INFLATION

Inflation in brief

Inflation means a reduction in the value of money; in other words, a rise in general price levels. The literal meaning of the word inflation is to blow up or get bigger. If the amount of money in a country - the money supply - grows faster than production in that country, the average price will rise as a result of the increased demand for goods and services. Inflation can also be caused by higher costs being charged on to the end-user. These might be raw material costs or production costs which have risen, but could also be higher tax rates. These price rises cause the value of money to fall. You can therefore buy less with the same amount of money. But this does not need to have an immediate effect on purchasing power. Purchasing power only declines if wages rises less rapidly than prices.

Consequences of limited inflation

Governments often strive for an inflation rate of around 2 to 3 percent per year. Such low inflation is beneficial for the economy. Low inflation encourages consumers to buy goods and services. Delaying will mean that they would have to pay more for the same product. Low inflation also makes it more appealing to borrow money, since interest rates are usually also low during periods of low inflation. Maintaining low inflation is therefore an important goal for governments and central banks because of the economic benefits.

Consequences of high inflation

As indicated above, limited inflation is good for the economy. But high inflation is less beneficial. High inflation can cause the population’s confidence in their own currency and economy to decline, and it can be less appealing for foreign investors to invest in the country concerned. High inflation therefore often has a harmful effect on economic growth. If inflation gets too high, a country’s central bank will often intervene by raising its interest rates and thus discourage the creation of money.

Consequences of deflation

The opposite of inflation is deflation. With deflation the real price level falls. You can therefore buy more and more with the same amount of money as time passes. Deflation is very bad for economic growth because it is very likely that consumers will postpone their purchases because they expect to have to pay less for them in the near future. In periods of deflation governments and central banks often seek to stimulate the economy, for example by lowering interest rates.

The most important inflation figures

A wide range of inflation figures are recorded and published in most countries and regions. These include consumer prices and producer prices. These figures make it possible to monitor price developments closely. This website features the following inflation figures for a large number of countries:

·        CPI consumer prices

CPI stands for ‘consumer price index’. It is a measure of the average price that consumers spend on goods and services in a market-based ‘basket’ of goods and services. In order to calculate the CPI, the prices of a collection of goods and services need to be collected. These prices are then weighted on the basis of the share that they have of average consumer spending. The index is usually calculated annually, but in some countries it is also done quarterly. For most countries the inflation based on the CPI is viewed as the most important inflation figure for the country. The CPI can be used to adjust things like wages/salaries and pensions. 

·        HICP consumer prices

The ECB created the HICP, the Harmonised Index of Consumer Prices, in order to be able to compare consumer prices between the various EU countries. This is a consumer price index which is comparable to the CPI and which has been harmonised for the EU. The HICP is a weighted average of the price indices of the member states and is calculated for each country. The EU sets itself the goal of safeguarding price stability, which means an HICP of around 2% a year in the medium term.

Source: global-rates.com