What is inflation?

Inflation is a sustained increase in the price level for goods and services, which is accompanied by a corresponding inflation and a loss of purchasing power. Depending on the trigger, the level of the inflation rate and the awareness of the market participants, different forms of inflation can be distinguished from one another.

In this lesson we explain the basics of inflation, introduce you to the different types of inflation and explain the situation in Germany. You will then have the opportunity to consolidate your knowledge with a few exercise questions.

The term inflation comes from the Latin word inflatio, which means something like “inflate” or “swell”.

Synonyms: currency depreciation | inflation rate

Why should you know the different types of inflation?

According to bestitude, inflation is a very common phenomenon around the world, and to some extent it is even desirable. Inflation can also be a clearly visible sign of an economic crisis, which is why you should definitely deal with this topic. You will learn what effects inflation can have on economies and what reactions market participants can expect.

Understanding the process of inflation

Basically, inflation is to be understood as persistent monetary devaluation that extends over a medium to long-term period, which is particularly noticeable in the individual market participants through a continuous price increase. This means that less and less goods can be bought with one monetary unit and the purchasing power of market participants decreases. Inflation is measured using a price index. The inflation rate shows the development of this index based on its percentage change over time.

Types of inflation

Different types of inflation can be distinguished from one another, depending on how quickly the currency depreciates and whether the public notices it or not. It is noticeable that not every form of inflation is equated with an economic crisis.

Types of inflation

inflation

Open inflation

If there is open inflation, it only means that the public is aware of the development and is reacting accordingly. Every market participant can find out about the rise in the general price level and the associated data is collected regularly. In Germany, open inflation is the rule, as the Federal Statistical Office and the State Statistical Offices regularly collect, process and publish very large amounts of data.

Covert inflation

In contrast to open inflation, the individual market participants do not know that hidden inflation will lead to a price increase or inflation. Although these are available, they are not perceived as such and are not communicated either. On the one hand, this may have political reasons, but it can also be due to insufficient data collection. Consumers assume that the value of money will stagnate, which is also known as the illusion of money value. The more frequent measurements are made, the shorter the hidden inflation.

Creeping inflation

The creeping inflation is the sensational least kind of inflation. The inflation rate is comparatively low and is hardly noticed as such, which is why it is described as “creeping”. There are no uniformly established principles as to when inflation is referred to as creeping inflation.

However, inflation rates between 2% and 5% are common. However, creeping inflation should not be dismissed as harmless, as it usually continues for years or even decades. During this time, an enormous loss of value can arise, which is not even perceived as such by many market participants.

Creeping inflation can also have advantages. Debtors, who are known to include the state itself, are in a better position as a result of monetary devaluation. The European Central Bank (ECB) itself sets an inflation target between 0% and 2% in order to avoid panic buying and thus a faster rise in the inflation rate. In addition, in the event of creeping inflation, investors will be more willing to invest in order to compensate for the loss.

Galloping inflation

One speaks of galloping inflation when the inflation rate has reached 20% or more. The associated price increases are clearly noticeable and the reactions on the part of market participants are correspondingly. Consumers are increasingly panic buying and investors are trying to invest as much capital as possible in assets that are stable in value, such as raw materials, precious metals or real estate.

Hyperinflation

The increase in runaway inflation is hyperinflation. Such is spoken of when inflation rates have reached 50% or more. The speed of circulation of money is constantly increasing, since every market participant is now trying to spend his money on goods as quickly as possible. This leads to a positive feedback effect through even stronger demand and correspondingly high price increases. Ultimately, the citizens’ trust in the domestic currency is completely lost, which means that they resort to foreign currencies or scarce material goods as a substitute currency in order to supply themselves with essentials via the black market.

Demand inflation

The demand inflation is due to a rapidly growing demand for goods, resulting in a correspondingly rapid increase in prices. If demand inflation occurs, the trigger is usually to be found on the side of the producer. These are already working at the limit of capacity and can no longer increase production – at least in the short to medium term. As a result, the providers are no longer able to satisfy the entire demand for products. Instead, the prices for the corresponding products are increased, which leads to price-induced inflation.

Inflation rate and measurement of inflation

As a rule, the central banks try to keep the price level of their national economy as stable as possible. A slight inflation, which should be below 2% if possible, is definitely desirable. This inflation rate can be seen as a kind of “safety margin” to deflation. There are two approaches to measuring the current inflation rate: using the annual price changes for goods and services and using the GDP deflator.

The price changes are determined using so-called shopping baskets. This is a representative compilation of different goods and services to determine a price index (consumer price index in Germany). The GDP deflator, on the other hand, shows the price changes of all goods that are created in the respective economy.

Example: inflation rate in Germany

The inflation rate in Germany is calculated from the price increase in a product basket compiled by the Federal Statistical Office. This shopping basket is a representative collection of products and services that an average end consumer spends money on over the course of a year.

The shopping cart currently consists of products from the following categories:

  • Food and non-alcoholic beverages
  • Tobacco products and alcoholic beverages
  • Clothing and shoes
  • Housing, gas, water and fuel
  • Furniture and furnishings
  • Health and care
  • traffic
  • Messaging
  • Leisure, culture and entertainment
  • Education
  • Hotels and restaurants
  • Other goods and services

In 2019, inflation in Germany fluctuated between 2% (April) and 1.1% (December). Even within the last ten years, the value has always been between 0% and 2% and was therefore exactly within the defined framework. The last time there were larger deviations was in 2008 (2.6%), which can be seen as an effect of the economic crisis.

 

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