essay about effects of inflation

What is inflation?

Inflation has been top of mind for many over the past few years. But how long will it persist? In June 2022, inflation in the United States jumped to 9.1 percent, reaching the highest level since February 1982. The inflation rate has since slowed in the United States , as well as in Europe , Japan , and the United Kingdom , particularly in the final months of 2023. But even though global inflation is higher than it was before the COVID-19 pandemic, when it hovered around 2 percent, it’s receding to historical levels . In fact, by late 2022, investors were predicting that long-term inflation would settle around a modest 2.5 percent. That’s a far cry from fears that long-term inflation would mimic trends of the 1970s and early 1980s—when inflation exceeded 10 percent.

Get to know and directly engage with senior McKinsey experts on inflation.

Ondrej Burkacky is a senior partner in McKinsey’s Munich office, Axel Karlsson is a senior partner in the Stockholm office, Fernando Perez is a senior partner in the Miami office, Emily Reasor is a senior partner in the Denver office, and Daniel Swan is a senior partner in the Stamford, Connecticut, office.

Inflation refers to a broad rise in the prices of goods and services across the economy over time, eroding purchasing power for both consumers and businesses. Economic theory and practice, observed for many years and across many countries, shows that long-lasting periods of inflation are caused in large part by what’s known as an easy monetary policy . In other words, when a country’s central bank sets the interest rate too low or increases money growth too rapidly, inflation goes up. As a result, your dollar (or whatever currency you use) will not go as far  today as it did yesterday. For example: in 1970, the average cup of coffee in the United States cost 25 cents; by 2019, it had climbed to $1.59. So for $5, you would have been able to buy about three cups of coffee in 2019, versus 20 cups in 1970. That’s inflation, and it isn’t limited to price spikes for any single item or service; it refers to increases in prices across a sector, such as retail or automotive—and, ultimately, a country’s economy.

How does inflation affect your daily life? You’ve probably seen high rates of inflation reflected in your bills—from groceries to utilities to even higher mortgage payments. Executives and corporate leaders have had to reckon with the effects of inflation too, figuring out how to protect margins while paying more for raw materials.

But inflation isn’t all bad. In a healthy economy, annual inflation is typically in the range of two percentage points, which is what economists consider a sign of pricing stability. When inflation is in this range, it can have positive effects: it can stimulate spending and thus spur demand and productivity when the economy is slowing down and needs a boost. But when inflation begins to surpass wage growth, it can be a warning sign of a struggling economy.

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Inflation may be declining in many markets, but there’s still uncertainty ahead: without a significant surge in productivity, Western economies may be headed for a period of sustained inflation or major economic reset , as Japan has experienced in the first decades of the 21st century.

What does seem to be changing are leaders’ attitudes. According to the 2023 year-end McKinsey Global Survey on economic conditions , respondents reported less fear about inflation as a risk to global and domestic economic growth . But this sentiment varies significantly by region: European respondents were most concerned about the effects of inflation, whereas respondents in North America offered brighter views.

What causes inflation?

Monetary policy is a critical driver of inflation over the long term. The current high rate of inflation is a result of increased money supply , high raw materials costs , labor mismatches , and supply disruptions —exacerbated by geopolitical conflict .

In general, there are two primary types, or causes, of short-term inflation:

• Demand-pull inflation occurs when the demand for goods and services in the economy exceeds the economy’s ability to produce them. For example, when demand for new cars recovered more quickly than anticipated from its sharp dip at the beginning of the COVID-19 pandemic, an intervening shortage  in the supply of semiconductors  made it hard for the automotive industry to keep up with this renewed demand. The subsequent shortage of new vehicles resulted in a spike in prices for new and used cars.
• Cost-push inflation occurs when the rising price of input goods and services increases the price of final goods and services. For example, commodity prices spiked sharply  during the pandemic as a result of radical shifts in demand, buying patterns, cost to serve, and perceived value across sectors and value chains. To offset inflation and minimize impact on financial performance, industrial companies were forced to increase prices for end consumers.

Learn more about McKinsey’s Growth, Marketing & Sales  Practice.

What are some periods in history with high inflation?

Economists frequently compare the current inflationary period with the post–World War II era , when price controls, supply problems, and extraordinary demand in the United States fueled double-digit inflation gains—peaking at 20 percent in 1947—before subsiding at the end of the decade. Consumption patterns today have been similarly distorted, and supply chains have been disrupted  by the pandemic.

The period from the mid-1960s through the early 1980s in the United States, sometimes called the “Great Inflation,” saw some of the country’s highest rates of inflation, with a peak of 14.8 percent in 1980. To combat this inflation, the Federal Reserve raised interest rates to nearly 20 percent. Some economists attribute this episode partially to monetary policy mistakes rather than to other causes, such as high oil prices. The Great Inflation signaled the need for public trust  in the Federal Reserve’s ability to lessen inflationary pressures.

Inflation isn’t solely a modern-day phenomenon, of course. One very early example of inflation comes from Roman times, from around 200 to 300 CE. Roman leaders were struggling to fund an army big enough to deal with attackers from multiple fronts. To help, they watered down  the silver in their coinage, causing the value of money to slowly fall—and inflation to pick up. This led merchants to raise their prices, causing widespread panic. In response, the emperor Diocletian issued what’s now known as the Edict on Maximum Prices, a series of price and wage controls designed to stop the rise of prices and wages (one helpful control was a maximum price for a male lion). But because the edict didn’t address the root cause of inflation—the impure silver coin—it didn’t fix the problem.

How is inflation measured?

Statistical agencies measure inflation first by determining the current value of a “basket” of various goods and services consumed by households, referred to as a price index. To calculate the rate of inflation over time, statisticians compare the value of the index over one period with that of another. Comparing one month with another gives a monthly rate of inflation, and comparing from year to year gives an annual rate of inflation.

In the United States, the Bureau of Labor Statistics publishes its Consumer Price Index (CPI), which measures the cost of items that urban consumers buy out of pocket. The CPI is broken down by region and is reported for the country as a whole. The Personal Consumption Expenditures (PCE) price index —published by the US Bureau of Economic Analysis—takes into account a broader range of consumer spending, including on healthcare. It is also weighted by data acquired through business surveys.

How does inflation affect consumers and companies differently?

Inflation affects consumers most directly, but businesses can also feel the impact:

• Consumers lose purchasing power when the prices of items they buy, such as food, utilities, and gasoline, increase. This can lead to household belt-tightening and growing pessimism about the economy .
• Companies lose purchasing power and risk seeing their margins decline , when prices increase for inputs used in production. These can include raw materials like coal and crude oil , intermediate products such as flour and steel, and finished machinery. In response, companies typically raise the prices of their products or services to offset inflation, meaning consumers absorb these price increases. The challenge for many companies is to strike the right balance between raising prices to cover input cost increases while simultaneously ensuring that they don’t raise prices so much that they suppress demand.

How can organizations respond to high inflation?

During periods of high inflation, companies typically pay more for materials , which decreases their margins. One way for companies to offset losses and maintain margins is by raising prices for consumers. However, if price increases are not executed thoughtfully, companies can damage customer relationships and depress sales —ultimately eroding the profits they were trying to protect.

When done successfully, recovering the cost of inflation for a given product can strengthen relationships and overall margins. There are five steps companies can take to ADAPT  (adjust, develop, accelerate, plan, and track) to inflation:

• Adjust discounting and promotions and maximize nonprice levers. This can include lengthening production schedules or adding surcharges and delivery fees for rush or low-volume orders.
• Develop the art and science of price change. Instead of making across-the-board price changes, tailor pricing actions to account for inflation exposure, customer willingness to pay, and product attributes.
• Accelerate decision making tenfold. Establish an “inflation council” that includes dedicated cross-functional, inflation-focused decision makers who can act quickly and nimbly on customer feedback.
• Plan options beyond pricing to reduce costs. Use “value engineering” to reimagine a portfolio and provide cost-reducing alternatives to price increases.
• Track execution relentlessly. Create a central supporting team to address revenue leakage and to manage performance rigorously. Traditional performance metrics can be less reliable when inflation is high .

Beyond pricing, a variety of commercial and technical levers can help companies deal with price increases in an inflationary market , but other sectors may require a more tailored response to pricing.

Learn more about our Financial Services , Industrials & Electronics , Operations , Strategy & Corporate Finance , and  Growth, Marketing & Sales Practices.

How can CEOs help protect their organizations against uncertainty during periods of high inflation?

In today’s uncertain environment, in which organizations have a much wider range of stakeholders, leaders must think about performance beyond short-term profitability. CEOs should lead with the complete business cycle and their complete slate of stakeholders in mind.

CEOs need an inflation management playbook , just as central bankers do. Here are some important areas to keep in mind while scripting it:

• Design. Leaders should motivate their organizations to raise the profile of design  to a C-suite topic. Design choices for products and services are critical for responding to price volatility, scarcity of components, and higher production and servicing costs.
• Supply chain. The most difficult task for CEOs may be convincing investors to accept supply chain resiliency as the new table stakes. Given geopolitical and economic realities, supply chain resiliency has become a crucial goal for supply chain leaders, alongside cost optimization.
• Procurement. CEOs who empower their procurement  organizations can raise the bar on value-creating contributions. Procurement leaders have told us time and again that the current market environment is the toughest they’ve experienced in decades. CEOs are beginning to recognize that purchasing leaders can be strategic partners by expanding their focus beyond cost cutting to value creation.
• Feedback. A CEO can take a lead role in playing back the feedback the organization is hearing. In today’s tight labor market, CEOs should guide their companies to take a new approach to talent, focusing on compensation, cultural factors, and psychological safety .
• Pricing. Forging new pricing relationships with customers will test CEOs in their role as the “ultimate integrator.” Repricing during inflationary times is typically unpleasant for companies and customers alike. With setting new prices, CEOs have the opportunity to forge deeper relationships with customers, by turning to promotions, personalization , and refreshed communications around value.
• Agility. CEOs can strive to achieve a focus based more on strategic action and less on firefighting. Managing the implications of inflation calls for a cross-functional, disciplined, and agile response.

A practical example: How is inflation affecting the US healthcare industry?

Consumer prices for healthcare have rarely risen faster than the rate of inflation—but that’s what’s happening today. The impact of inflation on the broader economy has caused healthcare costs to rise faster than the rate of inflation. Experts also expect continued labor shortages in healthcare—gaps of up to 450,000 registered nurses and 80,000 doctors —even as demand for services continues to rise. This drives up consumer prices and means that higher inflation could persist. McKinsey analysis as of 2022 predicted that the annual US health expenditure is likely to be $370 billion higher by 2027 because of inflation.

This climate of risk could spur healthcare leaders to address productivity, using tech levers to boost productivity while also reducing costs. In order to weather the storm, leaders will need to quickly set high aspirations, align their organizations around them, and execute with speed .

What is deflation?

If inflation is one extreme of the pricing spectrum, deflation is the other. Deflation occurs when the overall level of prices in an economy declines and the purchasing power of currency increases. It can be driven by growth in productivity and the abundance of goods and services, by a decrease in demand, or by a decline in the supply of money and credit.

Generally, moderate deflation positively affects consumers’ pocketbooks, as they can purchase more with less money. However, deflation can be a sign of a weakening economy, leading to recessions and depressions. While inflation reduces purchasing power, it also reduces the value of debt. During a period of deflation, on the other hand, debt becomes more expensive. And for consumers, investments such as stocks, corporate bonds, and real estate become riskier.

A recent period of deflation in the United States was the Great Recession, between 2007 and 2008. In December 2008, more than half of executives surveyed by McKinsey  expected deflation in their countries, and 44 percent expected to decrease the size of their workforces.

When taken to their extremes, both inflation and deflation can have significant negative effects on consumers, businesses, and investors.

For more in-depth exploration of these topics, see McKinsey’s Operations Insights  collection. Learn more about Operations consulting , and check out operations-related job opportunities  if you’re interested in working at McKinsey.

Articles referenced:

• “ Investing in productivity growth ,” March 27, 2024, Jan Mischke , Chris Bradley , Marc Canal, Olivia White , Sven Smit , and Denitsa Georgieva
• “ Economic conditions outlook during turbulent times, December 2023 ,” December 20, 2023
• “ Forward Thinking on why we ignore inflation—from ancient times to the present—at our peril with Stephen King ,” November 1, 2023
• “ Procurement 2023: Ten CPO actions to defy the toughest challenges ,” March 6, 2023, Roman Belotserkovskiy , Carolina Mazuera, Marta Mussacaleca , Marc Sommerer, and Jan Vandaele
• “ Why you can’t tread water when inflation is persistently high ,” February 2, 2023, Marc Goedhart and Rosen Kotsev
• “ Markets versus textbooks: Calculating today’s cost of equity ,” January 24, 2023, Vartika Gupta, David Kohn, Tim Koller , and Werner Rehm  
• “ Inflation-weary Americans are increasingly pessimistic about the economy ,” December 13, 2022, Gonzalo Charro, Andre Dua , Kweilin Ellingrud , Ryan Luby, and Sarah Pemberton
• “ Inflation fighter and value creator: Procurement’s best-kept secret ,” October 31, 2022, Roman Belotserkovskiy , Ezra Greenberg , Daphne Luchtenberg, and Marta Mussacaleca
• “ Prime Numbers: Rethink performance metrics when inflation is high ,” October 28, 2022, Vartika Gupta, David Kohn, Tim Koller , and Werner Rehm
• “ The gathering storm: The threat to employee healthcare benefits ,” October 20, 2022, Aditya Gupta , Akshay Kapur , Monisha Machado-Pereira , and Shubham Singhal
• “ Utility procurement: Ready to meet new market challenges ,” October 7, 2022, Roman Belotserkovskiy , Abhay Prasanna, and Anton Stetsenko
• “ The gathering storm: The transformative impact of inflation on the healthcare sector ,” September 19, 2022, Addie Fleron, Aneesh Krishna , and Shubham Singhal
• “ Pricing during inflation: Active management can preserve sustainable value ,” August 19, 2022, Niels Adler and Nicolas Magnette
• “ Navigating inflation: A new playbook for CEOs ,” April 14, 2022, Asutosh Padhi , Sven Smit , Ezra Greenberg , and Roman Belotserkovskiy
• “ How business operations can respond to price increases: A CEO guide ,” March 11, 2022, Andreas Behrendt ,  Axel Karlsson , Tarek Kasah, and  Daniel Swan
• “ Five ways to ADAPT pricing to inflation ,” February 25, 2022,  Alex Abdelnour , Eric Bykowsky, Jesse Nading,  Emily Reasor , and Ankit Sood
• “ How COVID-19 is reshaping supply chains ,” November 23, 2021,  Knut Alicke ,  Ed Barriball , and Vera Trautwein
• “ Navigating the labor mismatch in US logistics and supply chains ,” December 10, 2021,  Dilip Bhattacharjee , Felipe Bustamante, Andrew Curley, and  Fernando Perez
• “ Coping with the auto-semiconductor shortage: Strategies for success ,” May 27, 2021,  Ondrej Burkacky , Stephanie Lingemann, and Klaus Pototzky

This article was updated in April 2024; it was originally published in August 2022.

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• Personal Finance

Why Is Inflation Bad? 3 Effects Of Inflation

Updated: Jul 29, 2022, 3:57pm

The latest inflation report piled bad news atop of bad news. The June Consumer Price Index (CPI), which the Bureau of Labor Statistics uses to track price changes for 80,000 goods and services, indicated that prices rose 9.1% over the past year.

The report continues a trend of high inflation that started last year. In 2020, the annual rate of inflation was 1.2%. In 2021, it was 4.7%.

But what does this continued high inflation mean? And does anyone actually benefit from high prices?

What Is Inflation?

Simply put, inflation is an economic term used to describe rising prices.

Inflation occurs when people spend more on the same amount of goods and services than they were, say, a year ago.

When everybody pays more and gets less for it, it can have some profoundly devastating effects on the economy—and some people get hurt more than others.

“In every economic environment, there are winners and losers and inflation is no exception.  However, the longer high inflation persists, the harder it is to find winners,” says Jeanette Garretty, chief economist at Robertson Stephens, a wealth management firm based in San Francisco. “Ultimately, high inflation seeps into the nooks and crannies of every balance sheet and income statement.”

Here are some reasons inflation can be so devastating to everybody’s bank accounts.

3 Ways Inflation Hurts Consumers and the Economy

1. less purchasing power.

The most obvious impact of inflation is that it hurts your purchasing power. If you can’t buy as many goods and services as you did before inflation, your quality of living will eventually diminish.

“Essentials will take precedence over non-essentials as everyone tries to stretch the purchase side of their budget,” says Angelo DeCandia, a professor of business at Touro University. “Think more money spent on groceries and gasoline, and less spent on travel and entertainment.”

Less purchasing power really hurts families that were already experiencing financial hardship , says Dan North, senior economist at trade credit insurer Allianz Trade.

“Inflation hits the lowest-income families harder because items such as gasoline and food make up a much larger portion of their budgets, leaving less for discretionary spending,” North says. “So, for example, where they used to have money to go out to dinner, even fast food, or [go to the] the movies once a month, now they won’t at all.”

And if you’re already stretching your budget to the limit, it’s harder to make adjustments to reduce your costs. For instance, if you’re already using the cheapest toilet paper or paper towels on the shelf, you can’t trade down.

In fact, a 2021 study from the University of Pennsylvania found that lower-income households had to spend about 7% more on goods and services last year compared to 2019 or 2020, while higher-income households had to spend 6% more. Remember, the annual rate of inflation for 2021 was 4.7%.

2. Less Savings

If rising prices for essentials is eating into your budget more than normal, you probably aren’t putting as much money into a savings account. A June 2022 Forbes Advisor-Ipsos survey found that 42% of respondents were saving less money than usual .

“Inflation makes all of our income and savings less valuable,” says Todd Steen, professor of economics at Hope College in Holland, Michigan.

If you’re not able to save as much as you used to, you may be less prepared for financial emergencies, forcing you to rely on costly credit cards or loans to pay unexpected bills.

And even if you have money in savings already, that decreased purchasing power means your emergency fund might not stretch enough to cover a financial crisis during an inflationary period.

If you have $1,000 socked away for a rainy day, you’re certainly better off than not having it. But here’s an example of how inflation can eat at the value of your savings.

Car repair prices went up 9% from June 2021 to June 2022 according to the CPI . If you had a $900 car repair in June 2021, in June 2022, that same car repair would have been $981. Suddenly your $1,000 saved up is a little less valuable.

And this trend may continue for a while, according to Steen.

“Inflation is a difficult problem to get rid of in an economy, because when prices increase, workers want to have higher wages and salaries to keep up,” he says. “This can lead to future price increases, and the cycle continues.”

3. Loss of Goods and Services

Some industries do pretty well during inflationary times, particularly ones in which you can’t hold off your spending indefinitely, like supermarkets, gas stations and funerals—but some businesses are completely devastated.

That’s because when inflation runs rampant, consumers spend their money on products and services that they absolutely need, and hold back on what they don’t.

You’re going to get your car repaired if you need it. You’ll keep spending money on food.

But you might not take your kids to a trampoline park. You might instead opt for a free city playground with the youngsters, instead. Decisions like that are understandable when prices are high but collectively, they can damage segments of the economy.

“That could mean your favorite pizza place closes, or your nail salon drops a service because it’s become too costly,” says Callie Cox, an investment analyst at eToro, social investment and multi-asset brokerage company with 10 offices worldwide.

Does Inflation Eventually Go Down?

Yes, inflation will eventually decrease.

Economists want inflation to stabilize, so that prices either level off or creep up gradually over time.

If prices go down enough, where inflation goes below 0%, that’s called deflation. Deflation comes with its own slate of negative effects—when customers aren’t buying products or services, business owners may lower prices to be more competitive, but they may also need to lay off workers.

Deflation can lead to a recession , which takes place when the economy shrinks instead of grows.

Read more: Is The U.S. Economy Heading For Stagflation?  

Deflation can also contribute to a depression—which is more severe than a recession—as it did during the Great Depression. For one example, consider that between 1929 and 1932, real estate prices in New York City dropped by 67% .

Plunging prices sound great in theory,  but if you’re out of a job and barely have any money, even cheap stuff is going to be too expensive.

The U.S. central bank, the Federal Reserve, never wants inflation to drop too much – or climb too much. The sweet spot is considered to be a rate of 2% annual rate of inflation , which allows households and businesses to keep spending (and saving) as prices go up bit by bit over time.

If inflation is higher than 2%, the Fed generally will raise the federal funds rates (which leads to increased interest rates) to try to slow the economy’s growth and lower inflation. If inflation is under 2%, it will often lower interest rates, to get consumers excited about borrowing money (say, to purchase a new car or home), which tends to keep the economy humming along.

What’s Next For Inflation in the U.S.?

It’s hard to say what’s next. The Federal Reserve has already raised rates several times this year and is expected to do so until the fed funds rate reaches 3.5% . This is expected to push prices downward, but it comes with some risk of entering a recession. A recent Reuters poll of economists determined that the country has a 40% chance of going into a recession .

If inflation continues to run amok, DeCandia says that educational and career choices could start to shift.

“We’ve all heard the story of how Grandpa had to drop out of school to help support the family,” he says. “Could that become a new reality with sustained inflation? Even if it were to be less dramatic, the impact of higher inflation could change the course of education for younger people in several ways.”

“In some cases, it may even eliminate grad school dreams,” DeCandia says.

DeCandia also says some people may be more likely to choose the job with the highest salary and put some of the other extras—like personal fulfillment in your career —aside.

If consumers change their education or career plans in order to survive high inflation, it could be to the detriment of their long-term financial health.

If people are struggling to save for an extended period of time, it may make it harder to plan to buy a house, save for vacations or send kids to college, says DeCandia.

“For some people, the whole idea of owning a home may have to be moved to the back burner,” he says.

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Geoff Williams is a Loveland, Ohio-based writer specializing in personal finance and small business issues. He has been freelancing for 30 years, writing for numerous publications including The Wall Street Journal, U.S. News & World Report, CNNMoney.com, Reuters and many more. He also is the author of several books and has a popular culture blog called "The TV Professor" (thetvprofessor.com).

What is inflation, and why has it been so high?

Subscribe to election ’24, ben harris ben harris vice president and director - economic studies , director - retirement security project @econ_harris.

April 3, 2024

Transcript:

Inflation, the change in price of goods and services over time, is often confused with the cost of things.  

Inflation is not about how much things cost, but rather how prices are changing in a given month or year.   

There’s no single culprit.   Early in the pandemic, there were fewer workers and disruptions in the availability of goods due to snarled shipping routes and shuttered childcare centers, among other factors.  

At the same time, demand for some products soared: pandemic-era stimulus programs left shoppers with extra cash to spend, and everyone wanted to buy the same types of things.

More recently, inflation has been driven mostly by the cost of buying or renting a home. This is due to entirely different reasons, mainly that new homebuilding has been slow and older Americans are not moving out of their homes as frequently.

Inflation has slowed since its peak, but that only means prices aren’t rising as quickly as before. The chance that prices actually fall are very slim, although we have seen price declines in products likes eggs and used cars.

Still, the U.S. has made great progress. Reining in inflation has not led to a recession and widespread job loss.  

Cooling inflation, while keeping unemployment at historically low levels, has been the ideal scenario, or what economists like to call a “soft landing.” 

The Fed has targeted an average inflation rate of 2% and will use the tools necessary to get the economy to that place. It’s less a question of “if” inflation will reach this level, and more a question of “when” and how much economic pain it will take.  

Right now it seems like the answer appears to be “soon” and “not too much.”   

The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online  here . The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.

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What Causes Inflation? 

• Walter Frick

Why your money is worth less than it used to be.

What causes inflation? There is no one answer, but like so much of macroeconomics it comes down to a mix of output, money, and expectations. Supply shocks can lower an economy’s potential output, driving up prices. An increase in the money supply can stoke demand, driving up prices. And the expectation of inflation can become a self-fulfilling cycle as workers and companies demand higher wages and set higher prices.

Since the financial crisis of 2008 and the Great Recession, investors and executives have grown accustomed to a world of low interest rates and low inflation. No longer. In 2021, inflation began rising sharply in many parts of the world, and in 2022 the U.S. saw its worst inflation in decades.

• Walter Frick is a contributing editor at Harvard Business Review , where he was formerly a senior editor and deputy editor of HBR.org. He is the founder of Nonrival , a newsletter where readers make crowdsourced predictions about economics and business. He has been an executive editor at Quartz as well as a Knight Visiting Fellow at Harvard’s Nieman Foundation for Journalism and an Assembly Fellow at Harvard’s Berkman Klein Center for Internet & Society. He has also written for The Atlantic , MIT Technology Review , The Boston Globe , and the BBC, among other publications.

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Economic essays on inflation

• Definition – Inflation – Inflation is a sustained rise in the cost of living and average price level.
• Causes Inflation – Inflation is caused by excess demand in the economy, a rise in costs of production, rapid growth in the money supply.

• Costs of Inflation – Inflation causes decline in value of savings, uncertainty, confusion and can lead to lower investment.

• Problems measuring inflation – why it can be hard to measure inflation with changing goods.
• Different types of inflation – cost-push inflation, demand-pull inflation, wage-price spiral,
• How to solve inflation . Policies to reduce inflation, including monetary policy, fiscal policy and supply-side policies.
• Trade off between inflation and unemployment . Is there a trade-off between the two, as Phillips Curve suggests?
• The relationship between inflation and the exchange rate – Why high inflation can lead to a depreciation in the exchange rate.
• What should the inflation target be? – Why do government typically target inflation of 2%
• Deflation – why falling prices can lead to negative economic growth.
• Monetarist Theory – Monetarist theory of inflation emphasises the role of the money supply.
• Criticisms of Monetarism – A look at whether the monetarist theory holds up to real-world scenarios.
• Money Supply   – What the money supply is.
• Can we have economic growth without inflation?
• Predicting inflation
• Link between inflation and interest rates
• Should low inflation be the primary macroeconomic objective?

See also notes on Unemployment

Home — Essay Samples — Economics — Political Economy — Inflation

Essays on Inflation

Inflation essay topics and outline examples, essay title 1: understanding inflation: causes, effects, and economic policy responses.

Thesis Statement: This essay provides a comprehensive analysis of inflation, exploring its root causes, the economic and societal effects it generates, and the various policy measures employed by governments and central banks to manage and mitigate inflationary pressures.

• Introduction
• Defining Inflation: Concept and Measurement
• Causes of Inflation: Demand-Pull, Cost-Push, and Monetary Factors
• Effects of Inflation on Individuals, Businesses, and the Economy
• Inflationary Policies: Central Bank Actions and Government Interventions
• Case Studies: Historical Inflationary Periods and Their Consequences
• Challenges in Inflation Management: Balancing Growth and Price Stability

Essay Title 2: Inflation and Its Impact on Consumer Purchasing Power: A Closer Look at the Cost of Living

Thesis Statement: This essay focuses on the effects of inflation on consumer purchasing power, analyzing how rising prices affect the cost of living, household budgets, and the strategies individuals employ to cope with inflation-induced challenges.

• Inflation's Impact on Prices: Understanding the Cost of Living Index
• Consumer Behavior and Inflation: Adjustments in Spending Patterns
• Income Inequality and Inflation: Examining Disparities in Financial Resilience
• Financial Planning Strategies: Savings, Investments, and Inflation Hedges
• Government Interventions: Indexation, Wage Controls, and Social Programs
• The Global Perspective: Inflation in Different Economies and Regions

Essay Title 3: Hyperinflation and Economic Crises: Case Studies and Lessons from History

Thesis Statement: This essay explores hyperinflation as an extreme form of inflation, examines historical case studies of hyperinflationary crises, and draws lessons on the devastating economic and social consequences that result from unchecked inflationary pressures.

• Defining Hyperinflation: Thresholds and Characteristics
• Case Study 1: Weimar Republic (Germany) and the Hyperinflation of 1923
• Case Study 2: Zimbabwe's Hyperinflationary Collapse in the Late 2000s
• Impact on Society: Currency Devaluation, Poverty, and Social Unrest
• Responses and Recovery: Stabilizing Currencies and Rebuilding Economies
• Preventative Measures: Policies to Avoid Hyperinflationary Crises

Report on Inflation and Its Causes

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• Inflation and Cost of Living

When the Going Gets Expensive

• How Inflation Affects Housing

The Bottom Line

How inflation affects your cost of living.

• What Is Inflation: How it Works & Examples
• 9 Common Effects of Inflation
• How to Profit From Inflation
• When Is Inflation Good for the Economy?
• How Does Current Cost of Living Compare to 20 Years Ago?
• Why Are P/E Ratios Higher When Inflation Is Low?
• What Causes Inflation and Who Profits From It?
• Understand the Different Types of Inflation
• Wage Push Inflation
• Cost-Push Inflation
• Cost-Push Inflation vs. Demand-Pull Inflation: What's the Difference?
• Inflation vs. Stagflation: What's the difference?
• What is the Relationship Between Inflation and Interest Rates?
• Inflation's Impact on Stock Returns
• How Does Inflation Affect Fixed-Income Investments?
• How Inflation Affects Your Cost of Living CURRENT ARTICLE
• How Inflation Impacts Your Savings
• How Inflation Eats Away at Your Retirement Income
• What Impact Does Inflation Have on the Dollar Value Today?
• Inflation and Economic Recovery
• Hyperinflation
• Why Didn't Quantitative Easing Lead to Hyperinflation?
• Worst Cases of Hyperinflation in History
• How the Great Inflation of the 1970s Happened
• Stagflation
• Purchasing Power
• Consumer Price Index (CPI)
• Why Is the Consumer Price Index Controversial?
• Core Inflation
• Headline Inflation
• GDP Price Deflator
• Inflation Accounting
• Inflation-Adjusted Return
• Inflation Targeting
• Real Economic Growth Rate
• Real Gross Domestic Product (GDP)
• Real Income
• Real Interest Rate
• Real Rate of Return
• Wage-Price Spiral

Up until very recently, inflation wasn't talked about much, and for good reason. In 2019, the overall annual rate of inflation in the U.S. was running at 1.8% according to the World Bank (CPI). In 2020, the rate was 1.2%.

In the summer of 2021, however, inflation began to rear its ugly head once again, with U.S. consumer prices recording their largest annualized increases in more than 13 years. From there, inflation continued to surge. Overall inflation in 2021 was 4.7% and it reached a peak of 9.1% in June 2022.

Since then, the inflation rate has gradually come down but it still remains high. For the 12 months that ended in September 2023, the annualized inflation rate in the U.S. stood at 3.7%.

Still, we've been through worse inflationary times. There's talk about inflation and cost of living increases, but what do these terms really mean? And most important, how do they affect your daily life?

Key Takeaways

• Inflation measures the increase in the price of goods and services. Or, the decrease in the buying power of the dollar.
• Cost of living measures the change in price, up or down, of the basic necessities of life like food, housing, and healthcare.
• Housing prices are affected by many factors but one of the biggest of them is the cost of borrowing.

Investopedia / Ellen Lindner

The Difference Between Inflation and Cost of Living

People often use the phrases inflation and cost of living as if they were synonymous. They are not, although they're closely related.

• Inflation is the big picture. As the cost of goods and services rises, the buying power of the dollar falls. The inflation rate is often measured by the change in the Consumer Price Index (CPI), a monthly measure by the Bureau of Labor Statistics (BLS) that averages the cost of a standard basket of goods and services from areas around the country. It reports the result as a percentage rise or drop in CPI.
• Cost of living has a different focus. This number represents the average cost of an accepted standard of living including food, housing, transportation, taxes, and healthcare. The figure for the cost of living is frequently used to compare the minimum income needed to live in various locations. According to Payscale's calculator, as of Oct. 14, 2023, the cost of living in New York City is 128% higher than the national average. As a comparison, the cost of living in Chapel Hill, North Carolina is 2% higher than the national average.

Cost of living is a far more difficult number to pin down than inflation. It varies widely not only by region but by demographic group. Whether your own cost of living goes up or down depends on how you live and where you live .

The amount that Social Security recipients receive is adjusted annually based on the cost of living. The increase for 2023 was 8.7%. The increase for 2024 is 3.2%.

Most people feel the effects of cost-of-living increases in their daily lives. But rising prices hit the middle class hard, and the lower-paid harder.

Higher food, gasoline, and utility costs mean less money for savings and less for discretionary spending. To compensate, consumers buy less, switch to cheaper substitutes, look harder for bargains, or put off major purchases.

The annualized inflation rate in the U.S. for the 12 months ending September 2023.

The Paycheck Factor

An increase in the cost of living is irrelevant only if your paycheck is growing at a similar rate. After a painful lag, the paychecks of full-time workers appear to be catching up with the rate of inflation, and even surpassing it a bit.

According to the Bureau of Labor Statistics, the median weekly earnings for full-time wage earners was $1,118 in the third quarter of 2023. That's an increase of 4.5% from a year earlier compared to the 3.5% increase in the Consumer Price Index for All Urban Consumers (CPI-U) for the same period.

How Inflation Affects the Housing Market

You would assume that higher inflation means higher prices for real estate, and that is often the case, at least at the start of a significant spike in inflation. But then things can get complicated.

To keep inflation rates under control, the Federal Open Market Committee (FOMC) often steps in and raises the federal funds rate , which is the interest rate charged to banks that use the Federal Reserve Bank as a source of short-term loans. This has a domino effect on every other loan rate, including the rates for home mortgages.

As the cost of home loans goes up, many consumers are squeezed out of the market, leading to a slowdown in home sales. With homes on the market for longer periods, sellers drop their asking price to attract buyers. 

Lower interest rates helped the U.S. housing market make its recovery after the gut punch of the 2007-2008 financial crisis and then again during the COVID-19 pandemic. Higher interest rates have the opposite effect, reducing demand for loans in order to cool down inflation.

What Is the Relationship Between Inflation and the Cost of Living?

Inflation is the increase in the average price of a basket of goods. It reduces the purchasing power of consumers, meaning that a unit of currency buys less than it did before inflation.

The cost of living measures the average cost of the accepted standard of living in a specific area.

Inflation increases the cost of living.

What Are the 3 Causes of Inflation?

The three causes of inflation are demand-pull (when the demand for goods and services is greater than the supply, putting upward pressure on prices), cost-push (when the total supply of goods and services that can be produced falls), and built-in inflation, also known as inflation expectations.

That last factor is the pressure on wages that is created when workers believe that inflation will continue and demand higher wages to maintain their cost of living. Higher wages mean higher costs, which are passed onto consumers as price increases.

Why Has Inflation Been Slowing?

In 2023, inflation slowed while not disappearing altogether. The most obvious reason is a series of interest rate increases imposed by the Federal Reserve as a deliberate tactic to defeat inflation.

However, that is not the only reason. Another big factor is the normalization of the global economy after the disruption caused by the COVID-19 pandemic. Supply chain disruptions caused delivery delays and shortages around the world. Production shutdowns and labor shortages added to the disruption. Costs rose throughout 2021 and rose more in 2022.

Inflation and cost of living are related metrics but not identical. While inflation measures the average increase in prices of a basket of goods, cost of living looks at the expense of a certain standard of living, which can change by location.

Increases in inflation increase the overall cost of living and if wages are not increasing to match the increase in the cost of goods and services, the value of a consumer's dollar will decrease.

The World Bank. " Inflation, Consumer Prices (Annual %) - United States ."

U.S. Bureau of Labor Statistics. " Consumer Price Index-June 2021 ," Page 1.

U.S. Bureau of Labor Statistics. " Consumer Prices Up 9.1 Percent Over the Year Ended June 2022, Largest Increase in 40 Years ."

U.S. Bureau of Labor Statistics. " Consumer Price Index – September 2023 ," Page 1.

U.S. Bureau of Labor Statistics. " Consumer Price Index: Home ."

U.S. Bureau of Labor Statistics. " Consumer Price Index Frequently Asked Questions ," Select "What goods and services does the CPI cover?"

Payscale. " Cost of Living Chapel Hill, North Carolina ."

Payscale. " Cost of Living in New York, New York ."

Congressional Research Service. " Introduction to U.S. Economy: Inflation ," Pages 1-2.

U.S. Bureau of Labor Statistics. " Usual Weekly Earnings of Wage and Salary Workers Third Quarter 2023 ," Page 1.

Board of Governors of the Federal Reserve System. " About the FOMC ."

Board of Governors of the Federal Reserve System. " FAQs: What Is Inflation and How Does the Federal Reserve Evaluate Changes in the Rate of Inflation? "

Federal Reserve Bank of St. Louis, FRED. " Federal Funds Effective Rate ."

World Economic Forum. " An Expert Explains: How COVID-19 Exposed the Fragility of Global Supply Chains ."

U.S. Bureau of Labor Statistics. " Consumer Price Index: 2022 in Review ."

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AP®︎/College Macroeconomics

Course: ap®︎/college macroeconomics   >   unit 2.

• Winners and losers from inflation and deflation

Lesson summary: The costs of inflation

• The costs of inflation

Lesson overview

Key takeaways

The redistribution effect of inflation.

• Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out.
• Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed. Can you walk me through that? For example, suppose Jerry borrows $ 10 ‍   from Michonne and promises to pay her back $ 11 ‍   next year. This year $ 1 ‍   can buy one can of tuna, so in Jerry’s mind, he is promising to pay back 11 ‍   cans of tuna next year in exchange for the ability to buy 10 ‍   cans this year. Suppose over the course of that year there is inflation and the price of tuna doubles. This means that Jerry is paying back the value of only 5.5 ‍   cans of tuna, so he benefits from this inflation. Michonne, on the other hand, is hurt because she thought she was getting more cans of tuna in exchange for her loan.

The redistribution effects of disinflation and deflation

Common misperceptions.

• A common misperception is that inflation is bad for everyone (who likes more expensive stuff?). But this is not the case. Inflation reduces the value of money. Because of that, people who have borrowed money benefit from a higher inflation rate when they pay the money back. The interest rate that a borrower pays is effectively lower thanks to inflation.
• Another common misperception is that disinflation and deflation are good for everyone (who doesn't enjoy cheaper stuff?). The problem is, deflation increases the purchasing power of money. People who have borrowed money are paying back that loan with money that is effectively worth more than the money they borrowed. Deflation effectively increases the interest rate that a borrower pays.
• A very common misperception is that inflation should always be avoided. Deflation has such a destructive impact on an economy that most policymakers agree that avoiding deflation is a far more important objective. As a result, the goal of policymakers is not zero inflation, but small and predictable inflation rates.

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Essay on Inflation: Meaning, Measurement and Causes

Let us make in-depth study of the meaning, measurement and causes of inflation.

Meaning of Inflation:

By inflation we mean a general rise in prices. To be more correct, inflation is a persistent rise in general price level rather than a once-for-all rise in it.

Rate of inflation is either measured by the percentage change in wholesale price index number (WPI) over a period or by percentage change in consumer price index number (CPI).

Opinion surveys conducted in India and the United States reveal that inflation is the most important concern of the people as it affects their standard of living adversely A high rate of inflation erodes the real incomes of the people. A high rate of infla­tion makes the life of the poor people miserable. It is therefore described as anti-poor, inflation redistributes income and wealth in favour of the rich.

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Thus, it makes the rich richer and the poor poorer. Above all, a high rate inflation adversely effects output and encourages investment in unproductive channels such as purchase of gold, silver, jewellery and real estate. Therefore, it adversely affects long-run economic growth, especially in developing countries like India. Inflation has therefore been described ‘as enemy number one’.

Measurement of Rate of Inflation:

Inflation has been one of the important problems facing the economies of the world. Precisely stated, inflation is the rate of change of general price level during a period of time. And the general price level in a period is the result of inflation in the past. Through rate of inflation economists measures the cost of living in an economy. Let us explain how rate of inflation is measured. Suppose P i X represents the price level on 31st March 2006 and P represents the price level on 31st March 2007. Then the rate of inflation in year 2006-07 will be equal to

Thus, rate of inflation during 2006-07 will be 10 per cent. This is called point-to-point inflation rate. There are 52 weeks in a year, average of price indexes of 52 weeks of a year (say 2005-06) can be calculated to compare the average of price indexes of 52 weeks of year 2006-07 and find the inflation rate on the basis of average weekly price levels of a year. In both these ways rate of inflation in different years is measured and compared.

It is evident from above that price level in a period is measured by a price index. There are several commodities in an economy which are produced and consumed by the people. It is through construction of a weighted price index that economists aggregate money prices of several commodi­ties which are assigned different weights.

In India the wholesale price Index (WPI) of all commodities with base year 1993-94 price level at the end of fiscal year is used to measure rate of inflation and is widely reported in the media. Since the wholesale price index does not truly indicate the cost of living, separate Consumer Price Index (CPI) for agricultural labourers and Consumer Price Index (CPI) for industrial workers (with base 1982 = 100) at the end of fiscal year are constructed to measure rate of inflation.

In constructing the Consumer Price Index (CPI) the price of a basket of goods which a typical consumer, industrial worker or agricultural labourer as the case may be are taken into account.

What Causes Inflation?

1. keynes’s view:.

Classical economists thought that it was the quantity of money in the economy that determined the general price level in the economy. According to them, rate of inflation depends on the growth of money supply in the economy. Keynes criticized the ‘ Quantity Theory of Money’ and showed that expansion in money supply did not always lead to inflation or rise in price level.

Keynes who before the Second World War explained that involuntary unemployment and depression were due to the deficiency of aggregate demand, during the war period when price rose very high he explained that inflation was due to excessive aggregate demand. Thus, Keynes put forward what is now called demand-pull theory of inflation.

Demand – Pull Inflation

Thus, according to Keynes, inflation is caused by a situation whereby the pressure of aggregate demand for goods and services exceeds the available supply of output (both begging counted at the prices ruling at the beginning of a period). In such a situ­ation, rise in price level is the natural consequence.

Now, this imbalance between aggregate demand and supply may be the result of more than one force at work. As we know aggregate demand is the sum of consumers’ spending on consumer goods and services, government spending on consumer goods and services and net investment being planned by the entrepreneurs.

But excess of aggregate demand over aggregate supply does not explain persistent rise in prices, year after year. An important factor which feeds inflation is wage-price spiral. Wage-price spiral operates as follows: A rise in prices reduces the real consumption of the wage earners. They will, therefore, press for higher money wages to compensate them for the higher cost of living. Now, an increase in wages, if granted, will raise the prime cost of production and, therefore, entrepreneurs will raise the prices of their products to recover the increment in cost.

This will add fuel to the inflationary fire. A further rise in prices raises the cost of living still further and the workers ask for still higher wages. In this way, wages and prices chase each other and the process of inflationary rise in prices gathers momentum. If unchecked, this may lead to hyper-inflation which signifies a state of affairs where wages and prices chase each other at a very quick speed.

2. Monetarist View:

The Keynesian explanation of demand-pull inflation is important to note that both the original quantity theorists and the modem monetarists, prominent among whom is Milton Friedman, explain inflation in terms of excess demand for goods and services. But there is an important difference between the monetarist view of demand-pull inflation and the Keynesian view of it. Keynes explained inflation as arising out of real sector forces.

In his model of inflation excess demand comes into being as a result of autonomous increase in expenditure on investment and consumption or increase in government expenditure. That is, the increase in aggregate expenditure or demand occurs independent of any increase in the supply of money.

On the other hand, monetarists explain the emergence of excess demand and the resultant rise in prices on account of the increase in money supply in the economy. To quote Milton Friedman, a Nobel Laureate in economics. “Inflation is always and everywhere a monetary phenomenon…… and can be produced only by a more rapid increase in the quantity of money than in output.”

Friedman holds that when money supply is increased in the economy, then there emerges an excess supply of real money balances with the public over their demand for money. This disturbs the monetary equilibrium. In order to restore the equilibrium the public will reduce the money balances by increasing expenditure on goods and services.

Thus, according to Friedman and other modern quantity theorists, the excess supply of real monetary balances results in the increase in aggregate demand for goods and services. If there is no proportionate increase in output, then extra money supply leads to excess demand for goods and services. This causes inflation or rise in prices. Thus, according to monetarists let by Prof. Milton Friedman, excess creation of money supply is the main factor responsible for inflation.

Cost-Push Inflation:

Even when there is no increase in aggregate demand, prices may still rise. This may happen if the costs, particularly the wage costs, increase. Now, as the level of employment increases, the demand for workers rises progressively so that the bargaining position of the workers is enhanced. To exploit this situation, they may ask for an increase in wage rates which are not justi­fiable either on grounds of a prior rise in productivity or cost of living.

The employers in a situation of high demand and employment are more agreeable to concede to these wage claims because they hope to pass on these rises in costs to the consumers in the form of rise in prices. Therefore, when inflation is caused by rise in wages or hike in other input costs such as rise in prices of raw materials, rise in prices of petroleum products, it is called cost-push inflation. If this happens we have another inflationary factor at work.

Besides the increase in wages of labour without any increase in its productivity, or rise in costs of other inputs there is another factor responsible for cost-push inflation. This is the increase in the profit margins by the firms working under monopolistic or oligopolistic conditions and as a result charging higher prices from the consumers. In the former case when the cause of cost-push inflation is the rise in wages it is called wage-push inflation and in the latter case when the cause of cost-push inflation is the rise in profit margins, it is called profit-push inflation.

In addition to the rise in wage rate of labour and increase in profit margin, in the seventies the other cost-push factors (also called supply shocks) causing increase in marginal cost of production became more prominent in bringing about rise in prices. During the seventies, rise in prices of raw materials, especially energy inputs such a hike in crude oil prices made by OPEC resulted in rise in prices of petroleum products.

For example, sharp rise in world oil prices during 1973-75 and again in 1979-80 produced significant cost-push factor which caused inflation not only in Indian but all over the world. Now, in June-August 2004 again the world oil prices have greatly risen. As a result, in India prices of petrol, diesel, cooking gas were raised by petroleum companies. This is tending to raise the rate of inflation.

Related Articles:

• Essay on the Causes of Inflation (473 Words)
• Demand Pull Inflation and Cost Push Inflation | Money
• Difference between Demand Inflation and Cost Inflation
• Cost-Push Inflation and Demand-Pull or Mixed Inflation

Essay on Inflation

Students are often asked to write an essay on Inflation in their schools and colleges. And if you’re also looking for the same, we have created 100-word, 250-word, and 500-word essays on the topic.

Let’s take a look…

100 Words Essay on Inflation

Understanding inflation.

Inflation is when prices of goods and services rise over time. This means you need more money to buy the same things. It’s like a slow-motion robbery!

Causes of Inflation

Impact of inflation.

Inflation affects everyone. If your income doesn’t increase as fast as inflation, you’ll have less buying power. But, if you’re a business owner, you might be able to raise prices and make more money.

Controlling Inflation

Governments try to control inflation by adjusting interest rates, taxes, and government spending. It’s a tricky balancing act to keep inflation low but not too low.

250 Words Essay on Inflation

Inflation, a crucial economic concept, refers to the rate at which the general level of prices for goods and services is rising, subsequently eroding purchasing power. It’s an indicator of the economic health of a nation, with moderate inflation signifying a growing economy.

The Causes of Inflation

Inflation generally occurs due to two primary factors: demand-pull and cost-push inflation. Demand-pull inflation transpires when demand for goods and services surpasses their supply. On the other hand, cost-push inflation arises when the costs of production escalate, causing producers to increase prices to maintain profit margins.

Effects of Inflation

Inflation impacts various aspects of the economy. It erodes the purchasing power of money, causing consumers to spend more for the same goods or services. Inflation can also create uncertainty in the economy, affecting investment and saving decisions. However, moderate inflation can stimulate spending and investment, driving economic growth.

Managing Inflation

Central banks attempt to control inflation through monetary policy. By adjusting interest rates, they influence the level of spending and investment in the economy. Higher interest rates typically reduce spending, curbing inflation. Conversely, lower interest rates stimulate spending, potentially leading to inflation.

500 Words Essay on Inflation

Introduction to inflation.

Inflation is a complex economic phenomenon that affects every aspect of our lives, from the cost of living to the value of money. It is defined as the rate at which the general level of prices for goods and services is rising, subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.

Inflation is primarily caused by an increase in the money supply that outpaces economic growth. Ever since the end of the gold standard, governments have had the ability to create money at will. If a nation’s money supply grows too rapidly compared to its production of goods and services, prices will increase, leading to inflation.

Additionally, inflation can be spurred by demand-pull conditions, where demand for goods and services exceeds their supply. Cost-push inflation, on the other hand, occurs when the costs of production increase, causing producers to raise prices to maintain their profit margins.

Impacts of Inflation

Moreover, inflation can harm savers if the inflation rate surpasses the interest rate on their savings. It also favors borrowers, as the real value of their debt diminishes over time. This redistribution of wealth from savers to borrowers can lead to social and economic inequalities.

Inflation is an intricate part of our economic systems. It is a double-edged sword that can stimulate economic growth when mild, but can also lead to economic instability when it becomes too high. Understanding inflation is crucial for policymakers, investors, and consumers alike as it influences our decisions and shapes our economic reality. By effectively managing inflation, governments can promote economic stability and growth, thereby improving the standard of living for their citizens.

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Inflation: Causes, Problems, Impacts on Economy

Introduction.

Inflation measures how expensive a particular category of goods and services has become in a certain period, usually a year. It is a rate of increase in commodities prices over a certain period. It is usually measured broadly, such as the increase in the cost of living or the overall increase in prices. On the other hand, it can be calculated more specifically, such as the prices of certain goods and services. Irrespective of the context, it is representative of how much more expensive a certain category of goods and services has become over a particular period. Inflation has both negative and positive impacts on the economy, including decreased purchasing power, reduction of unemployment, and increased spending and investments.

Causes of Inflation

Inflation is caused by various factors that include the outcomes of lax monetary policies. For instance, if the supply of money becomes larger than the economy’s size, the currency’s value goes down. In this situation, the purchasing power decreases even as prices keep increasing. The relationship between the size of the economy and the supply of money is known as the quantity theory of money.

Moreover, pressures can also exist on the demand or supply side of the economy, leading to inflation. Phenomena such as natural disasters cause supply shocks that harm production, leading to increased production costs. They might result in high oil prices, which reduces the supply rate, leading to cost-push inflation, where the disruption in supply causes price increases. A good example is the fuel and food inflation that affected the global economy in 2008 (Oner, n.d.). In this case, fuel and food prices were transferred among countries by international trade.

Demand shocks are also another factor that causes inflation. They can be stimulated by expansionary policies of a country’s central bank by lowering interest rates or when a government increases spending, leading to economic growth and a boost to overall demand. However, if the increase in demand surpasses the production capacity of an economy, it can cause a strain on resources, leading to demand-pull inflation. Policymakers need to strike the correct balance of boosting growth and demand without overly stimulating the economy to cause inflation.

Finally, the expectations of various stakeholders in an economy might also result in inflation. If corporate organizations or individuals have higher expectations of higher prices within an economy, they portray these expectations in contractual price adjustments and wage negotiations. It is a type of behavior that greatly influences how the next cycle of inflation will look after increased wages or contracts exercised as agreed. People base their expectations on what has happened in the past, leading to inflation patterns.

Problems of Inflation

Inflation is a problem because it affects the purchasing power of households and can also be disastrous to a country’s economy. A household’s nominal income does not increase at the same rate as prices. It becomes worse off because increased prices erode its purchasing power while income remains the same. It, therefore, means that the household can only afford to purchase less due to diminished purchasing power. Its standard of living is influenced by its real income, meaning that it would be low due to a stagnant income. Prices of commodities change daily and at different rates instead of wages that take much longer. In an environment characterized by inflation, prices that rise unevenly will reduce the purchasing power of some consumers, which erodes their real income.

Inflation can also create distortions in the purchasing power of payers or recipients of fixed interest rates. For example, pensioners receiving a fixed interest rate might lower purchasing power if inflation becomes higher than the fixed rate. Similarly, borrowers paying a fixed interest rate would have difficulty servicing their debt if inflation becomes higher than the fixed rate.

Impact of Inflation on the Economy

Inflation has both negative and positive effects on the economy. The most significant effect of inflation is that it reduces the currency’s purchasing power because of price hikes across the economy. When the prices of a basket of goods and services, which are difficult to substitute, rise, they decrease purchasing power.

Inflation also positively impacts the economy because it encourages people to invest and spend more. People will tend to buy goods due to impending inflation and decreased purchasing power. People will buy early before their cash loses value and stock up on goods that will not value, such as stuffing the freezer or filling up the gas tank. Increased capital investments in business circles might not have been possible under different circumstances. Some investors might buy precious metals or gold during times of inflation to neutralize its effects on their investments. Also, equities are used to shield investors against the effects of inflation.

However, the urge to invest and spend in the face of inflation stimulates more inflation that can be catastrophic. When individuals and businesses spend more to reduce the amount of time they can hold on to their currency before it depreciates, the economy is flooded with money nobody wants. It means that the supply of money exceeds, by far, its demand, making the price of money fall at a faster rate. The situation becomes catastrophic when there is a tendency to stockpile goods rather than keep money, leading to hoarding incidences, resulting in empty store shelves. People are desperate to offload their money, leading to a frenzy of spending activity when they get their pay.

Inflation is also known for pushing down the unemployment rate. The rate at which wages change is much slower in response to economic shifts. The downward wages stickiness is usually attributed as the main cause of the great depression. It increased unemployment because workers did not want pay cuts leading to mass firings. The same situation can work in the opposite direction through wages’ upward stickiness. It means that when inflation reaches a certain level, the payroll costs for employers fall, making them able to hire new employees.

Therefore, there is an inverse correlation between inflation and unemployment, referred to as the Phillips Curve. However, as unemployment falls, employers are compelled to pay new workers more because of their skills (Floyd et al., 2021). As wages become higher, consumer spending power also increases, making the economy become overheated and stimulating more inflation, a situation known as the cost-push inflation.

The History, Evolution and Importance of Inflation and Unemployment

The great inflation defined the macroeconomic events of the mid-twentieth century. It lasted for nearly twenty years and led to the abandonment of the established monetary system during the WW2 period. There were two serious energy shortages, four recessions, and the implementation of price and wage controls during this time. The great inflation also brought a positive change in the macroeconomic theory, which is used today to guide the monetary policies of central banks around the world.

In 1964, inflation was measured as more than 1% per year and stayed there for the next six years. However, it began spiking upwards from the mid-1960s to nearly 14% by 1980 (Brian, 2013). After that, it began declining and stabilized at around 3.5 % (Brian, 2013). The great inflation had its origins in policies that allowed the supply of money to be excessive. After WW2, the Employment Act of 1946 promoted maximum purchasing power, employment, and production. The Keynesian stabilization policy was used in the post-WW2 era to deal with the high unemployment rate by managing aggregate spending, taxation and spending policies (Brian, 2013). Central banks still use this policy to stabilize economic activities and manage spending. However, this policy had an erroneous assumption that there was a direct relationship between inflation and unemployment. It assumed that higher inflation rates could neutralize low unemployment rates.

In short, inflation should not be regarded as a negative phenomenon because it also positively impacts the economy. The major negative impact that inflation has on the economy is that it reduces a currency’s purchasing power which subsequently increases the cost of living and lowers the standard of living of households. However, it plays an important role in reducing unemployment and increasing spending and investments. These positive characteristics of inflation have a major impact on the economy and have the ability to stimulate growth. Since it stimulates spending and investments, inflation leads to economic growth more so because its negative correlation with unemployment increases the employment rate to spur growth in the economy.

Brian, M. (2013). The Great Inflation . Federal Reserve History. Web.

Floyd, D., Boyle, M. & Schmitt, K. (2021). 9 Common Effects of Inflation . Investopedia. Web.

Oner, C. (n.d.). Inflation: Prices on the Rise . International Monetary Fund. Web.

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Inflation’s Wild Ride

Inflation has surged and moderated since the pandemic. As the presidential election approaches, politicians are focused on who is to blame. How did we get here?

By Jeanna Smialek ,  Karl Russell and Lazaro Gamio

Coming into and through 2019, the economy was strong and the Consumer Price Index, a key measure of inflation, was low. For some, that seemed like a bad thing — economists worried that chronically low inflation could increase the risk of future economic stagnation.

In early 2021, President Biden ushered in a large stimulus package, which included one-time checks of $1,400. The aid, which former President Donald J. Trump previously suggested, followed major relief packages passed by his administration.

Some economists warned that the government was pumping too much money into the system, and that the fresh round of aid to households and state governments risked igniting inflation.

Within a few months, inflation began to pick up. At first, that was partly because of the way the data was measured: Price increases had been slow in 2020 amid pandemic lockdowns, and the annual data were lapping those low readings, so they looked strong.

But under the surface, prices were starting to pick up for a few important products.

Consumer demand surged with the stimulus checks. But as families began buying products in huge quantities, hot demand crashed into limited supply.

The Federal Reserve initially treated the price pop as “transitory,” meaning that it would most likely fade on its own. But officials had started growing nervous as inflation showed signs of broadening. Rents began rising quickly, as did prices of other services.

The Fed backed away from promises to keep interest rates low for a long time, and in March 2022, it raised its benchmark rate from near zero in an effort to slow inflation.

Russia’s invasion of Ukraine helped push up food and fuel prices, and it became clear that inflation was jumping to levels not seen in decades. The Fed jerked rates up sharply as inflation rose.

The Consumer Price Index inflation peaked at 9.1 percent that summer, as an array of products and services, from cars to restaurant meals, climbed rapidly in price.

Higher interest rates will “bring some pain to households and businesses,” Jerome H. Powell, the Fed chair, warned in August. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

But by late 2022, supply chain pressures were easing, allowing price increases on some goods to cool. The Fed slowed its rate increases as inflation decelerated. But officials still thought there was a chance that the economy would weaken meaningfully before inflation was fully vanquished.

That fear became even more pronounced — and Fed staff began to actively forecast a recession — after a series of bank blowups in early 2023.

By mid-2023, though, inflation was notably cooler. Price jumps began to moderate even in service categories, which made economists hope that the deceleration might be the real deal.

Forecasters were suddenly surprised by how quickly inflation was coming down. Officials began to sound more optimistic about the prospects for a “soft landing,” in which the economy cools gradually, allowing inflation to return to normal without a recession.

The Fed even opted to skip a final quarter-point rate increase in December 2023. “Inflation has eased from its highs, and this has come without a significant increase in unemployment — that’s very good news,” Mr. Powell said.

“The signal that we’re taking is that it’s likely to take longer for us to gain confidence that we are on a sustainable path down to 2 percent inflation,” Mr. Powell said in May, after price increases had stalled for months. Inflation has recently cooled again, and policymakers are waiting to see if the trend lasts.

The question now is just how much continued progress on lowering inflation Fed officials will need to see to feel comfortable lowering interest rates.

Investors still think it is possible that the central bank will cut rates in September, based on market pricing. Fed officials themselves predicted one reduction this year and four in 2025, as of their June economic forecasts.

For politicians, that means that the November election will almost certainly happen against a backdrop of high interest rates that are making car leases, credit card borrowing and new mortgages pricey for consumers.

After years of elevated inflation, Americans are also still seeing much higher price levels at the grocery store, on car repair bills and at hotels than before the pandemic.

Price increases have slowed, but getting used to new price levels could take time for consumers.

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One theory for what could keep inflation under control is price controls

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NPR's Danielle Kurtzleben speaks to UMass-Amherst economics professor Isabella Weber about how price controls could tame inflation.

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The uneven impact of high inflation

• Inclusion and equality
• Social mobility and equal opportunity

Cite this content as:

Inflation indices – such as the national Consumer Price Indices (CPI) and the EU Harmonised Indices of Consumer Prices (HICP) – measure price changes for the overall economy, which may not reflect the inflation experience of an individual household or group of households. This paper contributes to previous studies of the distributive impact of recent high inflation in EU Member States. Producing more granular and recent results, this paper finds a substantial rise in effective inflation dispersion across households and confirms that lower-income households continue to experience higher inflation. This inflation gap remains even after energy prices have eased and when controlling for other household characteristics. Results also show that the distributive impact of inflation on household groups has varied over time, as changes in relative prices across the inflationary period have influenced the extent of the impact of inflation across population groups. Finally, differences in effective inflation rates have cumulated over time, particularly for households with lower-income and headed by people aged 60 years or more and with lower levels of education.

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Americans hate inflation: No traction for more positive economic developments

by Clea Simon, Harvard Gazette

Say "inflation" these days and the minds of most Americans jump to steep grocery bills and high interest rates.

As highlighted by two recent papers by Stefanie Stantcheva, the Nathaniel Ropes Professor of Political Economy, the majority are much less likely to focus on the more positive economic trends of the past few years, including wage growth and strong employment prospects.

What's more, Americans overwhelmingly oppose the tools that policymakers use to mitigate inflation 's worst effects. In fact, many see inflation as only getting worse when the Federal Reserve raises interest rates, as it did 11 times between spring 2022 and last summer.

"There hasn't been enough work to see how people understand inflation, what policies they want to support in order to fight inflation, and also how inflation actually impacts them," Stantcheva said.

For a paper titled "People's Understanding of Inflation," Stantcheva and graduate student co-authors Francesco Nuzzi (Harvard) and Alberto Binetti (Princeton) conducted a large-scale survey through which they found that most Americans believe inflation has been caused by government action, trailed by supply-chain disruptions and other COVID-related issues. Respondents expressed skepticism about rate hikes as an effective countermeasure.

Clear partisan differences surfaced in the findings. Republicans were more likely to blame inflation on the government (more than 75% of GOP voters vs. 60% of Democrats) and less likely to blame private companies.

All respondents saw inflation as more harmful to lower-income people , but Republicans were less likely to support policies that might help these households, such as expanding access to food stamps (supported by 80% of Democrats vs. 50% of Republicans) or boosting the minimum wage (80% for Democrats vs. 50% of Republicans).

The most cited burden of inflation was the impact on family budgets, notably the way it raises the stakes on household purchases and standard of living.

Among the details that caught Nuzzi's attention was the lack of ambiguity in survey responses. "People perceive inflation as unequivocally negative, rarely associating it with positive economic developments or with a good economy," he said.

Discussing the second paper , "Why Do We Dislike Inflation?" Stantcheva noted that inflation typically plays out in one of two ways. The first is a product of a booming economy. "There's high demand, things are going well, and that can actually generate inflation."

The other possibility, "stagflation," is associated with high unemployment and stagnant demand.

Most respondents viewed all inflationary episodes as "stagflation," Stantcheva said. "There is a perception that inflation is unambiguously a bad thing."

Views on the tools policymakers use in attempts to control inflation echoed findings from "People's Understanding of Inflation."

"People tend to think that policymakers do not face harsh trade-offs when it comes to fighting inflation," she said.

This is important, she added, because "when you ask people what type of policies they support to fight inflation … contractionary monetary policies like increasing interest rates or reducing money supply have very low support."

Stefanie Stantcheva, Why Do We Dislike Inflation? (2024). DOI: 10.3386/w32300

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This story is published courtesy of the Harvard Gazette , Harvard University's official newspaper. For additional university news, visit Harvard.edu .

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Thermal curvature perturbations in thermal inflation

• Bastero-Gil, Mar
• Gomes, Joaquim M.
• Rosa, João G.

We compute the power spectrum of super-horizon curvature perturbations generated during a late period of thermal inflation, taking into account fluctuation-dissipation effects resulting from the scalar flaton field's interactions with the ambient radiation bath. We find that, at the onset of thermal inflation, the flaton field may reach an equilibrium with the radiation bath even for relatively small coupling constants, maintaining a spectrum of thermal fluctuations until the critical temperature T c , below which thermal effects stop holding the field at the false potential minimum. This enhances the field variance compared to purely quantum fluctuations, therefore increasing the average energy density during thermal inflation and damping the induced curvature perturbations. In particular, we find that this inhibits the later formation of primordial black holes, at least on scales that leave the horizon for T > T c . The larger thermal field variance also reduces the duration of a period of fast-roll inflation below T c , as the field rolls to the true potential minimum, which should also affect the generation of (large) curvature perturbations on even smaller scales.

• particle physics - cosmology connection;
• power spectrum;
• primordial black holes;
• High Energy Physics - Phenomenology;
• Astrophysics - Cosmology and Nongalactic Astrophysics;
• General Relativity and Quantum Cosmology