In economic terms, inflation refers to an increase in the general price level of goods as well as services in a particular economy over a span of time. Due to a rise in price level, each currency unit has the power to purchase less goods and services. In other words, inflation results in eroding of money's purchasing power.
Economists are of the view that high inflationary rates are the result of excessive money supply growth. Low and moderate inflationary rates are usually caused due to changes associated with real demands for services and goods. It may also take place on account of fluctuations in supplies of goods, especially during scarcities. A universal thought regarding inflation is that it is the result of money supply increasing at a faster pace in comparison to the economic growth rate.
Measurement of inflation
Inflation is mathematically expressed by measuring the inflation rate of a Consumer Price Index. The Consumer Price Index refers to the costs of some goods and services bought by a general consumer. The inflation rate is basically the rate of change expressed in percentage associated with a price index over a certain time period.
Effects of inflation
High inflationary rates can bring in harmful effects for the overall economy. Market inefficiencies rise making it tough for companies for budgeting and long term planning. Company productivity is hampered as resources are shifted away from services and products to emphasize on profit/losses arising out of currency inflation.
Future uncertainty about money’s purchasing power discourages individuals to invest and save. Inflation can result in increase of hidden tax due to the fact that inflated earnings do push a tax payer to pay higher income tax.
High inflation results in redistribution of purchasing power from fixed income groups like pensioners, to those whose earnings get better for keeping pace with inflation. In countries with fixed exchange rates, increasing inflation results in exports becoming costlier, thereby affecting the balance of trade.
Inflation also negatively impacts trade due to increasing instability of prices relating to currency exchange. Individuals buying consumer goods resort to hoarding due to no other alternatives existing for utilizing excess cash value before money gets devalued. This results in shortage of hoarded objects.
Nowadays, major mainstream economists usually prefer a condition of a low, gradual inflationary rate. Low inflation is said to lower the impact of economic recessions by allowing adjustments in the labor market to take place quickly in the period of a downturn. Secondly, the risk of a liquidity trap is also reduced. (Liquidity trap refers to a situation when a nation’s nominal interest rate is lowered to zero with a bid to tackle inflation, but the liquidity resulting from it gives no stimulation to the economy).