services.
Creeping inflation is a mild form of inflation where prices rise slowly, usually at a rate of 1-3% annually.
Most central banks regard creeping inflation as safe and essential for economic growth.
This is because creeping inflation encourages investment and growth as businesses seek to take advantage of the rising prices.
Creeping inflation is seen as a manageable and necessary aspect of a healthy economy.
2. Walking inflation: This occurs when the prices of goods and services increase at a moderate rate.
It is a moderate form of inflation where prices rise at a faster rate than creeping inflation, usually between 3-10% per year.
Walking inflation serves as a warning signal for the government to control it before it turns into running inflation.
If the government is not able to control walking inflation, it turns to run inflation
3. Running inflation: This occurs when the prices of goods and services increase at a more than moderate rate.
A sustained annual rise in average prices between 10% to 20% per annum falls under the category of running inflation.
Running inflation has a significant adverse effect on the economy. It causes the currency of a country to lose value in the global economy and makes fixed-income earners poorer as the purchasing power of their income will be reduced significantly.
Running inflation usually marks the start of potential economic instability.
That is why most governments try to eliminate running inflation by implementing strong monetary and fiscal policies.
4. Hyperinflation: If the government and other policymakers are not able to control running inflation, it results in a devastating form of inflation, called hyperinflation.
Hyperinflation is the extreme form of inflation where the prices of goods and services increase at a fast rate.
A sustained annual rise in average prices above 25% per annum falls under the category of hyperinflation.
Hyperinflation tends to have devastating impacts on the economy as it may result in a breakdown in the monetary system, a loss of confidence in the currency, and social unrest.
During hyperinflation, prices tend to rise very fast at double or triple-digit rates such that the purchasing value of money reduces frequently.
Hyperinflation could get so extreme that the inflation rate is no longer measurable or the inflation is no longer controllable.
Summary
To conclude, here are the things you should note about inflation.
- Inflation connotes a general and persistent increase in the price level of goods and services in an economy.
- There are five characteristics of inflation, which are:
- It is a persistent increase in the general price level
- It is a monetary phenomenon
- It is a post-full employment phenomenon
- It is a state of disequilibrium
- It is caused by the excess of aggregate demand over supply
- Based on severity, inflation can be classified into creeping inflation, walking inflation, running inflation and hyperinflation
