Inflation refers to the general increase in the prices of goods and services in an economy over a certain period of time. This reduces the purchasing power of money, meaning that the same amount of money can buy fewer goods or services than before. Inflation is often measured as a percentage change in the price level compared to the previous year and is an important indicator of a country's economic stability.
Inflation is a complex phenomenon that can have various causes, such as increased demand for goods and services, higher production costs or an expansionary monetary policy. The effects of inflation are far-reaching, as it influences both the purchasing power of consumers and the planning and investments of companies. The term itself is therefore firmly anchored in the economic vocabulary and plays a central role in analyzing economic developments and shaping economic policy.
The term “inflation” is derived from the Latin word “inflare”, which means “to inflate” or “to puff up”. In the economic context, inflation describes the process of “inflating” the price level for goods and services in an economy. Originally, the term was used to describe the expansion of the money supply in circulation, which in many cases is accompanied by rising prices. Over time, however, the meaning of the term has broadened to include the general rise in prices, regardless of the underlying causes.
The inflation rate is a measure of the percentage increase in the general price level of goods and services in an economy over a given period of time, usually one year. It indicates the average rate of price increases and is an important indicator of economic stability and purchasing power in an economy.
How exactly does the inflation rate work?
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To the article on inflation rate
The development of inflation can be influenced by a variety of factors. These factors often work together and reinforce each other. Here are the most important factors that can contribute to the emergence of inflation:
| Allocation of the factor | Factor | Description |
|---|---|---|
| Demand-side factors | Increase in consumer spending | Higher demand due to increased household spending drives prices. |
| Government spending | Increased government spending, especially in times of crisis, increases demand and leads to higher prices. | |
| Low interest rates | Favorable loans promote consumption and investment, which increases demand and thus prices. | |
| Increased exports | Strong exports increase demand for domestic goods and drive up prices. | |
| Supply-side factors | Rising production costs | Higher costs for raw materials, energy or wages are often passed on to consumers. |
| Commodity price shocks | Sudden rises in commodity prices increase production costs and therefore final prices. | |
| Production bottlenecks | Disruptions in production, e.g. due to natural disasters, reduce supply and increase prices. | |
| Monetary policy factors | Monetary expansion | Excessive expansion of the money supply without corresponding economic growth leads to rising prices. |
| Quantitative easing | Central bank measures that increase the money supply can generate inflationary pressure. | |
| Exchange rate depreciation | A depreciation of the currency increases the cost of imports and thus domestic prices. | |
| Expectation-induced factors | Inflation expectations | Expectations of rising prices lead to price increases and wage demands being brought forward. |
| Wage-price spiral | Rising wages lead to higher production costs and price increases, which in turn lead to further wage demands. | |
| External factors | Global commodity prices | International commodity price fluctuations have a direct impact on domestic inflation. |
| Imported inflation | More expensive imports lead to a general rise in domestic prices. | |
| Geopolitical risks | Conflicts or tensions that disrupt trade routes or resource supplies can increase prices. | |
| Structural factors | Changing market structures | Monopolies or oligopolies can push through price increases more easily, which can lead to inflation. |
| Demographic changes | Changes in the population influence production capacities and thus price trends. | |
| Technological advances | While deflationary in the long term, technical innovations can lead to price increases in the short term. |
These factors often interact with each other and can lead to inflation in different combinations and intensities. A comprehensive understanding of these factors is crucial for the development of effective economic policy measures to combat inflation.
Inflation can have a variety of effects on the economy, society and people's daily lives. Here are the most important consequences of inflation:
These consequences illustrate how profoundly inflation can affect a country's economy and social fabric, especially if it is not controlled.
Important terms relating to inflation
| Term | Definition |
|---|---|
| Inflation | The general increase in the price level of goods and services in an economy over a period of time, resulting in a reduction in purchasing power. |
| Inflation rate | The percentage increase in the price level (measured by indices such as the CPI) over a given period of time, typically one year. |
| Consumer Price Index (CPI) | A measure that represents the average price change of a basket of goods and services consumed by households. |
| Core inflation | The rate of inflation that excludes volatile components such as food and energy prices to measure the underlying inflation trend. |
| Deflation | A decline in the general price level, which leads to an increase in purchasing power, but is often associated with economic problems such as recession. |
| Stagflation | An economic situation in which high inflation is accompanied by high unemployment and stagnating economic growth. |
| Hyperinflation | An extremely high and often out-of-control rate of inflation where prices rise very quickly and sharply, which can render the currency virtually worthless. |
| Money supply inflation | Inflation caused by an excessive increase in the money supply in an economy without a corresponding increase in the supply of goods. |
| Wage-price spiral | A vicious circle in which rising wages lead to higher production costs and thus to higher prices, which in turn leads to further wage demands. |
| Demand inflation | Inflation caused by increased demand for goods and services that exceeds supply. |
| Cost inflation | Inflation caused by rising production costs (e.g. for raw materials or wages) and passed on by companies through price increases. |
| Harmonized Index of Consumer Prices (HICP) | A measure of inflation used in the European Union to measure price changes on a comparable basis between member states. |
| Perceived inflation | The subjective perception of price increases by consumers, which often differs from the actual, measured inflation rate. |
| GDP deflator | A price index that captures the price changes of all goods and services produced in a country and is used to measure the rate of GDP inflation. |
| Imported inflation | Inflation caused by rising prices for imported goods, often due to exchange rate devaluations or global price increases. |
This table provides a compact overview of key terms relating to inflation and their meaning.
Governments and central banks have various measures at their disposal to combat inflation and maintain a stable price level. These measures can be roughly divided into monetary policy, fiscal policy and structural measures:
By using a combination of these measures, governments and central banks can curb inflation and restore price stability. However, the success of these measures depends heavily on the precise diagnosis of the causes of inflation and the effective implementation of the corresponding strategies.
Inflation can be divided into different types, depending on its causes, effects and the extent of price increases. Here are the main types of inflation:
The following diagram shows an overview of the types of inflation that exist.
Each of these types of inflation has different causes and economic consequences, which requires a differentiated approach and targeted economic policy measures.
This type of inflation occurs when the total demand for goods and services exceeds the total supply. Typical causes are
Cost-push inflation occurs when production costs rise and companies pass these costs on to consumers. This can be caused by
This form of inflation is caused by an excessive expansion of the money supply. If the central bank puts too much money into circulation without the economy growing accordingly, the price level rises. This can be caused by:
Creeping inflation describes a slow, steady increase in prices, typically in the range of 1-3% per year. This form of inflation is considered normal and often healthy for a growing economy.
Galloping inflation is a form of rapid and uncontrolled inflation in which prices rise at double-digit or even higher rates each year. This can lead to significant economic problems as purchasing power decreases sharply and uncertainty increases.
Hyperinflation is an extreme form of inflation in which prices rise dramatically in a very short period of time, often in the three-digit or higher percentage range. It is usually the result of extreme mismanagement of monetary policy, such as uncontrolled money printing. A well-known example is the hyperinflation in Germany in the 1920s.
Core inflation measures the price increase of a certain basket of goods, but without volatile components such as food and energy prices. It is often used to assess the long-term inflation trend, as it is less influenced by short-term fluctuations.
Imported inflation occurs when the prices of imported goods rise, for example due to exchange rate changes or international price shocks. This type of inflation can be particularly significant in countries that are highly dependent on imports.
Deflationary inflation describes a phase of falling inflation rates in which the price level continues to rise, but at a slower rate than before. Disinflation should not be confused with deflation (a general fall in prices).
Stagflation is an unusual combination of stagnating economic growth, high unemployment and simultaneously high inflation. This situation poses a particular challenge for economic policy, as traditional measures to combat inflation could further impair growth.
How different is hyperinflation?
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To the article on hyperinflationThis table summarizes the most important types of inflation, their description and typical causes.
| Type of inflation | Description | Causes |
|---|---|---|
| Demand inflation | Price increase due to excessive demand compared to supply. Demand inflation | Increase in consumer spending, government spending, low interest rates, rising exports. |
| Cost inflation | Price increase due to higher production costs. | Higher commodity prices, rising wages, higher taxes, imported cost increases. |
| Money supply inflation | Price increase due to excessive expansion of the money supply. | Low interest rates, government financing through money printing, quantitative easing. |
| Creeping inflation | Slow, steady price increases, typically 1-3% per year. | General economic growth, moderate increase in the money supply. |
| Galloping inflation | Rapid and uncontrolled price increases at double-digit or higher rates. | Extreme economic imbalances, excessive expansion of the money supply. |
| Hyperinflation | Extreme inflation with dramatic price increases in a very short period of time. | Uncontrolled money printing, severe economic crises. |
| Core inflation | Price increase of a basket of goods without volatile components such as food and energy. | Changes in the price level of stable goods and services, independent of short-term fluctuations. |
| Imported inflation | Price increase due to rising prices for imported goods. | Exchange rate changes, international price shocks, dependence on imports. |
| Deflationary inflation | Slowdown in the rate of inflation, in which the price level continues to rise, but at a slower rate. Deflationary inflation | Decline in demand, economic slowdown, restrictive monetary policy. |
| Stagflation | Combination of stagnating economic growth, high unemployment and high inflation. | Supply shocks, wrong economic policy, structural problems in the economy. |
To calculate inflation, the percentage change in the price level of a basket of goods over a certain period of time is often measured. The most common method of calculating inflation is to use the consumer price index (CPI).
Assuming that the CPI in the base period (year 2020) is 100 and the CPI in the comparison period (year 2021) is 105, the inflation rate is calculated as follows:
Inflation rate (%) = (105 - 100 / 100) x 100 = 5%
In this example, the inflation rate is 5%, which means that prices have risen by 5% on average.
By using this method, it is possible to calculate inflation precisely and understand how the price level has changed over time.
How exactly does the inflation rate work?
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To the article on inflation rateThe Harmonized Index of Consumer Prices (HICP) is a statistical indicator that measures price changes for a basket of goods and services consumed by the average household in a given period. This index is used within the European Union to compare inflation in the different Member States and is harmonized to ensure comparability.
The products and services included in the HICP are divided into different categories and each of these categories is given a specific weight. This weight reflects the proportion of expenditure that households spend on average on this category. The weights are updated regularly to reflect changes in household consumption habits. The exact weights may vary slightly by country and year as they are based on current household consumption expenditure.
| Main category | Typical weighting (%) | Examples of included expenses |
|---|---|---|
| Food and non-alcoholic beverages | 10-20% | Food, non-alcoholic beverages |
| Alcoholic beverages and tobacco | 2-5% | Alcoholic beverages (beer, wine), tobacco products |
| Clothing and shoes | 5-10% | Clothing and shoes for men, women, children |
| Housing, water, electricity, gas and other fuels | 20-30% | Rental costs, electricity, gas, water, other housing costs |
| Furnishings, household appliances, maintenance | 5-10% | Furniture, household appliances, household repairs |
| Health | 3-8% | Medical services, medication, preventive healthcare |
| Transportation | 10-15% | Vehicles, fuel, public transportation, vehicle maintenance |
| Communications | 2-4% | Telephone and internet services, postal charges |
| Leisure and culture | 5-10% | Leisure activities, cultural events, vacation trips, books, newspapers |
| Education | 1-3% | Tuition fees, educational services |
| Accommodation and food services | 5-8% | Expenditure on restaurants, cafés, hotels |
| Other goods and services | 3-5% | Insurance, financial services, personal care products |
The weights of the individual categories are based on household consumption expenditure, which is determined by surveys and studies, such as the Income and Expenditure Survey (EVS). These surveys provide detailed information on how much households spend on various goods and services. The weights are then set to accurately reflect the structure of consumption expenditure of an average household in a country or region.
The weights in the HICP are regularly adjusted to reflect changes in consumer behavior. For example, spending on communication technologies may have increased in recent years, while spending on other categories such as clothing may have fallen in relative terms. Such changes are reflected in the weightings in order to reflect inflation as accurately as possible.
The weighting of products in the HICP is crucial to how the inflation rate is calculated and how accurately it reflects the reality of consumers. By regularly adjusting the weightings, the HICP can better reflect current consumption trends and price developments.
When inflation occurs, many people invest in tangible assets such as real estate, gold, shares and commodities, as these tend to retain or even increase in value while the purchasing power of money decreases.
The inflation rate measures the percentage increase in the price level within a certain period of time, while the consumer price index (CPI) is a measure that represents the price level of a defined basket of goods and services at a certain point in time. The inflation rate is often calculated on the basis of changes in the CPI.
Inflation usually benefits debtors, as the real value of their debts falls, as well as owners of tangible assets such as real estate or shares, whose value often rises with inflation.
Inflation is often followed by a phase of stabilization in which monetary policy is tightened, inflation is brought under control and the economy adjusts to a new price level.
Deflation is worse than inflation because it leads to a fall in demand, which inhibits economic growth, increases unemployment and can trigger a downward spiral of falling prices and a shrinking economy.
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