Inflation is a fundamental concept in economics and a major concern for policy makers, businesses, workers, and investors. Inflation is the continuous and significant increase in the prices of various goods and services in an economy over a long period of time. On the contrary, inflation can be viewed as an erosion of the economy’s money (one unit of money buys fewer goods and services than in previous times).
The CPI is the most popular measure of inflation in the United States, and uses the so-called “market basket” of goods to measure the price changes that the average consumer experiences in the economy. However, central bank economists and bankers often use the “core inflation” measure, which includes the same “market basket” of goods, but excludes food and energy prices.
The Producer Price Index (PPI) is a measure of inflation that tracks the prices of goods received by producers. Although the scale has been in use for a long time, changes in the composition and orientation of some economies from manufacturing to services have reduced the importance of its use today.
Another option for measuring prices and inflation is the GDP deflator. As the name implies, this index is a price measurement tool used to convert nominal GDP into real GDP. The GDP deflator is a broader measure than the Consumer Price Index (CPI) because it includes goods and services purchased by businesses and governments.
While there is no consensus on the “correct” rate of inflation for the economy (or even whether it is necessary), there is some consensus on the different effects of expected and unexpected inflation. When inflation is expected, economic agents can plan and act (companies raise prices, workers demand higher wages, and lenders raise interest rates). Unexpected inflation is a bigger problem when unexpected inflation hurts workers, regular income earners, and savers. On the other hand, unexpected inflation tends to favor firms that can raise prices quickly without having to raise wages immediately. It also benefits borrowers who are able to repay their debts with money whose economic value is less than what they borrowed.
Unexpected inflation can cause many problems in the economy in the long run. Companies invest less money in long-term projects due to uncertainty about returns. In addition to distorting price information, consumers spend more time trying to protect themselves from inflation and less time in productive activities. Times of inflation also tend to shift investment away from companies to fixed assets, depriving companies of the capital they need to grow and expand.
The cause of inflation is controversial in economic theory, as some economists believe that there are different types of inflation.
For example, “cost-push inflation” is the lack of suitable substitutes due to the high prices of goods and services, the oil crisis of the 1970s being an important example of this. This is Keynes’ view because monetarists do not believe that increases in the prices of goods and services will lead to inflation without an increase in the money supply.
Demand-pull inflation assumes that inflation is an increase in the prices of goods and services because aggregate demand exceeds aggregate supply. To describe it in one sentence: Too much money, too little merchandise. Like cost inflation, monetarists oppose the existence of inflation because aggregate demand increases in the absence of a change in the money supply. Keynesianism: an economic theory created by the British economist John Maynard.