Meanings of Inflation

Meanings of Inflation

Whether electricity, the ticket for the tram or a small mixed bread: everything is getting more and more expensive. Reports of price increases in various areas seem to be part of everyday life. Instead of saying that everything is getting more and more expensive, one can of course also say: The money is worth less and less. This process of currency devaluation is called inflation. Economics researches which mechanisms play a role in price increases or inflation and which factors are decisive for inflation to occur.

  • Inflation manifests itself in price increases or monetary devaluations.
  • There are different doctrines in science on the complex of inflation. However, there is no generally accepted theory of inflation.
  • The consumer price index is used to measure inflation. Price developments for a selection of goods are incorporated into the index.
  • In the case of hyperinflation, the monthly inflation rate is 50 percent. They have no purely economic causes.

Causes: How does inflation occur?

According to digopaul, various factors always work together to create inflation . The fact that the money supply increases can contribute to inflation. This can happen when the central bank wants to increase liquidity in the market. But if this increases general demand, then prices increase and money loses value. This also happens when the demand for certain products increases so much that the providers cannot provide them quickly enough. If consumers cannot switch to other goods, this can lead to inflation. This is also the case when production costs increase across the board, for example due to a sharp rise in energy prices.

Shopping basket and consumer price index: a measure of the inflation rate

The Federal Statistical Office measures inflation in Germany with the help of a so-called shopping basket. The shopping cart contains various long-lived and short-lived goods (goods and services) in a certain number and selection. The development of the prices for this basket of goods results in the consumer price index, from which the annual and monthly inflation rate can be determined by comparing it with the previous year or the previous month.

Composition of the shopping cart

The shopping basket is considered to be representative of consumer spending by private households, i.e. it contains prices for clothing and food as well as prices for repairs or insurance . The domestic principle regulates that the shopping cart also includes the expenditure of tourists from abroad. The product selection is determined by representative samples: In each of 94 regions of the Federal Republic there are selected cities and municipalities. In the representative shops located there, the most frequently sold products are interesting for the shopping cart. The number of these is determined by their share in consumer spending. Over 300,000 prices are collected every month.

Perceived inflation

Which goods are included in the shopping cart and how they are weighted can be traced using the price kaleidoscope of the Federal Statistical Office. However, the method for determining the shopping basket is not undisputed. For example, the shopping cart consists of durable and short-lived goods. Of course, the average household buys short-lived goods more often than long-lived goods. If the prices for short-lived goods rise faster than for long-lived goods, the perceived inflation is significantly higher than the officially measured inflation. The difference was clearly visible when the euro was introduced at the beginning of 2002. The prices for short-lived goods rose noticeably, so that soon the talk was of the “Teuro”. However, the official inflation rate this year was below two percent and did not reflect this perception.

How do technological innovations affect inflation?

Another problem with the composition of the shopping cart is technological innovations. A typical 1965 television is difficult to compare to a 1985 or 2005 television. In order to map the increase in quality of these increasingly important products, price investigators have been using the so-called hedonic method since 2002. The models for this were the USA and Great Britain. This method tries to quantify the additional benefits of innovations. It lowers the official inflation rate, but it is not without controversy.

What is hyperinflation?

When there is hyperinflation, prices rise rapidly. A common value is an inflation rate of around 50 percent per month. In contrast to inflation, hyperinflation has no purely economic causes, but is related to upheavals that, for example, trigger a war and which in turn have a negative impact on the national economy. Capital flight, cash shortages and the loss of bonds can fuel the process of hyperinflation.

Example: German inflation 1914 to 1923

The drastic inflation in Germany after the First World War is a good example of hyperinflation. At that time, the value of money lost drastically, as the example of postage shows. For example, a letter cost 0.40 marks on January 31, 1921, a year later already 2.00 marks and on January 21, 1923 already 50 marks, at the height of the hyperinflation at that time the postage even rose into the millions. The prices of other products – such as food – have risen just as rapidly.

During an inflation, the population loses confidence in money and tries to convert it into goods as quickly as possible. However, since more money gets into circulation this way, inflation will only continue to drive.

Today: inflation rate of two percent

Even today there is a slight inflation – albeit not nearly as drastic as we know it from history books. The European Central Bank has declared an annual inflation rate of two percent to be permissible. With annual inflation of two percent, you would pay an average of 102 euros next year for what you get for 100 euros today.

Consequences of inflation: when money is worth less

So when money loses value, debts get smaller and smaller, but so do savings. If you save on a car, which costs 50,000 euros today, then in five years the 50,000 euros will probably no longer be enough. The longer you save for the future, the stronger this influence. If you save for retirement , for example , you have to take into account today that in 30 or 40 years you can buy 1000 euros less than today. You then need more money to maintain your current standard of living.