Inflation refers to an increase in the price level that goes on for a long period of time–months or even years on end. Inflation refers to an ongoing increase in the price level that is not just a one-time, one-shot matter, such as a price increase associated with a tax or international tariff or wage change or relative price change that may take a few weeks or a month or so to work its way through the payments by producers and consumers. It is important to distinguish between an ongoing increase of the price level–inflation–versus a one-time increase in the cost of some particular goods.
It is easy to think that if you go to the supermarket and you see the prices of the vegetables or fish or meats you buy all go up suddenly a few weeks in a row, that it is inflation. Or, if you go to your gas station, you might see your gas prices going up and up. It is also easy to think that if your wages don’t go up in synch to cover what you find in the markets where you shop, that there is something amiss going on, and to attribute it to inflation.
None of that is likely to reflect inflation. If you experience prices going up for just you, most likely it’s a result of new taxes or tariffs or relative price changes that are specific to your region or temporary reflections of your tastes and interests. Inflation is a matter of an ongoing increase in the price level for all goods and services–price increases that are ongoing for months on end or even years on end, for not just a few categories of goods and services as a one-shot matter, but for all goods and services on average, for a long time.
Measuring the price level is one of the most important and most difficult matters for understanding inflation. What you experience as an increase in the price level may depend on where you live–in a city or in a particular area of the country–or your age group, or statistical matters such as how to average over hundreds or millions or thousands of millions of people’s experiences. But what you experience may just be a matter of local price increases, or tax increases in your local or state area. How to deflate–that is, how to convert or compare the prices you pay for the goods and services you buy each month to some kind of real or relative prices comparable to what others pay–is not easy.
Historically, inflation has happened only when the money supply has increased faster than the underlying supply of goods and services for an ongoing period of time. Usually that involves a money suppy that is produced in a separate manner. A famous example includes the European inflation after the discovery of the New World in the 1500s-1600s, when gold and silver were suddenly brought back to Europe en masse and coined. More recent examples include the U.S. inflation during the 1970s, when inflation rates went from 5% to over 11% in 1979.
Hyperinflation–inflation rates that get out of control to the point they are in the hundreds or thousands of percentage increases every month–can also happen. When hyperinflation happens, it becomes even more clear that some government printing or centralized control printing of money as a government function, perhaps to fund the government in ways no one else will fund it, is going on.
Definitions and Basics
Inflation, from the Concise Encyclopedia of Economics
Economists use the term “inflation” to denote an ongoing rise in the general level of prices quoted in units of money. The magnitude of inflation–the inflation rate–is usually reported as the annualized percentage growth of some broad index of money prices. With U.S. dollar prices rising, a one-dollar bill buys less each year. Inflation thus means an ongoing fall in the overall purchasing power of the monetary unit….
In the United States, the inflation rate is most commonly measured by the percentage rise in the Consumer Price Index, which is reported monthly by the Bureau of Labor Statistics (BLS). A CPI of 120 in the current period means that it now takes $120 to purchase a representative basket of goods that $100 once purchased….
Inflation, at SocialStudiesforKids.com.
One of the concepts of economics most talked about by adults is inflation. Simply put, inflation is a rise in prices relative to money available. In other words, you can get less for your money than you used to be able to get….
Consumer Price Indexes, from the Concise Encyclopedia of Economics
The purpose of a price index is to summarize information on the prices of multiple goods and services over time. Consumer spending accounts for about two thirds of the U.S. gross domestic product (GDP). The Consumer Price Index (CPI) and the Personal Consumption Expenditure deflator (PCE) are designed to summarize information on the prices of goods purchased by consumers over time. In a hypothetical primitive society with only one good–say, one type of food–we would not need a price index; we would just follow the price of the one good. When there are many goods and services, however, we need a method for averaging the price changes or aggregating the information on the many different prices. The rate of change of prices–inflation–is important in both macro- and microeconomics….
Hyperinflation, by Michael K. Salemi, from the Concise Encyclopedia of Economics
Inflation is a sustained increase in the aggregate price level.Hyperinflation is very high inflation. Although the threshold is arbitrary, economists generally reserve the term hyperinflation to describe episodes where the monthly inflation rate is greater than 50 percent. At a monthly rate of 50 percent, an item that cost $1 on January 1 would cost $130 on January 1 of the following year….
Deflation and disinflation: Money Supply, by Anna J. Schwartz, from the Concise Encyclopedia of Economics
… Economic activity declines and either disinflation (reduced inflation) or deflation (falling prices) results….
In the News and Examples
Allan Meltzer on Inflation, podcast at EconTalk. Feb. 2009.
Allan Meltzer, of Carnegie Mellon University, talks with EconTalk host Russ Roberts about the current state of monetary policy and the potential for inflation. Meltzer explains why inflation hasn’t happened yet, despite massive increases in reserves created by Fed policy. Then he explains why inflation is coming and why it will be politically difficult for the Fed to stop it. Meltzer also analyzes the Japanese experience in recent years and talks about why so many investment banks overreached and destroyed themselves.
Adjusting for inflation is important: Capital Gains Taxes, by Stephen Moore, from the Concise Encyclopedia of Economics
The tax treatment of capital gains has other unique features. One is that capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power, but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income. In fact, Alan Blinder, a former member of the Federal Reserve Board, noted in 1980 that, up until that time, “most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary world.”…
How does the Federal Reserve control inflation? John Taylor on Monetary Policy, podcast at EconTalk
John Taylor of Stanford University talks about the Taylor Rule, his description of what the Fed ought to do and what it sometimes actually does, to keep inflation in check and the economy on a steady path. He argues that when the Fed has deviated from the Rule in recent years, the economy has performed poorly. Taylor also assesses the chances for a monetary or financial disaster and the Fed’s recent expanded role in intervening in financial markets.
A Little History: Primary Sources and References
Gold Standard, by Michael D. Bordo, from the Concise Encyclopedia of Economics
Widespread dissatisfaction with high inflation in the late seventies and early eighties brought renewed interest in the gold standard. Although that interest is not strong today, it strengthens every time inflation moves much above 6 percent. This makes sense. Whatever other problems there were with the gold standard, persistent inflation was not one of them. Between 1880 and 1914, the period when the United States was on the “classical gold standard,” inflation averaged only 0.1 percent per year….
Irving Fisher, from the Concise Encyclopedia of Economics
Fisher was a pioneer in the construction and use of price indexes. James Tobin of Yale has called Fisher “the greatest expert of all time on index numbers.” Indeed, from 1923 to 1936, his own Index Number Institute computed price indexes from all over the world.
Fisher was also the first economist to distinguish clearly between real and nominal interest rates. He pointed out that the real interest rate is equal to the nominal interest rate (the one we observe) minus the expected inflation rate. If the nominal interest rate is 12 percent, for example, but people expect inflation of 7 percent, then the real interest rate is only 5 percent. Again, this is still the basic understanding of modern economists….
No problem in economics has been more hotly debated than that of the various relations of price levels to interest rates. These problems are of such vital importance that I have gone to much trouble and expense to have such data as could be found compiled, compared, and analyzed. The principal result of these comparisons are given in this chapter….