Monday, August 13, 2007

Inflation Explained.

  • Inflation measures the increase in cost of living. Basically it refers to the annual percentage increase in the general price level.
  • Inflation means that the value of money decreases. Basically, if prices increase it means that £10 will buy less goods than previously.
  • Hyper inflation occurs when prices increase at an exponential rate of say over 1000%. When this occurs it creates great instability in the economy. In extreme cases it can lead to a barter economy where people stop using money but trade goods. Examples include Germany in the 1920s and Hungary 1946. Recent examples include Croatia



  • Inflation is measured in the UK using the CPI - Consumer Price Index. However, in the past the government used the RPI and RPIX. Some people argue RPI is more accurate because it included housing costs and taxes excluded from the CPI.
  • The government has an inflation target of CPI 2% +/- 1%. In the past 10 years, the UK has been relatively very successful in maintaining low inflation.

High inflation is considered harmful to the economy because:

  1. It creates uncertainty amongst firms and consumers. This leads to lower investment and economic growth.
  2. High inflation is associated with unsustainable economic growth. This leads to the boom and bust situation of the late 1980s
  3. High inflation reduces UK's international competitiveness.
  4. See also: Costs of inflation

  • The opposite of inflation is deflation.

Deflation means prices fall. If this is caused by increased productivity and lower costs it is good. however if deflation is caused by an economic recession, then this is considered harmful because falling prices discourages people from spending. The last time the UK had deflation was in the 1930s great depression.

Inflation Links

2 comments:

Stephanie Thomson said...

'if prices increase it means that £10 will buy less goods than previously.'

This should really say 'fewer' goods rather than 'less goods'.

Anonymous said...

I'm not sure. 'Goods' is a noun that only appears in plural form so that would suggest that it's not countable. You can't really say 1 good, 2 goods etc. In this sense, 'less goods' is absolutely fine.