Inflation, with its consistent rise in prices across various sectors of any economy, is a familiar lifestyle aspect we all encounter. Whether experiencing increases in everyday purchases such as groceries or movie tickets, or reflecting back on the lower costs of the past, it's a common experience.
While it might sound counterintuitive, economists believe a small amount of inflation is beneficial to the health of a country’s economy. Usual targets for central banks sit between 2% to 3% for inflation maintenance. Anything significantly beyond this range spikes worry for hyperinflation, an overpowering scenario of uncontrollable and rapid inflation.
History has witnessed severe instances of hyperinflation. Perhaps the most acclaimed is Germany in the early 1920s where inflation rates reached escalated levels of 30,000% per month. A more drastic example is Zimbabwe with an astonishing figure of 79,600,000,000% monthly inflation in November 2008, as reported by Steve H. Hanke and Alex K. F. Kwok.
Additionally, the economic environment can face the punishing impact of stagflation, where economic stagnation and inflation occur simultaneously. This brings about a challenging combination of sluggish economic growth, high unemployment rates, and rampant inflation. The phenomenon is fairly infrequent, with its latest significant occurrence being during the 1970s in the United States and the United Kingdom, causing considerable concern for both nations' central banks.
Stagflation is particularly problematic for central banks as it escalates the risks associated with fiscal and monetary policy responses. With such a condition, raising interest rates to combat inflation could potentially surge unemployment, while decreasing interest rates could induce inflation even further, leaving central authorities in a bind.
Another type of fluctuation is deflation or negative inflation, where the prices of goods and services decrease. Greater money value due to a reduced money supply or a decline in demand triggered by surplus supply or reduced consumer spending tends to cause negative inflation. Reduced prices, though a relief for customers, burdens the economy long-term as businesses often have to cut costs and lay off employees to adapt, leading to increased unemployment rates.
Defining inflation might be straightforward, but understanding its causes is a complex matter. Theories and interpretations differ, with the most influential approaches being those of the Keynesian and monetarist economic schools.
Keynesian economists emphasise economic pressures like increased production cost leading to inflation and propose government intervention for resolution. On the other hand, monetarist economists place the blame on the money supply expansion, suggesting that central banks should maintain stable growth for the money supply in harmony with GDP.
Keynesian economics, named after British economist John Maynard Keynes, promotes government intervention for economic outcomes like increased employment or stability in the business cycle. The Keynesian perspective sees inflation as a result of economic pressures such as rising production costs, advocating for split types of inflation: cost-push and demand-pull inflation.
Monetarism, closely related to American economist Milton Friedman, is focused on how money influences the economy, specifically the effects of changes to the money supply. Monetarists are generally more sceptical about government intervention, warning that they can possibly do more harm than good. Milton Friedman himself argued in his co-written publication, A Monetary History of the United States, 1867-1960, that policy decisions of the Federal Reserve heightened the severity of the Great Depression.
Monetarists see inflation as the consequence of an expanding money supply, encapsulated by Friedman’s famous phrase, “inflation is always and everywhere a monetary phenomenon.” For them, elements like labour costs or consumer demand hold less significance than the supply of money.
Regardless of the perspective, inflation remains a complex topic with many layers. It ranges from extreme cases of hyper or stagflation to those minor increases in everyday purchases that often go unnoticed. Different schools of thought, namely Keynesian and monetarist, have contrasting views on what triggers inflation, proving that there is more depth to this economic phenomenon than meets the eye.