Inflation

Inflation is a continual increase in prices throughout a nation's economy. The rate of inflation is_determined by changes in the price level, an average of all prices. If some prices rise and others fall,_the price level may not change. Therefore, inflation occurs only if most major prices go up.

Inflation reduces the value--also called the purchasing power--of money. During an inflationary_period, a certain amount of money buys less than before. For example, a worker may get a salary_increase of 10 percent. If prices remain stable, the worker can buy 10 percent more goods and_services. But if prices also increase 10 percent, the worker's purchasing power has not changed. If_prices rise more than 10 percent, the worker cannot buy as much as he or she previously could.

Inflation has many causes. It may result if consumers demand more goods and services than_businesses can produce. Inflation may also occur if employers grant wage increases that exceed_gains in productivity. The employers pass most or all of the cost of the wage increase along to_consumers by charging higher prices. A government can try to control inflation by increasing taxes,_raising interest rates, decreasing the money supply, reducing government spending, and setting limits_on wages and prices. But the government's task is difficult, chiefly because it may trigger a recession_when it attempts to reduce inflation.

The opposite of inflation is deflation, a decrease in prices throughout a nation's economy. Deflation_tends to occur during periods of economic depression but may also happen at other times. For a_discussion of the economic conditions sometimes associated with deflation.

Kinds of inflation

Mild inflation occurs when the price level increases from 2 to 4 percent a year. If businesses can_pass the increases along to consumers, the economy thrives. Jobs are plentiful, and unemployment_falls. If wages rise faster than prices, workers have greater purchasing power. But mild inflation_usually lasts only a short time. Employers seek larger profits during periods of economic growth, and_unions seek higher wages. As a result, prices rise even further--and inflation increases.

Moderate inflation results when the annual rate of inflation ranges from 5 to 9 percent. During a_period of moderate inflation, prices increase more quickly than wages, and so purchasing power_declines. Most people purchase more at such times because they would rather have goods and_services than money that is declining in value. This increased demand for goods and services causes_prices to rise even further.

Severe inflation occurs when the annual rate of inflation is 10 percent or higher. This type of inflation_is also called double-digit inflation. During a period of severe inflation, prices rise much faster than_wages, and so purchasing power decreases rapidly.

When inflation is severe, debtors benefit at the expense of lenders. If prices increase during the_period of a loan, the debtor repays the debt with dollars less valuable than those that were borrowed.

In terms of purchasing power, the lender does not get back as much money as was lent.